Preparing to Acquire PPP Loan Borrowers

Many Latin entrepreneurs create holding companies in the United States, and many such companies have taken advantage of the US government’s Paycheck Protection Program (“PPP”) as well as the US Small Business Administration’s (“SBA”) Economic Injury Disaster Loan (“EIDL”) program.

The PPP and EIDL programs are liabilities of a company’s balance sheet.  PPP loans are eligible for forgiveness under certain circumstances, while the EIDL are generally low interest, 30-year loans.  These U.S. government economic stimulus programs raise various issues for potential acquirors that all Latin entrepreneurs, whether selling or acquiring a U.S. based company, should keep in mind. 

EIDL Loans

The EIDL program, which was in existence prior to the COVID-19 crisis, provides loans for businesses facing disaster-related economic injuries.  These loans are provided and administered by the SBA, and do not involve private lenders.  EIDL loan documents include terms requiring SBA approval of any change in ownership of an EIDL borrower, including reorganizations, mergers or restructurings.  SBA approval of asset sales of EIDL borrowers may be required where an EIDL loan is for more than $25,000, as the SBA requires collateral for these loans and often takes a blanket security interest in borrower property.  Personal guarantors may also be required where a CARES Act EIDL program loan is for more than $200,000. 

Requests for approval of transfers of EIDL borrower entities should be made to the SBA directly, and the SBA loan officer administering such loans will coordinate the approval process.

PPP Loan Basics

The (“PPP”) is a key element of the U.S. Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and has allocated billions of dollars to the provision of loans (“PPP Loans”) to eligible borrowers (“PPP Borrowers”).  Unlike EIDL program loans, PPP Loans are regulated and administered by both government and private entities, as PPP Loans are regulated by the SBA and funded and coordinated through third party private lenders (“Lenders”).  PPP Borrowers may be eligible for loan forgiveness (funded by the SBA) if funds borrowed are used for eligible payroll costs, payments on business mortgage interest payments, rent or utilities during either the 8 or 24 week period following disbursement.  PPP Borrowers may apply for such forgiveness at any time up to the maturity date of the loan, and loan payments under PPP Loans are deferred for PPP Borrowers who apply for such forgiveness until the SBA remits a PPP Borrower’s loan forgiveness amount to the applicable Lender.

Even with these favorable terms offered to PPP Loan borrowers, parties hoping to acquire a PPP Borrower via an acquisition or merger (a “Contemplated Acquisition”) must approach PPP Loans as both a loan owed by the target borrower and a unique regulatory issue requiring specific analysis and response.  For starters, as with any material contract of a target business, buyers should ensure that there are not unfavorable or default provisions of applicable PPP Loan documents that will be triggered by a Contemplated Acquisition.  Looking beyond these document specific issues, however, the SBA has issued procedural guidance as to actions that buyers in a Contemplated Acquisition must take where a “Change of Ownership” will occur.

Has a Change of Ownership Occurred?

SBA guidance advises that a “Change of Ownership” will be considered to have occurred when  (i) at least 20% of the PPP Borrower’s equity is transferred (including to an affiliated party), (ii) a PPP Borrower sells or otherwise transfers at least 50 percent of its assets (measured by fair market value), whether in one or more transactions, or (iii) a PPP Borrower is merged with or into another entity.  

Note that regardless of any change of ownership, a PPP Borrower remains responsible for (i) performance of all obligations under their PPP Loan, (2) the certifications made in connection with their PPP Loan application, including the certification of economic necessity, and (3) compliance with all other applicable PPP requirements (including requirements related to consummating a Contemplated Acquisition). 

Notification of PPP Lender and Next Steps

Prior to consummating any Change of Ownership, a PPP Borrower must notify the Lender in writing of the Contemplated Acquisition and provide the Lender with a copy of the proposed agreements or other documents that would affect the proposed transaction.  Note that, absent PPP Loan document specific requirements, the SBA has not provided specific guidelines as to how far in advance of a Contemplated Acquisition such Lender notice must be given, what documents are required, or if such notice necessitates Lender consent to a Contemplated Acquisition.

Following the provision of this Lender notice, the next steps parties to a Contemplated Acquisition may take with respect to a PPP Loan vary, particularly regarding whether or not SBA approval of a Contemplated Acquisition is required, depending on a number of factors, as outlined in the scenarios that follow.

Scenario #1: Fully Satisfied PPP Loan

Where the PPP Loan is fully satisfied, there are no approval requirements with respect to the Contemplated Acquisition.  Additionally, where the loan forgiveness process has been completed by a PPP Borrower with respect to the PPP Loan and either (i) the SBA has remitted funds to the Lender in satisfaction of the PPP Loan, or (ii) the PPP Borrower has repaid any remaining balance on the PPP Loan, no SBA approval is required for a related Contemplated Acquisition.

Scenario #2: Less Than 50% of the Equity or Assets of a PPP Borrower Transferred

Where the PPP Loan is not fully satisfied or forgiven, SBA approval will not be required with respect to a related Contemplated Acquisition where 50% or less of the equity or the assets (measured using fair market value) of the PPP Borrower are transferred.  Note that in these cases, required Lender approvals pursuant to PPP Loan documentation will still be required.  Additionally, 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 considered in the aggregate.

Scenario #3: Forgiveness Application Completed and Lender Escrow Established

In the event that the PPP Loan is not either fully satisfied or forgiven, and the Contemplated Acquisition involves a transfer of greater than 50% of the equity or assets (measured using fair market value) of the PPP Borrower, SBA approval of the Contemplated Acquisition will not be required where (i) the PPP Borrower completes a forgiveness application reflecting its use of all of the PPP loan proceeds and submits it, together with any required supporting documentation, to the PPP Lender, and (ii) 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 the SBA’s decision) is completed, the escrow funds must be disbursed first to repay any remaining unforgiven PPP loan balance plus interest. 

Scenario #4: Apply for SBA Approval

Any Contemplated Acquisition involving a Change of Ownership that does not fit previously described Scenarios 1 through 3 must receive SBA approval and will require that the buyer in such a Contemplated Acquisition accept the Borrower’s PPP Loan obligation whether through acquisition of the equity of the Borrower or, in the case of an asset sale, by expressly assuming these obligations.

Requests for SBA approval of a Contemplated Acquisition must include (i) the reason that the PPP borrower cannot fully satisfy the PPP Note or escrow funds as contemplated in the previously discussed Scenarios 1 or 3, (ii) the details of the Contemplated Acquisition, (iii) a copy of the executed PPP Loan documentation, (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 regarding the Contemplated Acquisition, (v) disclosure of whether the buyer has an existing PPP Loan and, if so, the SBA loan number for such PPP Loan, and (vi) a list of all owners of 20 percent or more of the Buyer entity (if applicable).

The SBA review process can take up to 60 calendar days following the submission of a request for SBA approval.

An Ounce of PPP-Preparation Is Worth a Pound of Cure

Purchasers of PPP Borrowers should make sure that discussions regarding the handling of outstanding PPP Loans take place early in the deal process.  Due Diligence requests should specifically request PPP Loan and other SBA related correspondence and documentation.  Additionally, acquirers should be aware of the potential delays that may arise from acquiring a PPP Borrower and plan accordingly.  Finally, counsel for both buyers and sellers should cooperate in ensuring that submissions to the SBA or Lenders are accurate and contain agreed-upon information regarding Contemplated Acquisitions.  The CARES Act has allowed many businesses to survive an unprecedented economic crisis, and simple preparation will ensure that your Contemplated Acquisition reaps the benefits.