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October 15 2020

Mergers and Acquisitions in a Paycheck Protection Program World

By: Michael J. Huff

Numerous businesses throughout the United States have taken advantage of the Paycheck Protection Program (“PPP”) to support their ongoing operations during the COVID-19 pandemic.  PPP potentially has significant implications for businesses considering a merger, or a sale or acquisition of ownership interest or business assets.  Among other concerns and considerations, in negotiating and drafting agreements, businesses need to consider whether SBA approval of a transaction is required, potential financial implications of PPP, and other questions about which clear guidance has not been issued.

I.  Requirement for SBA Consent

In many circumstances, a borrower which has an SBA loan must obtain SBA’s consent prior to closing a transaction which will result in a change of ownership.  Helpfully, for purposes of PPP, SBA issued a procedural notice setting forth circumstances where consent must be obtained for a transaction among parties which have PPP loans.

A “change of ownership” for purposes of PPP is defined as follows:

1.  A transfer or sale of at least 20% of the stock or other ownership of the borrower, in one or more transactions, including to an existing owner or affiliate;

2.  The sale or transfer of at least 50% of the borrower’s assets (measured by fair market value) in one or more transaction; or

3.  A merger of the borrower with or into another entity.

For purposes of determining if the transfer thresholds set forth above have been met, all sales or transfers from the date upon which the borrower’s PPP loan was approved through the present date will be considered.

Prior to any change of ownership, a PPP borrower must notify its PPP lender of the contemplated transaction and provide it a copy of the proposed agreements and other documents which would effectuate the proposed transaction.  The actions which a lender needs to complete vary based upon the status of a borrower’s PPP loan.

In the event a PPP loan has been fully repaid or forgiven, there are no restrictions on a change of ownership.

In the event a PPP loan obtained by buyer or seller is still outstanding as of the time of closing, there are circumstances where SBA’s approval will not be required, depending on a variety of factors such as what interests are being transferred and whether or not the seller has created an interest-bearing escrow account with its lender in the amount of the PPP loan.  If a borrower does not satisfy the requirements necessary to avoid obtaining SBA’s approval, then SBA’s approval must be obtained before a transaction can close.

Notwithstanding any change of ownership, a PPP borrower remains responsible for performance of all obligations under a PPP loan, the certifications made in connection with its loan application, including the certification of economic necessity, and compliance with all other PPP requirements. 

Further, following any change in ownership, both the buyer and seller remain subject to the terms and conditions of the PPP loan and share liability for any use of PPP funds for unauthorized purposes by the buyer.

Buyers which have PPP loans have additional requirements following a “change of ownership” transaction which is either a transfer of ownership interest or a merger.  In such circumstances, a buyer must segregate and delineate PPP funds and expenses and provide documentation to provide compliance with respect to each PPP loan.

Because it may take some time to obtain approval of a proposed transaction, parties are encouraged to contact legal counsel regarding any proposed merger or acquisition early in the negotiation process.

II.  Financial Considerations

There are various financial considerations posed by PPP which should be addressed in merger and acquisition agreements.  For example, in certain instances, sellers may want to exclude PPP loan balances from company debts for purposes of a valuation.  However, a buyer cannot assume full forgiveness of a PPP loan when negotiating a transaction.  Thus, parties may want to include purchase price adjustments, warranties, and indemnification provisions to protect against certain financial risks.  Of course, in transactions which include a post-closing net working capital adjustment, the effect of a PPP loan on net working capital should be considered.

Additionally, a buyer needs to ensure that following the closing of a transaction where the seller had a PPP loan that its covenants will not be breached under its existing credit facilities.

Notwithstanding a sale, all borrowers, whether buyer or seller, need to remain in compliance with the terms of their PPP loan.  Thus, among other considerations, sellers which intend to receive forgiveness for their PPP loans should assure prior to selling all or a portion of their assets in an asset sale that they have used enough funds on payroll to satisfy the requirement that 60% of PPP proceeds be used on payroll.

III.  Unanswered Questions

There are a variety of questions which remain unanswered and which should be addressed on a case-by-case basis in each transaction where at least one party obtained a PPP loan.  Some of the questions currently being considered relate to circumstances where one party was taking advantage of the Employee Retention Tax Credit (“ERTC”), the effect of the SBA’s “present effect” rule on various transactions, and what a transaction indicates about a party’s access to capital.

A)  Employee Retention Tax Credit

PPP and the ERTC are mutually exclusive.  It is unknown at this time how SBA and the IRS will view treat stock sales and mergers which result in the combination of companies where one had a PPP loan and the other is taking advantage of ERTC, although it is possible the party taking ERTC will be deemed ineligible and may need to remit to the IRS taxes which were not paid.

B)  “Present Effect Rule” and Effect on Eligibility

To the extent the parties to a merger or acquisition transaction entered into a letter of intent or other agreement in anticipation of the transaction prior to the time at which a PPP loan was obtained, the parties should consider the effect of the SBA’s “present effect rule.”  The SBA’s present effect rule gives full effect to agreements in principle for purposes of determining the size of a borrower.  If two entities which are combining pursuant to sale of ownership interest or a merger previously entered into a letter of intent or other agreement, they should consider the first day upon which the transaction may be given effect and, if collectively, the combination of the two companies would result in a violation of the size limitations set forth for PPP.  Such an agreement may result in a subsequent finding that a party was ineligible for PPP and may result in the parties being required to repay the PPP loan.

C)  Access to Capital

PPP borrowers were required to certify that current economic uncertainty made the borrower’s request for a PPP loan necessary to support its ongoing operations.  Borrowers were required to take into account their access to other sources of liquidity to support their operations in a manner that is not significantly detrimental to the business.  It is unknown how SBA may view the necessary certification when a buyer possesses sufficient capital to acquire the ownership interest or assets of a seller, or when the seller is anticipating a cash windfall from a potential sale of assets or ownership interest.

Because of the variety of issues posed by PPP loans in the context of a merger or acquisition, parties are encouraged to contact their attorney upon the commencement of discussions regarding a transaction so risks concerning PPP loans can be appropriately addressed in any transaction document and so it can be determined if it will be necessary to obtain approval for the transaction from SBA.