After months of confusion for borrowers, lenders, and their respective counsel, the United States Small Business Administration (“SBA”) has finally provided guidance on change of ownership transactions for borrowers that have outstanding Paycheck Protection Program (“PPP”) loans. Borrowers, many of whom have been economically devastated, have been forced into making difficult decisions about how to survive the pandemic. One solution can be through merger and acquisition activity, but, unfortunately, the lack of clarity has impeded activity in the market.
While many lenders are still awaiting guidance from the SBA before they accept forgiveness applications, there had been no clear guidance on how to process requests from borrowers for consent to a change in control transactions. Many lenders were left relying on servicing guidelines set forth for 7(a) and 504 loans here, which requires lenders to obtain SBA prior approval for all change of ownership transactions before delivering consent.
On October 2, 2020, the SBA provided clarity by issuing a Procedural Notice here. The SBA notice relaxed the stringent requirement for SBA prior approval on all change in ownership transactions. Instead, it set forth rules as summarized below:
All change in ownership transactions (stock or equity purchase and asset purchase transactions) that amount to the sale of either fifty percent (50%) of the stock or equity interests, or the sale of fifty percent (50%) of the assets (as measured by fair market value) will require (i) the lender’s consent; (ii) escrow of the full amount of the PPP loan, including all interest and fees, with the lender; and (iii) a completed loan forgiveness application delivered with all supporting documentation to the PPP Lender.
The SBA clarified, though, when the transaction could proceed without SBA prior approval. The SBA notice provides that SBA prior approval is not needed in the following circumstances
- If the PPP loan has been fully satisfied, then SBA prior approval is not required. This occurs in two ways:
- The PPP loan has been repaid in full including all interest and fees; or
- The loan forgiveness process is complete and the SBA has remitted funds for forgiveness to the lender.
- If the borrower is proposing a stock or equity transaction, SBA prior approval is not needed for the following circumstances:
- The contemplated transaction proposes the sale of less than fifty percent (50%) of the ownership interests of the PPP borrower (in aggregate); or
- The contemplated transaction for the sale of fifty percent (50%) or more of the ownership interests, and the borrower completes the following actions:
- The borrower completes and submits to the lender a loan forgiveness application reflecting its use of all of the PPP loan proceeds with all required supporting documentation; and
- The borrower establishes an interest bearing escrow account controlled by the lender equal to the outstanding balance of the PPP Loan, plus all interest, fees, costs.
- If the borrower is proposing an asset sale, SBA prior approval is not needed for the following circumstances:
- The contemplated transaction proposes the sale of less than fifty percent (50%) of the assets of the business, as determined by the fair market value of the assets; or
- The contemplated transaction proposes the sale of fifty percent (50%) or more of the assets of the business, and the borrower completes the following actions:
In all other situations, the borrower must obtain both lender consent and SBA prior approval. It is important to keep in mind the following important points in assessing a change in ownership transaction for a borrower with a PPP loan:
- As of the date of this article, many lenders have not opened their loan forgiveness portal, and therefore are not accepting loan forgiveness applications. In this situation, SBA prior approval will likely be required if the lender does not accept the borrower’s completed loan forgiveness application and required supporting documentation.
- The form SBA 7(a) Note for PPP loans, utilized by most lenders, requires lender consent for a change in ownership – whether or not SBA prior approval is needed. In almost all circumstances the borrower will need to request lender consent, and most lenders will likely require the escrow of the PPP loan proceeds.
- Lenders must provide notice to the SBA Loan Servicing Center within five (5) days of the transaction closing. Therefore, borrowers and lenders need to be kept apprised on the status of the transaction.
- The new owner (buyer) will remain subject to all obligations under the PPP Loan, and the SBA makes clear its position that it will have recourse against both the borrower and the new owner. Any definitive purchase agreement should contain representations and indemnities taking this into account.
- If the new owner (buyer) has a separate PPP loan, the borrower (seller) and new owner (buyer) are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower.
Given the intricacies of the eligibility for the PPP loan, eligibility for forgiveness, and complicated nature of navigating a sale process, it is highly advisable that borrowers, new owners, and lenders consult with counsel regarding any change in ownership transactions that contain an outstanding PPP loan.