On October 2, 2020, the Small Business Administration (SBA) issued a long awaited Procedural Notice providing guidance with respect to a change of ownership of businesses that borrowed Paycheck Protection Program (PPP) loans. PPP loans were made commencing in early April, and since then we have witnessed first-hand the frustration experienced by business owners having to deal with the uncertainty of the treatment of PPP loans in the context of a change of ownership (often compounded by the inability of PPP lenders to accept forgiveness applications). The new guidance provides sellers with some certainty with regard to the procedures for selling a business that has borrowed a PPP loan.
What is a Change of Ownership?
For purposes of the PPP, a “change of ownership” is considered to have occurred when (1) at least 20% of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity, (2) the PPP borrower sells or otherwise transfers at least 50% of its assets (measured by fair market value), whether in one or more transactions, or (3) a PPP borrower is merged with or into another entity. For purposes of determining a change of ownership, all sales and other transfers occurring since the date of approval of the PPP loan must be aggregated to determine whether the relevant threshold has been met. For publicly traded borrowers, only sales or other transfers that result in one person or entity holding or owning at least 20% of the common stock or other ownership interest of the borrower must be aggregated.
While not clearly stated in the guidance, it would appear that a transaction that does not satisfy one of the change of ownership descriptions above does not constitute a “change in ownership” subject to determination of whether SBA consent is required, and presumably, no consent of SBA is required with respect to such transaction.
Does an Indirect Change of Ownership Require SBA Consent?
A PPP borrower may be owned by one or more entities, each of which may also be owned by multiple individuals or other entities. The SBA form of note does not specify whether a change of ownership (which the form provides is a default absent lender consent) applies only to direct ownership interests or would include indirect ownership interests, although the PPP loan application only required reporting of direct ownership interests in the borrower. As a result, the general understanding has been that only changes in direct ownership interests were covered by PPP loans.
The Procedural Notice does not address this issue. The term “common stock or other ownership interest” could be meant to refer to stock or other interests such as partnership or limited liability company interests or other forms of direct equity issued by the PPP borrower. Alternatively, “other ownership interest” could be meant to cover indirect interests, such as ownership of a corporation that itself owns an interest in the borrower. Further guidance from SBA will be needed in order to provide a definitive answer as to whether the change of ownership requirement is limited to direct ownership of a PPP borrower or is meant to include indirect ownership changes. Guidance as to the meaning of “other ownership interests” would also be helpful in determining whether a “change of ownership” has occurred.
Does Notice of the Change of Ownership Need to Be Given?
Yes, prior to the closing of any change of ownership transaction, the PPP borrower must notify the PPP lender in writing of the contemplated transaction and provide the PPP lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction.
Is SBA Consent Required for a Change of Ownership?
There are no restrictions on a change of ownership if, prior to the closing, the PPP loan has been fully satisfied, either by the borrower repaying the PPP loan in full, or by the SBA having remitted funds to the PPP lender in full or partial satisfaction of the PPP loan with the PPP borrower repaying any remaining balance in the case of partial satisfaction by the SBA. The guidance does not allow for transactions where the pay-off occurs simultaneously with or immediately after consummation of a change in ownership transaction. Accordingly, transactions should be structured to cause the pay-off to occur prior to consummation of the other components of the sale.
If the PPP loan is not fully satisfied as described above prior to the closing of the change of ownership, then the SBA’s consent will be required unless the PPP borrower or the terms of the transaction satisfy the applicable conditions set forth below.
- Sale of Stock/Ownership Interest or Merger. The PPP lender may (but apparently is not required to) approve the change of ownership and SBA’s prior approval will not be required if the following conditions are met for a change of ownership structured as a sale or other transfer of common stock or other ownership interest or as a merger:
(i) The sale or other transfer is of 50% or less of the common stock or other ownership interest of the PPP borrower (in determining whether a sale or other transfer exceeds this 50% threshold, all sales and other transfers occurring since the date of approval of the PPP loan must be aggregated), or
(ii) the PPP borrower completes a forgiveness application reflecting its use of all of the PPP loan proceeds (partial use doesn’t appear to be permitted) and submits it, together with any required supporting documentation, to the PPP lender, and an interest-bearing escrow account controlled by the PPP lender is established with funds equal to the outstanding balance of the PPP loan. After the forgiveness process (including any appeal of SBA’s decision) is completed, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest. Note that the guidance requires the escrow account to be interest bearing, and while funding the full amount of the PPP loan with accrued interest into a non-interest bearing account would seem to be an acceptable alternative, the guidance doesn’t provide for it. The guidance doesn’t require a particular party to fund the escrow, or address what becomes of the escrow funds should the PPP loan be forgiven. Presumably this would be addressed between the buyer and seller, and the ultimate disposition of the escrow funds would be documented in the escrow agreement.
