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The Paycheck Protection Program (“PPP”) was launched in April of 2020 to facilitate over 4.9 million loans totaling in excess of $521 billion, with a second round of funding for the program currently being negotiated in Congress.
The vast majority of borrowers have properly obtained these loans and have managed to facilitate receiving complete or almost complete forgiveness, based upon having spent at least 60% of the loan amounts on payroll, state payroll taxes, and group health insurance, and having spent the rest of the loan amounts on the above items and/or utilities, interest, and rent that qualify under the rules.
Borrowers and their advisors have had to struggle with varying interpretations and limitations that have been periodically issued by the SBA, many of which have discriminated against employee-owners whose compensation and benefits that count toward forgiveness may sometimes be limited.
Given that loans were based upon the average of 2.5 months of payroll costs for most borrowers, and that borrowers were given up to 28 weeks to spend sufficient amounts to qualify for forgiveness, most borrowers are simply waiting for their banks or advisors to assist them with filling out a forgiveness application, and then having it approved by the bank and submitted to the SBA to clear the loan from their balance sheets.
Under the present rules the lender has 60 days from receipt of the completed application to approve and send it to the SBA, the SBA then has 90 days from receipt to make any objection or cause the loan to be considered as satisfied. Unfortunately, the time periods have not begun for many borrowers whose banks have not yet begun to accept applications, and whose accountants are neck-deep in October 15th tax filing deadlines.
It now appears that consent/escrow requirements will need to be complied with, even when it is completely clear that the borrower qualifies for complete forgiveness. These requirements include prohibitions against transferring part ownership of the borrower entity or transferring or selling the assets of the borrower. These new rules will cause significant hardship for borrowers whose PPP loan documents do not prevent assignment, and for those who simply would not have known that there were transfer rules.
On Saturday, October 3rd the Small Business Administration issued a procedural notice on PPP loans and changes of entity ownership. PPP loan advisor Barry Portugal, who works with SCORE (a nonprofit resource partner of the SBA) as a Manasota Chapter mentor, had this to say about the new Notice:
“This notice is critically important to those small business owners who may be thinking of selling or merging their businesses due to the economic impact of Coronavirus. For business owners who find themselves unable to keep their doors open despite the PPP loan funds they received, they will now be faced with the need to notify their PPP lender in writing of the contemplated transaction and provide the PPP Lender with a copy of the proposed agreements. This Notice will add yet another layer of complexity to an already complicated business environment for business owners.”
These transfer prohibitions are set forth in the PPP loan agreements, and do not appear to violate the federal legislation (the CARES Act or the Paycheck Protection Program Flexibility Act of 2020), the interim rules, FAQs (“questions and answers”), or the terms of the forgiveness applications or the instructions thereto that were issued on June 20, and have not been modified since.
My associate, Brandon Ketron, J.D., CPA, L.L.M., and our friend, Kevin Cameron, CPA, will be discussing these new rules and where things now stand in a free webinar on Wednesday, October 11, 2020 at 11:00 a.m. EDT. Please send an email info@gassmanpa.com with the subject line “Transfer” and we will send you an invite. If you cannot make the live presentation we will provide you with a replay and a copy of our PowerPoint slides.
By my view, loan forgiveness should not be lost if a borrower has completely spent the amount borrowed on forgivable expenses, and has not reduced the workforce or payroll, or the compensation of any employee in a manner that would cause loss of forgiveness, which will sometimes be the case.
Those borrowers who qualify for complete forgiveness would expect to only have to wait for the formality of having bank acceptance of a forgiveness application, with SBA approval thereto to occur, or to be considered to have occurred, pursuant to the time parameters described above as lenders and the SBA do their best to comply with the many applicable rules and over 4 million applications being handled by people and computers that have not done this before.
The provisions of the new Notice are summarized below:
1. Will Not Apply After a PPP Note is “Fully Satisfied”
A PPP note is considered to be “fully satisfied” only once one of the following has occurred:
- The borrower has repaid the PPP note in full;
- The SBA has remitted funds to the bank lender in full satisfaction of the PPP note; or
- The borrower has repaid any remaining balance on the note and has completed the loan forgiveness process in accordance with the PPP rules.
If and when the PPP note is “fully satisfied” by having met one of the above 3 requirements there will no longer be any restriction whatsoever on ownership transfers, so that the remaining rules described below will not apply.
2. Need Not Count Under 20% Ownership Transfer or Under 50% Value of Asset Transfer
An entity ownership transfer of less than 20% of total ownership does not count.
Also, an asset transfer of less than 50% in value of the assets of the borrower does not count.
The Notice considers a “change of ownership” to have occurred if any of the following has taken place:
- 20% or more of the ownership in the borrower is sold or transferred;
- the PPP loan borrower sells or transfers 50% or more of its assets based on their fair market value; or
- a PPP loan borrower merges with or into another entity.
It therefore appears, for example, that individuals who own an interest in a borrower entity can transfer up to 20% of ownership by gift or sale, or cause the entity to sell or transfer just under 50% of the assets of the borrower without being in violation of the rules or risking any loss or delay in forgiveness. We are assuming that a provision in a PPP note that prevents any transfer of assets or assignment of ownership without the consent of the lender will not be applicable to the extent permitted below, but it would be good to have something in writing from the SBA to confirm this.
