On Oct. 2, 2020, the Small Business Administration (SBA) issued SBA Procedural Notice Control No. 5000-20057 establishing requirements under the Paycheck Protection Program (PPP) for PPP borrowers considering a change in ownership. The procedural notice was effective Oct. 2 and does not provide any relief on compliance or timing for consent to PPP borrowers with change in ownership transactions that were in process but not consummated prior to that date.
The procedural notice provides clarification whether SBA consent is required for a proposed change
in ownership of a PPP borrower, which is summarized below, but does not clearly answer some questions regarding the applicability of these requirements. PPP borrowers must submit any notice required by the procedural notice and related requests for consent to change in ownership to their PPP lender, and the PPP lender then submits the notice information and consent request, if applicable, to the SBA. In addition, PPP borrowers should review their PPP note to determine whether PPP lender consent is also required for the proposed transaction. PPP lender consent could be required even if SBA consent is not required under the procedural notice.
SBA did not promulgate a required form of PPP loan note, but instead authorized each PPP lender to develop and implement its own form of promissory note in compliance with available PPP guidance. Many PPP lenders used the existing SBA form note intended for use in the previously existing SBA 7(a) small business loan program, while other PPP lenders used that SBA form of note as a basis for developing their own PPP note. The default provisions in the SBA form of note include a default if the borrower “[r]eorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender’s prior written consent.” Under SBA’s Standard Operating Procedures 50 57 2 (7(a) Loan Servicing and Liquidation) (SOP 50 57) and the related Servicing and Liquidation Actions 7(a) Lender Matrix, the lender is required to seek SBA consent for any change in ownership of a borrower under the 7(a) loan program in the first 12 months after final disbursement of the loan.
PPP loans were established as a temporary loan program under Section 7(a) of the Small Business Act and are generally subject to certain rules and regulations otherwise applicable to SBA 7(a) small business loans. In SBA Procedural Notice Control No. 5000-20038 effective July 23, 2020, SBA specified that PPP lenders are required to administer PPP loans in accordance with that SOP to the extent it “is not superseded by or conflict with PPP-specific requirements.” As a result, the SOP 50 57 requirement for SBA consent to changes in ownership appeared to apply to all PPP loans, but without further SBA guidance, significant uncertainty about how to manage requests for SBA consent roiled the program. The change in ownership procedural notice described in this alert attempts to clarify significant uncertainty about the administration of change of ownership transactions by PPP borrowers going forward. But for disposition or merger transactions that have already been consummated by PPP borrowers prior to the issuance of the procedural notice, no insight is provided about how SBA might treat those transactions during the forgiveness process, though as a general rule regulations and guidance do not apply retroactively.
What constitutes a change of ownership subject to the procedural notice?
One of the uncertainties causing difficulty in administering change in ownership requests to date has been ascertaining what sort of transactions require SBA consent. As a first step, the procedural notice establishes that a “change
of ownership” under the PPP would arise upon the occurrence of any the following circumstances:
- Equity acquisitions: A change of ownership would occur upon the sale or transfer of 20 percent or more of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity), including sales and transfers to existing owners or affiliates, as determined by aggregating all such sales or transfers that have taken place since the PPP loan was approved by SBA; provided that, with respect to public companies that are PPP borrowers, “only sales or other transfers that result in one person or entity holding or owning at least 20 [percent] of the common stock or other ownership interest of the borrower must be aggregated”;
- Asset sales: A change of ownership would occur upon the sale or other transfer of at least 50 percent of a PPP borrower’s assets (measured by fair market value), whether in one or more transactions; or
- Merger: A change of ownership would occur if a PPP borrower is merged with or into another entity.
Any transaction that does not satisfy one of the change of ownership descriptions above does not constitute a change in ownership subject to determination of whether SBA consent is required under the procedural notice and presumably, though not clearly stated in the procedural notice, no consent of SBA is required with respect to such transaction. That said, there are notice requirements described under the heading “General Notice Requirements” below that appear to apply to all such transactions, even if they do not satisfy the definition of a change of ownership under the procedural notice.
The SBA guidance in the procedural notice appears to be based on the assumption that PPP lenders used the SBA form of 7(a) loan note for PPP loans, but that was not a program requirement and is not the case for many lenders. Because there was no prescribed form of PPP note, some PPP notes may have more expansive restrictions on changes in ownership that would not require SBA consent under the terms of the procedural notice, but would require PPP lender consent or waiver for such transactions. As previously noted, even if a transaction under consideration by a PPP borrower does not constitute a change of ownership under the procedural notice, all PPP borrowers should review their form of PPP note to determine whether consent of their PPP lender might otherwise be required for that transaction by the terms of their PPP note.
