M&A Transactions and Paycheck Protection Loans

September 3, 2020

The CARES Act passed on March 27, 2020 provided forgivable Paycheck Protection Program (PPP) loans to small businesses to assist with the uncertain economic conditions resulting from the COVID-19 pandemic.  As most PPP borrowers have not yet submitted the application for PPP loan forgiveness, buyers and sellers in M&A transactions should carefully consider the impact of seller’s PPP loans prior to consummating an M&A transaction.

Buyer Due Diligence relating to Sellers with PPP loans

Prior to entering into any transaction, buyers need to add to their initial due diligence the question as to whether seller has an outstanding PPP loan.  Ideally, the seller/PPP loan recipient should attempt to obtain forgiveness of the PPP loan to minimize potential issues.  If that is not feasible, the buyer should conduct proper due diligence to assess the risk of consummating a transaction with a PPP borrower with an outstanding loan that has not yet been forgiven.  Risks to assess include whether the seller is eligible to receive the PPP loan based on size and economic necessity at the time of application, as well as likelihood of forgiveness.

Change of Control and Eligible PPP Expenses

The parties should review the PPP loan documentation to confirm whether a change of control could impact forgiveness and trigger a repayment obligation.   PPP loans must be used for payroll and other eligible expenses of the recipient.  If a borrower undergoes a change of control before the PPP funds have been used for eligible expenses, the borrower may have a difficult time confirming that the PPP loan funds were used for payroll and other eligible expenses, especially if the PPP loan funds are comingled with the buyer after the consummation of the transaction. This may impact the PPP borrower’s eligibility for forgiveness.

SBA Lender Consent prior to M&A Transactions with Outstanding PPP loans

The parties should confirm whether SBA lender (the bank) consent is required and should carefully review the PPP loan agreement to confirm whether seller and/or lender must obtain the consent of the SBA prior to consummating the transaction.   Failure to obtain consent could result in denial of PPP loan forgiveness and/or result in an immediate repayment obligation for borrower.  By way of background, PPP loans are administered by the Small Business Administration (SBA) and included in the category of SBA 7(a) loans.  These loans are subject to the same regulatory guidelines that apply to 7(a) loans generally.  Among such guidelines are requirements that a lender must obtain SBA consent before a borrower is permitted to engage in a “change of ownership” of a borrower within 12 months of the final disbursement of a 7(a) loan, including a PPP loan.   The form SBA promissory note contains restrictions regarding changes in the business and ownership without lender consent.   The SBA recently notified PPP lenders that “change of ownership” includes a sale of substantially all of the PPP borrower’s assets.

Hence, potential buyers, whether through a stock purchase, asset purchase or merger, should ensure that sellers are reaching out early to lenders to confirm whether consent is required prior to entering into the transaction.  Also, note that a PPP lender may need to obtain the consent of the SBA for any change of ownership.  Hence, PPP borrowers should expect the lender approval process to take a few weeks, at a minimum, as the lender needs to approve and then submit the approval to the SBA.

Timing of Transactions with Outstanding PPP Loans

The difficulty of obtaining consent could delay the transaction timeline, especially if loan forgiveness is preferable prior to the consummation of the transaction.  Even when consent is not required, the borrower may wish to submit for forgiveness prior to consummating the transaction.  The parties may also want to set up an escrow with the PPP lender with the expectation that the proceeds of the transaction will be released to seller after forgiveness is granted by the PPP lender.  If the parties wish to wait for the PPP loan to be forgiven, they should expect that the forgiveness process could take upward of 150 days.  The SBA lender has 60 days to review and approve the forgiveness application and the SBA has an additional 90 days to grant forgiveness.

PPP Loan Specific Indemnification and Post-Closing Covenants

If the parties enter into a purchase and sale agreement or merger agreement prior to loan forgiveness being granted, the documents should include appropriate indemnities and post-closing covenants to adequately allocate the PPP loan risk to the appropriate parties, including responsibilities with respect to seeking loan forgiveness and responding to any audits or investigations as well as the risks associated with any findings of non-compliance with the PPP rules.   The parties should also review the indemnitee caps and baskets as well as the survivability of the representations and warranties to make sure they are adequate to address the allocation of PPP loan risks.   The documents should also include a post-closing cooperation provision to ensure that the buyer and the seller have access to the documents necessary to submit for forgiveness and respond to any post-closing PPP related audits or investigations.

This article is for informational purposes only and is not intended to be legal advice. If you have any questions on the above, please reach out to Jason Schneider at Schneider Law Group at (919) 324-3599 or at jschneider@schneiderlawgroup.com.

Schneider Law Group is a business boutique law firm primarily focused on general corporate, M&A, securities, and tax strategy for growth-oriented businesses.  For more information, please visit www.schneiderlawgroup.com.