We recommend that both buyers and sellers considering a potential change of control transaction with a business that has borrowed funds under the PPP loan program should review the notice carefully.

On October 2, 2020, the Small Business Administration (SBA) released a procedural notice that details the steps that Paycheck Protection Program (PPP) loan borrowers and lenders must take when a borrower is engaging in a transaction in which a change in ownership will occur. This Alert summarizes the key points from the notice and the actions that a PPP loan borrower should take (and a purchaser or investor should ensure the borrower takes) in an M&A transaction.

The key points for buyers and investors to keep in mind when considering entering into a transaction with a change of ownership of a PPP borrower are:

• The PPP borrower is required to remain responsible for (1) performing all obligations under the PPP loan including applying for loan forgiveness and/or repayment, (2) satisfying the certifications (including the economic necessity certification) and (3) compliance with all applicable PPP rules and regulations;
• A transaction involving a change of control of a PPP borrower where the PPP loan has already been fully satisfied may not require prior approval from the SBA; and
• A transaction involving a change of control of a PPP borrower where the PPP loan balance remains outstanding may require both the lender’s approval and the approval of the SBA, as well as other conditions such as the borrower funding an escrow account in amount equal to the remaining PPP loan balance.

We recommend that both buyers and sellers considering a potential change of control transaction with a business that has borrowed funds under the PPP loan program should review the notice carefully and implement a plan prior to the closing of the transaction in order to comply with the SBA rules and receive the proper approvals.

Definition of Change of Ownership

For purposes of the PPP loan program, the SBA defines a “change of ownership” as an event where:

• At least 20% of the common stock or other ownership interest of a PPP borrower (including publicly traded entities) is sold or otherwise transferred, including to an affiliate or existing owner of the PPP borrower;[1]
• The PPP borrower sells or otherwise transfers in a single or multiple transactions at least 50% of its assets (measured by fair market value); or
• A PPP borrower is merged with or into another business.

PPP Lender Notification and Consent Requirements

Before the closing of a “change of ownership” transaction, a PPP borrower must notify the lender in writing of the proposed transaction and provide the lender with copies of the primary transaction documents. However, the specific procedures for SBA approval of the transaction will vary depending on the circumstances of the change of ownership and the status of the PPP loan, as summarized below. The basic distinction in the need for SBA approval is dependent upon (1) is the PPP loan fully satisfied or not; and (2) how much ownership of the borrower is being changed.

Changes of Ownership if a PPP Loan Is Fully Satisfied

There are no restrictions on a PPP borrower if, prior to the closing of the change of ownership transaction: (1) the borrower has fully repaid the PPP loan; or (2) the borrower has completed the loan forgiveness process and (a) the SBA has transferred funds to the PPP lender in full satisfaction of the PPP loan or (b) the PPP borrower has repaid any remaining balance on the PPP loan.

Changes of Ownership if a PPP Loan Is Not Fully Satisfied

Changes of Ownership Requiring Prior Lender Approval but Not SBA Approval

Transfers of Stock/Other Ownership Interests and Mergers

A PPP borrower is only required to obtain the approval of the lender, and not any additional approval from the SBA, if:

1. The transaction involves the sale or transfer of less than 50% of the PPP borrower’s common stock or other ownership interests; or
2. The PPP borrower completes a forgiveness application reflecting its use of the PPP loan proceeds and submits the application, along with all required documentation, to the lender. In addition, an escrow account controlled by the lender must be established with funds equal to the outstanding balance of the PPP loan. At the end of the forgiveness process, the escrow funds must be disbursed first to repay any remaining PPP loan balance (plus interest).

