SBA has issued a policy notice (attached) that outlines when SBA consent is required for changes of ownership and asset sales involving PPP borrowers and the limited conditions under which lenders may consent to such transactions without SBA consent. The policy notice is at best a mixed bag and is summarized in detail below.
The key takeaways are moderately good news for PPP borrowers who have submitted applications for full forgiveness (or can quickly do so) but are decidedly suboptimal for everyone else:
1. SBA consent to an M&A deal (whether stock or asset) is required unless, at or prior to closing:
a. The PPP borrower is has fully utilized the PPP proceeds; and
b. The PPP borrower has submitted a forgiveness application to its lender; and
c. The parties escrow the loan balance (in an account in the control of the PPP lender).
2. The SBA consent process is likely to beVERY unpalatable for most middle market and institutional buyers because:
a. Transaction documents must be submitted to SBA, which makes them subject to FOIA (although confidential treatment may be requested; it is not clear if it would apply to these types of deal docs).
b. In asset deals, the buyer must assume the PPP loan. This is exactly the opposite of what most buyers want and how virtually all PPP borrower asset sales are currently being structured.
c. SBA has a 60-day review period for any requested consent. It of course is not clear if SBA will take the full 60 days, but this puts a long potential delay in deals that may not even require HSR approval.
3. Even for stock deals NOT requiring SBA consent, the identities and ownership percentages of all new equity owners must be disclosed to SBA, as well as the identity and EIN of all owners of at least 20% of the equity of the buyer.
The practical effect of all of this is that:
A. Virtually all buyers and sellers will likely wait to close transactions until the borrower has fully used its PPP proceeds AND has applied for forgiveness, absent a compelling need to close earlier, and will establish an escrow equal to the loan balance.
B. Many buyers may not want to disclose their ownership to SBA, and thus these buyers may demand to treat the PPP loan simply as outstanding debt that must be repaid in full at closing.
C. This may ramp up pressure on lenders to open their forgiveness portals, as a failure to do so could prevent their borrowers from executing M&A transactions.
We are in the process of updating our article covering this, which should come out early this week. We have also scheduled a Webinar (see the attached invite) on this new M&A guidance, which will also cover updates on market treatment of these deals and other recent PPP developments:
Buying and Selling
Before taking a deeper dive into the new policy notice, here are a couple other quick hits coming from Mnuchin’s interview with House Ways & Means Committee Member Tom Reed (R-NY) (PPP discussion starts ~3:50):
· The Secretary defends the decision not to make expenses paid with forgiven loan proceeds deductible (tax indifferent). This may cause more borrowers to delay forgiveness applications until 2021 (unless of course they are contemplating a sale transaction).
· He also says the Administration is working to figure out a way to allow a slightly streamlined loan forgiveness feature for loans of $50,000 or less. This administrative route seems to be an acknowledgement that legislation to streamline the process is unlikely. This would simplify, but not eliminate, the process for 3.5M of the 5.2M PPP loans.
On to the policy notice:
Covered Transactions. This rule applies to:
· “Sales and other transfers” of “at least 20%of the common stock or other ownership” of PPP borrower, in one or more sales in the aggregate since the date of approval of the PPP loan, including to affiliates or existing owners.
o For public company borrowers, this only applies to transfers that result in one person or entity holding more than 20% of the equity.
o It is not clear whether “sale or other transfer” would also apply to aprimary issuance of new equity. It does not appear that this is intended to capture new issuances, but there’s also no exemption for it.
o But there is also no reference to voting equity, so transfers of non-voting equity may fall within this safe harbor.
· Sales of more than 50% (by FMV) of the assets of the PPP borrower, in one or more sales in the aggregate since the date ofapproval of the PPP loan.
When Lender May Consent *without* SBA consent.
· If the loans has been “fully satisfied” (either via payoff, or a final forgiveness decision and SBA’s remittance of funds, or a combination of the two. (Extremely helpful to know that no consent is required with respect to a loan that is … no longer outstanding).
· If the equity sale/transfer is for less than 50% of the PPP borrower’s equity, taking account all other transfers since the date of approval.
o There is no guidance whether this is a fully-diluted calculation, so it will be safest to assume that this applies only to outstanding equity.
o But there is also no reference to voting equity, so transfers of non-voting equity may fall within this safe harbor.
· In both stock and asset deals, SBA consent is not required if:
o The borrower “completes a forgiveness application reflecting its use of *all* of the PPP loan proceeds and submitsit to the PPP lender.”
§ The notice does *NOT* require that either or both of the above actions be completed prior to closing of the transaction. It is not clear whether this is just the usual poor drafting from SBA or whether it is intended to allow borrowers and lenders to retroactively “fix” deals which have already closed with SBA consent … or if there is some other thinking here. That said, the safest approach is to read this as if it actually does require these to be completed by the M&A closing.