Does a change in indirect ownership interests in a PPP borrower constitute a change
of ownership under the procedural notice?
Uncertainties about what constitutes a covered change in ownership transaction under SOP 50 57 as it applies to PPP have included (a) whether changes in ownership of a direct or indirect parent company of a PPP borrower requires SBA consent and (b) whether preferred, contractual or other economic ownership interests constitute a change
of ownership, even if no voting rights attach to such interests. The 7(a) loan program is designed for very small business concerns that typically do not have complex capital structures, and so complex ownership interests are generally not contemplated by existing guidance for the 7(a) loan program. In addition, the change in ownership provision of the SBA form of note does not specify whether it applies solely to direct ownership interests or would include indirect ownership interests, nor does it specify limitations on the types of ownership interests covered. That said, the PPP loan application only required reporting of certain direct ownership interests in the PPP borrower. As a result, a tentative general consensus had developed that only changes in direct ownership interests were required for PPP loans, though no consensus has emerged regarding what type of equity interests are covered.
Unfortunately, the procedural notice does not expressly answer either question. The definition of a covered change
of ownership refers to “common stock or other ownership interest of” a PPP borrower, which could be understood to refer only to direct equity interests in a PPP borrower, but “other ownership interests” could also be understood to refer to direct or indirect ownership interests, or preferred, economic, contractual or other non-voting ownership interests. To further complicate matters, Section 2(b)(vi) of the procedural notice requires that a request for SBA approval of a change
of ownership include “a list of all owners of 20 percent or more of the purchasing entity.” It is not clear from the procedural notice how SBA intends to use this information, as ownership of the owners of a PPP borrower was not required to be reported as part of the PPP loan application process, but it indicates an interest in a change in the indirect ownership of a PPP borrower that is not evident from the required form of PPP loan application or the express terms of the form of 7(a) note. As a result, further guidance from SBA is needed to clarify whether the change
of ownership requirement is limited to direct ownership of a PPP borrower or is intended to capture indirect ownership changes, as well as whether preferred, contractual and non-voting ownership interests are intended to be covered.
What change in ownership transactions do not require SBA consent?
Once a PPP borrower determines whether its proposed transaction constitutes a
change in ownership under the procedural notice, it must then determine whether
that change in ownership structure will require SBA consent. Under the terms of the procedural nNotice, none of the following change in ownership transactions requires SBA consent (each, an “Excluded Change in Ownership Transaction”):
- Pay-off of the PPP loan: Transactions in which the PPP loan will be paid off in full prior to consummation of the change in ownership require SBA consent if:
Note that the procedural notice does not expressly exclude transactions where the pay-off occurs simultaneously with or immediately after consummation of a change in ownership transaction, so, if possible, change in ownership transactions should be structured to cause the pay-off to occur prior to consummation of the other transactions.
- the PPP borrower has not obtained forgiveness but pays off 100 percent of the PPP loan prior to the consummation of the change in ownership transaction; or
- the SBA has remitted any approve forgiveness amount and PPP borrower pays off any remaining amount of the PPP loan prior to consummating the change in ownership transaction.
- Disposition of 50 percent or less of ownership interests: Transactions structured as a sale or transfer of
50 percent or less of the borrower’s common equity or other ownership interests of the PPP borrower, taking into account all such dispositions from the date of approval of the PPP loan, do not require SBA consent.
- Other ownership dispositions or mergers pending forgiveness and with escrow of outstanding PPP loan. Transactions structured as an ownership interest disposition or as a merger do not require SBA consent so long as the PPP borrower (a) has used all PPP proceeds, (b) has submitted its forgiveness application and required supporting documentation, and (c) has established an interest-bearing escrow account controlled by its PPP lender with funds equal to the “outstanding balance” of the PPP loan, which escrow arrangement must require that after forgiveness is remitted or denied by SBA and any permitted appeal process is completed, the escrow funds must be disbursed to pay off any PPP loan amount that is not forgiven plus accrued and outstanding interest. The requirement to pay principal and interest from the escrowed amount may assume that some material portion of the PPP loan will be forgiven, but suggests that PPP borrowers should escrow an amount equal to the outstanding principal and estimated interest through an estimated forgiveness date, which could be estimated as 150 days after the complete forgiveness application is submitted to the PPP lender based on PPP rules, in order to satisfy this requirement.
