In response to the COVID-19 pandemic, on March 27th, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law. Legislation that was passed by Congress with broad bipartisan support.

A prominent feature of the CARES Act has been the Paycheck Protection Program (PPP). The PPP is administered by the Small Business Administration (SBA), in cooperation with a broad range bank and non-bank lenders.

PPP loans that were extended to eligible recipients are eligible for forgiveness under certain conditions. Namely, if the funds were used for payroll costs, interest on mortgages, rent, and utilities, the recipient can seek forgiveness PPP loan’s principal and interest.

Beginning in August 2020, various lenders have begun the process of receiving forgiveness applications from those PPP loan recipients who deployed PPP loan proceeds within eight weeks of disbursement.

The COVID-19 pandemic and the resulting market instability has not stopped mergers and acquisitions (M&A) activity in the US. However, economic uncertainty has created renewed scrutiny -- and in some cases, further negotiation -- of purchase prices.

For sellers, PPP loan indebtedness can materially reduce a purchase price in an already heavily negotiated transaction. While PPP loan indebtedness is treated as a long-term liability for accounting purposes, sellers can negotiate the treatment of the PPP loan indebtedness separate from other indebtedness. If successful, this can result in the PPP loan amount being treated as a holdback of closing proceeds instead of indebtedness, which may result in a reduction of purchase price.

Though the terms of PPP loans vary from lender to lender, in most M&A scenarios PPP loans are assignable or otherwise do not fall due as the result of a change of control transaction.

On Oct 2, 2020, the SBA issued an SBA Procedural Notice addressing change of control transactions and the disposition of PPP loans in M&A.

Under the PPP, a “Change of Ownership” is defined as a transaction in which:

1. At least 20% of “the common stock or other ownership interest of a PPP borrower is sold or otherwise transferred.”
2. At least 50% of the seller’s assets (measured by fair market value) are sold or transferred.
3. A PPP borrower is merged into another entity.

Transactions not meeting any of the above definitions of a Change of Ownership enjoy a safe harbor relating to PPP loans in M&A, though most M&A transactions will meet one of the definitions of Change of Ownership.

If the PPP loan is

1. repaid in full or;
2. The seller has completed the PPP loan forgiveness application and;
1. There has been a remittance of funds to the PPP lender from the SBA or;
2. The seller has repaid any remaining balance on the PPP loan there is no restriction on an M&A transaction which would result in a Change of Ownership.

The SBA does not require its own approval prior to the closing of the M&A transaction in all settings. If there PPP loan remains outstanding at the closing of the M&A and the M&A transaction is structured as an equity transaction, the approval of the transaction by the SBA is unnecessary if:

1. The transaction is will result in the sale of 50% or less of the common stock or ownership interest of the seller or;
2. The seller completes a forgiveness application and establishes an interest-bearing escrow account with the PPP lender holding funds equal to the PPP loan’s outstanding principal and accrued interest as of the date of the establishment of the escrow.

After the forgiveness process is completed, the determination of the SBA will inform escrow instructions releasing the escrow funds to the seller or the PPP lender.

If there PPP loan remains outstanding at the closing of the M&A and the M&A transaction is structured as an asset sale transaction and the transaction will result in the sale of 50% or more of the seller’s assets, the approval of the transaction by the SBA is unnecessary if the seller completes a forgiveness application and establishes an interest bearing escrow account with the PPP lender holding funds equal to the PPP loan’s outstanding principal and accrued interest as of the date of the establishment of the escrow. After the forgiveness process is completed, the determination of the SBA will inform escrow instructions releasing the escrow funds to the seller or the PPP lender.

However, if the M&A transaction is not structured as described above, the SBA’s approval to the M&A transaction will be required and cannot be unilaterally satisfied by the PPP lender. The PPP lender will have to request approval from the SBA and must provide, at minimum:

1. The reason that the seller cannot fully satisfy the PPP loan as or establish the escrow;
2. The details of the requested transaction;
3. A copy of the executed PPP note;
4. Any letter of intent and the purchase or sale agreement setting forth the responsibilities of the seller and buyer;
5. Disclosure of whether the buyer has an existing PPP loan and any associated SBA loan number; and
6. A list of all owners of 20 percent or more of the purchasing entity.

The SBA may request risk mitigation measure and make its approval contingent on those measures being employed.

Sellers may be able to avoid a purchase price reduction in closing working capital calculations or indebtedness by creating a PPP loan holdback provision, which allows the seller to recover the amount of PPP loan indebtedness when forgiven.

Sellers must establish an escrow with the PPP lender and capitalize the escrow account in connection with the closing of the M&A. Depending on the PPP lender, this escrow account may be capitalized prior to closing or following closing.

In all instances, with respect to any transaction agreements, sellers should ensure that the ongoing obligation to satisfy outstanding indebtedness is addressed in the provisions of definitive agreements.