§ “All” proceeds appears to mean that borrowers whose PPP loans would not be fully forgiven cannot avail themselves of this safe harbor.
§ Some lenders have not yet opened their PPP portals. Their borrowers are not eligible to use this safe harbor.
o An “interest-bearing escrow accountcontrolled by the PPP Lender is established with funds equal to the outstanding balance of the PPP loan.”
§ It is not clear if SBA meant for the interest-bearing concept to match the interest rate applicable to the PPP loan (1%), but there is no minimum interest rate specified, so any minimal amount here is probably ok.
§ It’s not fully clear how SBA expects the PPP lender to control the escrow account, and could require the PPP lender to be essentially in the role of a payment or disbursement agent, but it seems reasonable to think that the PPP lender could simply either hold the money in a depository account that it can sweep (i.e., control within the meaning of the UCC), or be a party to an escrow agreement (along with the buyer and seller) with a third party escrow agent.
§ The escrow must be in amount equal to the “outstanding balance” of the PPP loan. This does not say “principal balance”, so it seems like SBA intends for this escrow account to cover interest accrued through the date of the closing of the M&A transaction.
· This amount will not, of course, be enough to cover the actual repayment amount if the SBA fully rejects the borrower’s PPP application, which is unlikely for most borrowers, but would be the case if SBA determined that the borrower were ineligible to have received the PPP loan(whether due to an improper “need certification” or otherwise).
· Thus, buyers may want the escrow account to include some additional interest accrual amount, to cover some reasonable forgiveness determination period.
o Upon receipt of SBA’s final forgiveness determination (including any appeal), the escrow account must first be disbursed to the PPP lender to pay “any remaining PPP loan balance plus interest.”
SBA Consent Requirements. In all other covered M&A deals not in the above safe harbor, SBA consent is required.
· The parties must submit to the PPP lender for submission to the SBA the following:
i. the reason that the PPP borrower “cannot fully satisfy the PPP Note … or escrow funds (This is such a weird way to phrase this and doesn’t seem to account for borrowers who could have most but not all of their loans forgiven and/or who have a lender who hasn’t opened its forgiveness portal, because even in such cases, a full escrow would not fit the borrower in the safe harbor. The use of “cannot” is especially curious and could potentially indicate an SBA policy position that it will not approve transactions where the PPP borrower “can” use the sale proceeds to pay off the PPP loan, but chooses to instead try to retain those via an application for partial forgiveness now or for future forgiveness in the future. However, this seems inconsistent with the requirements below regarding segregation and documentation of multiple buyer and seller PPP loans.))
ii. 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 purchasing entity.
· As noted above, in asset deals, the BUYER MUST ASSUME the PPP loan, which his likely to be a deal killer in many situations.
· “If deemed appropriate, SBA may require additional risk mitigation measures as a condition of its approval of the transaction.” It is not clear what these might be, but we already see most buyers and sellers escrowing an amount equal to the PPP loan balance (perhaps plus some expected interest amount). If the PPP lender is a beneficiary of (or controls) that escrow account, it does not seem likely that SBA would ask for much more.
Other Transaction Requirements. In all deals where the loan is not fully repaid at or prior to closing, the following requirements also apply:
· In stock deals, the borrower remains subject to all PPP obligations AND the new owners become subject to recourse to SBA if they (the new owners) use the proceeds for any unauthorized purpose. This will increase the signficiant of due diligence reviews to ensure that anticipated uses of PPP proceeds after closing are permissible.
· The following requirements appear to be drafted only to apply to stock deals:
o If any buyer entity has an existing PPP loan, the buyer and its owners must ensure that the proceeds and uses of each PPP loan are fully segregated and documented.
§ This may be especially challenging if a PPP borrower merges into another PPP borrower.
§ It seems as though this would likely apply to asset deals as well (though SBA may assume that PPP borrowers are not likely to be buyers?).
o The PPP lender must notify SBA of:
§ The identity of the new equity owners;
§ The new owners’ ownership percentage;
§ EINS for any owners of at least 20% of the equity.
· In all deals, the PPP lender must notify the SBA of the location and amount of any required escrow account within 5 business days of the closing of the M&A transaction.
· Note that there are other requirements that apply if the buyer is using a non-PPP SBA 7(a) loan to buy the PPP borrower, but those are not likely to be relevant to most of you, so I’m omitting them. Let our team know if you have questions about these.
Finally, note that this policy notice is directed at PPP Lenders, and is not an IFR, though it does provide that
“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.”.
We are reviewing the legal impact of this because, despite that language, it is not clear what the impact of a failure to comply with this notice is on:
A. PPP borrowers or their lenders with respect to M&A transactions that have already been completed and don’t meet these requiements (although we had recently been seeing SBA essentially enforcing something very similar to this in response to lender requests for consent to PPP M&A deals), or
B. PPP borrowers who close an M&A transaciton without notifying their lender and/or obtaining any consents that would be required by this notice.