- Asset Sale. The PPP lender may (but, again, is apparently not required to) approve the change of ownership and SBA’s prior approval will not be required for a change of ownership structured as an asset sale involving 50% of more of the seller’s assets if the PPP borrower complies with the provisions of clause (ii) above. Unlike the situation where SBA approval is required (see discussion below), assumption of the PPP note by the buyer is not a condition to utilizing this escrow exception, and whether or not the buyer assumes this liability will be a function of the negotiations between the buyer and the seller.
The guidance does not address the fact that many PPP lenders are not accepting forgiveness applications at this time, meaning that their PPP borrowers will not be able to satisfy the escrow requirement.
What is the Procedure for Obtaining SBA Consent?
If a change of ownership of a PPP borrower does not meet the conditions set forth above, prior SBA approval of the change of ownership is required and the PPP lender may not unilaterally approve the change of ownership. To obtain SBA’s prior approval of requests for changes of ownership, the PPP lender must submit the request to the SBA. The request must include:
(i) the reason that the PPP borrower cannot fully satisfy the PPP loan or provide the escrow funds as described above;
(ii) the details of the requested transaction;
(iii) a copy of the executed PPP note;
(iv) any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, seller (if different from the PPP borrower), and buyer;
(v) disclosure of whether the buyer has an existing PPP loan and, if so, the SBA loan number; and
(vi) a list of all owners of 20 percent or more of the buyer.
SBA approval of any change of ownership involving the sale of 50% or more of the assets of a PPP borrower will be conditioned on the buyer assuming all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms. In such cases, the purchase agreement must include appropriate language regarding the assumption of the PPP borrower’s obligations under the PPP loan by the buyer, or a separate assumption agreement must be submitted to SBA. If deemed appropriate, SBA may require additional risk mitigation measures as a condition of its approval of the transaction. The SBA will review and provide a determination within 60 calendar days of receipt of a complete request. PPP borrowers considering change in ownership transactions where SBA consent may be required are advised to seek such consent as early as possible.
While the guidance doesn’t address this issue, if a PPP consummates a change of ownership without having obtained SBA consent, it would likely result in a default under the applicable PPP note (as noted above, the SBA form 7(a) note provides that a change of ownership is a default without PPP lender consent, and a PPP lender will not consent without the required SBA approval), pursuant to which the PPP loan could be declared due and payable. In addition, although not stated in the guidance, such failure would likely result in denial of forgiveness of the PPP loan.
Regardless of any change of ownership, the PPP borrower remains responsible for (1) performance of all obligations under the PPP loan, (2) the certifications made in connection with the PPP loan application, including the certification of economic necessity, and (3) compliance with all other applicable PPP requirements. Additionally, the PPP borrower remains responsible for obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing those forms and supporting documentation to the PPP lender or to SBA upon request.
Terms Applicable to All Sales
For all sales or other transfers of common stock or other ownership interest or mergers, whether or not the sale requires SBA’s prior approval, in the event of a sale or other transfer of common stock or other ownership interest in the PPP borrower, or a merger of the PPP borrower with or into another entity, the PPP borrower (and, in the event of a merger of the PPP borrower into another entity, the successor to the PPP borrower) will remain subject to all obligations under the PPP loan. In addition, if the new owner uses PPP funds for unauthorized purposes, SBA will have recourse against the owner for the unauthorized use.
In addition, if any of the new owners or the successor arising from such a transaction has a separate PPP loan, then, following consummation of the transaction: (1) in the case of a purchase or other transfer of common stock or other ownership interest, the PPP borrower and the new owner are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower, and (2) in the case of a merger, the successor is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.
The guidance requires the PPP lender to notify the SBA, within five business days of completion of a sale transaction (regardless of whether it requires SBA approval), of the (i) identity of the new owners of the common stock or other ownership interest; (ii) the new owner’s ownership percentage; and (iii) the tax identification number for any owner holding 20 percent or more of the equity in the business; and (iv) location of, and the amount of funds in, the escrow account under the control of the PPP lender, if an escrow account is required. While the guidance does not expressly require the PPP borrower to provide this information to the PPP lender, as a practical matter it will likely be required to do so in connection with obtaining the lender’s consent as required under the PPP note.
While the SBA’s guidance is useful, as has been the case with much of the PPP regulations, some questions do remain. In particular, if the SBA’s consent to a sale is not required, is the PPP lender required to consent (assuming its loan documents require such consent prior to a sale)? Use of the words “may consent” would indicate that the lender is not required to do so, even if the escrow arrangement described above is implemented and the SBA’s consent is not required. If the PPP lender is required to consent, on what basis can they refuse to do so? Is a PPP lender required to agree to an escrow arrangement if the borrower request it to do so? Is this guidance meant to apply retroactively? How are sales that have been consummated going to be treated? What reasons will the SBA accept for not repaying the PPP loan or establishing an escrow? How does this work if the PPP borrower has not used all of the PPP loan proceeds?
In any event, we advise all PPP borrowers seeking to consummate a sale of their business to review their PPP loan documentation, as it may contain different or additional requirements applicable to their sale transaction.
For further information or guidance on this matter, please contact David Paseltiner.