Asset Sales

In an asset sale that is a change in ownership, a PPP borrower is only required to obtain the approval of the lender and not any additional approval from the SBA, if it satisfies the following conditions:

1. The PPP borrower must complete a forgiveness application reflecting its use of the PPP loan proceeds and submit the application, along with all required documentation, to the lender; and
2. An escrow account controlled by the lender must be established with funds equal to the outstanding balance of the PPP loan. At the end of the forgiveness process (including any appeals of the SBA’s decision on loan forgiveness), the escrow funds must be disbursed first to repay any remaining PPP loan balance (plus interest). In addition, the lender must notify the appropriate SBA Loan Servicing Center of the location of, and the amount of funds in, the escrow account within five business days of the closing of the transaction.

Changes of Ownership Requiring Prior SBA Approval

If the change in ownership of a PPP borrower does not satisfy the conditions summarized above (including if the PPP borrower does not have funds to establish the escrow account), the PPP borrower must first obtain the lender’s approval for such transaction and then the lender must seek prior approval from the SBA.

To obtain approval from the SBA, the lender will submit a request to the appropriate SBA Loan Servicing Center. The lender’s request for consent must include the following information:

1. An explanation of the reason why the PPP borrower cannot fully satisfy the PPP loan or arrange for the escrow in the full amount of the PPP loan;
2. Details of the proposed transaction;
3. A copy of the executed PPP promissory note;
4. Any letter of intent and the purchase or sale agreement effectuating the transaction;
5. Disclosure of whether the buyer has an existing PPP loan and the buyer’s PPP loan number;
6. A list of all owners of 20% or more of the buyer-entity in the proposed transaction; and
7. Any additional risk mitigation measures that the SBA may require as a condition of granting its approval to the proposed transaction.

Note that changes of ownership involving the sale of 50% or more of a PPP borrower’s assets (as measured by fair market value) must be conditioned on the purchasing entity assuming all of the PPP borrower’s PPP loan obligations, including responsibility for compliance with the terms and conditions for the PPP loan. The purchase or sale agreement must include language indicating that the purchasing entity has assumed all of the PPP borrower’s obligations under the PPP loan. If this language is not included, the parties must provide a separate assumption agreement to the SBA.

Other Relevant Provisions Relating to Transfers of Stock/Other Ownership Interests and Mergers

In the event of a transfer of stock or other ownership interests or a merger of the PPP borrower, the purchaser or successor (in the event of a merger) remains subject to all applicable PPP loan obligations. If the purchaser or successor uses PPP funds for unauthorized purposes, they will be subject to liability from the SBA. If the purchaser or successor entity also has a PPP loan, both the PPP borrower and the purchaser are responsible for segregating their PPP loans and documenting the proper use of PPP funds.

Upon the closing of a transaction where the buyer or successor (by merger) also has a PPP loan, the PPP borrower’s lender must notify the appropriate SBA Loan Servicing Center within five business days of the completion of the transaction, and provide the following information:

1. Identity of the new owner(s) of the PPP borrower’s common stock or other ownership interest;
2. New owner(s)’ ownership percentage(s);
3. Tax identification numbers for any owner(s) holding 20% or more of the PPP borrower’s equity; and
4. Location and amount of funds in escrow account under the lender’s control.

Continuing PPP Compliance

The notice makes clear that, even in the context of a change of ownership, a PPP borrower continues to remain responsible for performance of all obligations under the PPP loan and all other applicable PPP requirements, including the economic necessity certification and all other certifications made in connection with the PPP loan application. Additionally, the PPP borrower remains responsible for gathering and retaining all required PPP forms and supporting documentation and providing such forms and documentation upon the request of the lender or the SBA.

Changes of Ownership Funded by SBA 7(a) Loans

If a change of ownership transaction is financed by an SBA 7(a) loan, the parties must comply with all SBA loan program requirements, as defined in 13 CFR 120.10. Additionally, the 7(a) loan that finances the transaction may not be used to fund an escrow account if such an account is required.

PPP Loans Pledged in Paycheck Protection Program Liquidity Facility

If you have any questions about this Alert, please contact Nanette C. Heide, Sandra G. Stoneman, Stephen Morrissey, Mark Zhuang, any member of the COVID-19 Strategy Team or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.