SBA Guidance on PPP Loans in M&A Transactions

We wrote recently about how an extra layer of merger and acquisition due diligence should be triggered if the target business has taken a loan under the Paycheck Protection Program (“PPP”). Since we wrote, the Small Business Administration (“SBA”), which administers the PPP, issued what is called “Procedural Notice No. 5000-20057.” We will call it the “Guidance.” The SBA’s new Guidance is aimed at answering questions and establishing procedures with respect to a “change of ownership” of a business entity that has received a PPP loan.

The Guidance states that, where a “change of ownership” occurs, approval from the PPP lender and/or the SBA is required. Written notice and disclosure must be provided to the lender and the SBA (including copies of transaction documentation). Under some circumstances, PPP lenders may issue unilateral approvals. Under other circumstances, the SBA must approve the transaction. The SBA commits itself to providing a decision on approval within sixty (60) days.

The definition of “change of ownership” is very broad, covering transactions structured as EITHER a stock sale or an asset purchase. The definition is much broader than the definition used by most courts. In brief, the Guidance defines a change of ownership to occur when:

20% or more of the ownership is sold or transferred
The PPP borrower sells 50% or more of its assets
A merger into another entity of the PPP borrower takes place

As noted, if there is a change of ownership, as defined by the Guidance, then the PPP borrower must provide written notice and obtain approval. Unilateral lender approval is generally limited to the lower levels of what is defined as change of ownership. For example, unilateral PPP lender approval can be given where ONLY 20% of stock or LLC ownership units are transferred. This might cover a situation where ownership units are transferred, for example, between family members.

Note that notices and approvals are required for all PPP borrowers involved. Thus, the Guidance requirements can be triggered if the BUYER is a PPP borrower. For example, if both the target business and the acquiring business are PPP borrowers and the borrowers will be merged into a new entity, then, essentially, two SBA or lender approvals would be needed. Even if the acquiring business will remain, the Guidance still requires that, post acquisition, the buyer must segregate and delineate the different PPP funds, must track and allocate the different PPP expenses and demonstrate compliance with all PPP requirements for EACH PPP borrower. Even if only the buyer is a PPP borrower, the buyer will still have to demonstrate compliance with the PPP.

The Guidance does NOT apply to the following circumstances:

Where a PPP loan has been paid off or will be paid off as part of the M&A consummation
Where a PPP loan has been fully forgiven

If loan forgiveness is pending but not yet approved, the transaction can still proceed as long as the amount of the outstanding PPP loan is placed in escrow with the PPP lender.

If you have questions or need more information, contact the business lawyers at Revision Legal at 231-714-0100.

Due Diligence Obligations When a Target Has a PPP Loan

When a transaction target has received a PPP loan that has not been fully forgiven and fully paid, the acquirer’s due diligence must go beyond standard review. The SBA’s Procedural Notice No. 5000-20057 created a legal regime in which a change of ownership—as broadly defined by the Guidance—triggers mandatory notice and approval requirements. An acquirer who completes a transaction without obtaining the required approvals inherits not only the PPP loan obligation but also potential exposure for the target’s failure to comply with the Guidance, including possible False Claims Act liability if the target made misrepresentations in its forgiveness application. Due diligence should include: reviewing the PPP loan documentation and the borrower’s economic necessity certification; reviewing the forgiveness application and supporting documentation; confirming the current forgiveness status with the PPP lender; and assessing whether the target’s use of PPP funds was consistent with authorized uses under the CARES Act.

Escrow and Indemnification Provisions

Sophisticated acquirers routinely address PPP loan risk through transaction structuring. One approach is to condition closing on full forgiveness and payment of the PPP loan before acquisition closes. Where that is not feasible, the parties can establish an escrow arrangement holding an amount equal to the outstanding PPP loan balance, to be released to the seller upon full forgiveness or applied to repayment if forgiveness is denied. Indemnification provisions in the acquisition agreement should specifically address PPP-related liabilities, including any liabilities arising from SBA audit of the forgiveness application. The SBA has authority to audit PPP forgiveness applications for loans over $150,000 for up to six years after the loan is forgiven—this extended audit window means that PPP-related liabilities can surface long after closing.

Post-Merger Integration: Segregating PPP Funds and Expenses

Where both the target and the acquirer have outstanding PPP loans, or where the merged entity carries forward an unforgiven PPP loan, post-merger integration requires careful accounting segregation. The SBA’s Guidance requires that the merged entity maintain separate records showing that each PPP loan’s proceeds were used exclusively for allowable expenses attributable to the original borrower. Commingling of PPP funds with other corporate funds post-merger is a significant audit risk and may disqualify the loan from forgiveness. Companies that have completed acquisitions involving PPP borrowers should ensure that their accounting systems can produce segregated records and that forgiveness applications are filed in a timely manner.

False Claims Act Exposure

The False Claims Act, 31 U.S.C. §§ 3729–3733, imposes civil liability of up to three times the damages incurred by the government plus civil penalties per false claim. The Department of Justice has consistently taken the position that PPP loan applications and forgiveness certifications are claims under the False Claims Act. Acquirers of businesses that obtained PPP loans under questionable circumstances—including businesses that may not have met the “economic necessity” certification standard—should assess their potential successor liability exposure under the False Claims Act before closing.

Consult an M&A Attorney

M&A transactions involving PPP borrowers require careful legal structuring to address SBA approval requirements, forgiveness status, and potential compliance liabilities. The business law attorneys at Revision Legal have experience advising both acquirers and sellers on PPP-related M&A issues. Contact us at 231-714-0100.