- Asset dispositions pending forgiveness and with escrow of outstanding PPP loan. Transactions structured as a disposition of 50 percent or more of the PPP borrower’s assets (based on the fair market value thereof and aggregating all asset dispositions since approval of the PPP loan) do not require SBA consent so long as the PPP borrower (a) has used all its PPP loan funds, (b) has submitted its forgiveness application and required supporting documentation, and (c) has established an interest-bearing escrow account controlled by its PPP lender with funds equal to the “outstanding balance” of the PPP loan on the same terms described in the preceding clause.
Note that change in ownership transactions that do not require SBA consent are nonetheless subject to the specified notice requirements described under the heading “General Notice Requirements” below.
What change in ownership transactions do require SBA consent?
If a change in ownership transaction does not satisfy any of the exceptions specified under the heading “What change in ownership transactions do not require SBA consent?” above, prior consent of SBA is required before consummation of the proposed change in ownership transaction. The procedural notice does not specify what the penalty would be for failure to obtain such prior SBA consent, but the change in ownership transaction would likely result in a default under the applicable PPP note, especially for PPP notes based on the SBA form 7(a) note, pursuant to which any default could result in acceleration of the PPP loan. In addition, such failure by a PPP borrower to obtain the required consent could reasonably be expected to result in denial of forgiveness of the PPP loan, although that outcome is not expressly provided for in the procedural notice.
The procedural notice gives the SBA 60 days to respond to a change in control
consent request. As a result, PPP borrowers considering change in ownership transactions likely to require SBA consent should seek such consent as early in the process as possible to avoid delays to the consummation of the transaction.
Consent Request Requirements
All requests for SBA consent to a change in ownership transaction must be submitted by the PPP borrower to its PPP lender, which will then submit the request to the SBA. All such requests (unless otherwise specified below) must include the following information:
- the reason that the PPP borrower cannot pay off the existing PPP loan or escrow funds as required to qualify as an Excluded Change in Ownership Transaction;
- the details of the proposed change in ownership transaction;
- a copy of the PPP borrower’s executed PPP note;
- 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;
- disclosure of whether the purchasing entity has an existing PPP loan and, if so, the SBA loan number thereof;
- a list of all owners of 20 percent or more of the purchasing entity;
- solely with respect to changes in ownership transactions consisting of asset dispositions that are not Excluded Change in Control Transactions, evidence of provisions in the purchase agreement or an assignment and assumption agreement that the purchasing entity is assuming all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms; and
- if requested by SBA, additional information regarding risk mitigation measures that SBA may require as a condition to its consent to the transactions.
General Notice Requirements
In addition to the notice requirements specified above for a consent request, each PPP borrower must provide the information below “for all sales or other transfers of common stock or other ownership interest or mergers, whether or not the sale requires SBA’s prior approval.” Note that SBA elected not to use their defined term “change in ownership” for this requirement, so it must be assumed to apply to all such transactions whether or not the transactions qualify as a change in ownership under the procedural notice.
PPP borrowers must provide this information to PPP lender in time to allow the PPP lender to notify the SBA of such sale, transfer or merger transactions no later than five business days after the consummation of thereof:
- With respect to dispositions of ownership interests and mergers, but not asset dispositions:
- identity of the new owner(s) of the common stock or other ownership interest;
- new owner(s)’ ownership percentage(s);
- tax identification number(s) for any owner(s) holding 20 percent or more of the equity in the business; and
- location of, and the amount of funds in, the escrow account under the control of the PPP lender, if an escrow account is required.
- With respect to asset acquisitions, the location of, and the amount of funds in, the escrow account under the control of the PPP lender, if an escrow account is required.
The SBA procedural notice provides much-needed guidelines for proposed change in ownership transactions by PPP borrowers, but also establishes significant burdens for PPP borrowers and PPP lenders to comply with the new guidelines. In addition, further guidance is needed to clarify a number of issues, including the penalties for failure to comply and whether indirect ownership interests or economic, preferred or contractual interests are covered. We will continue to monitor developments in PPP guidance, including change
in ownership requirements. The authors and other McGuireWoods attorneys can assist with navigating this complex, evolving process.
McGuireWoods has published additional thought leadership analyzing how companies across industries can address crucial business and legal issues related to COVID-19.