As Kenneth Logsdon and Cort Hoge, attorneys with Dorsey & Whitney, LLP, noted in their article entitled PPP Loans and M&A Transactions: Lender and Borrower Considerations,
It is unclear how these rules would apply if a borrower receives additional assets by reason of having another entity merge into the borrower, or a borrower merges into another entity having the same exact ownership of the borrower so that there is no change in substance.
Oftentimes there are reasons that an entity in one state would merge into an entity in another state or acquire assets or liabilities by way of merger. It would seem that these types of changes should not cause issues, but the Notice makes no mention of any exception.
The Notice does not specifically address what occurs when a new investor may transfer money or assets to a borrower entity in exchange for more than 20% ownership, or a borrower entity may buy out an investor to cause more than a 20% reduction in ownership. It is not absolutely clear whether these types of changes will be controlled by this Notice.
3. A Sale or Transfer of up to 50% by Percentage of Ownership Requires Lender Acknowledgement without SBA Approval
A sale or transfer of up to 50% in common stock or other ownership interests does not require SBA approval. When calculating this 50% threshold, all sales or transfers that have occurred since the date of the borrower’s approval for a PPP loan must be aggregated.
A lender is required to report such a sale or transfer to the SBA as described in section 7 below.
4. Over 50% Transfer of Assets or Ownership
Borrowers that transfer more than 50% of the fair market value of the borrower’s assets or have more than a 50% change in ownership are therefore subject to the rules because the above exceptions will not apply.
5. Need for SBA Approval Eliminated by Escrow Deposit and Forgiveness Application
Even when a borrower would otherwise need SBA approval by reason of making a transfer of more than 50% in the value of assets or having a transfer of more than 50% of ownership, such approval will not need to be received as long as the borrower completes the following:
- The borrower must complete a loan forgiveness application that reflects its use of the loan proceeds; and
- The borrower must establish an interest-bearing escrow account with funds equal to the outstanding PPP loan balance.
In such situations, once the forgiveness process is completed the escrow funds must first be used to pay back any amounts owed on a PPP loan, plus interest, with the remainder going to the borrower.
If the borrower does not meet the above two requirements then SBA approval is required.
The PPP Lender must report the location of and the amounts in the escrow account to the appropriate SBA Loan Servicing Center within 5 business days of the transaction’s completion.
6. What to do if SBA Approval is required
If the borrower does not satisfy the escrow and forgiveness application requirements above and SBA approval is therefore required (for a transfer of more than 50% of assets or ownership) then the Notice provides that the lender must submit a written request to the applicable SBA Loan Servicing Center which must include the following:
- The reason(s) why the borrower cannot satisfy the PPP loan obligations or the escrow requirements described above;
- The details of the transaction;
- A copy of the executed PPP Note;
- Any letter of intent and the purchase/sale agreement that sets forth the borrower’s responsibilities as well as the responsibilities of the buyer and seller (if the seller is different from the borrower);
- Disclosure of any existing PPP loan of the buyer (and the applicable SBA loan number); and
- A list of all owners of the purchasing entity that have a 20% or greater ownership interest.
The SBA may, if deemed appropriate for the particular borrower, require risk mitigation measures as a condition of approval.
The SBA’s approval or denial must be given within 60 days of the receipt of request.
7. PPP Borrower Remains Liable
For all sales or transfers of common stock or other ownership interest and for all mergers, regardless of whether SBA approval is required, the Notice confirms that the PPP loan borrower remains subject to all obligations under the loan, even after the transfer occurs.
The Notice states that:
“[i]f any of the new owners or the successor arising from such a transaction has a separate PPP loan, then following consummation of the transaction . . . the PPP borrower and the new owner(s) are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower[.]”
Following either a merger or a sale or transfer of ownership of the borrower entity, the PPP Lender must notify the applicable SBA Loan Servicing Center within 5 business days after the transaction has been completed. This notification must include the following:
- The identity of the new owner(s) of the ownership interest (common stock or otherwise);
- The ownership percentages for the new owner(s);
- The Tax Identification Number for any owner(s) holding more than 20% interest in the entity; and
- The location of, and amount of funds in, the escrow account, if one is required.
8. PPP Loans Pledged in PPP Liquidity Facility
The PPP Liquidity Facility (“PPPLF”) extends credit to qualifying financial institutions that originate PPP loans by “taking the loans as collateral at face value.”
PPP lenders who have pledged notes to secure a loan under the Federal Reserve’s PPPLF Program must further comply with notification and other requirements of such program.
9. What is a Transfer of Assets from an Entity?
In many situations borrowers have had to close down, and have not been able to attract new capital because of obligations such as leases and bank loans that the entity cannot repay.
Many of these entities are now in bankruptcy, or will file bankruptcy in order to properly administer whatever assets remain, and to possibly sell any goodwill or going concern value and operational assets to a related or unrelated entity with the blessing of the bankruptcy court in what is known as a “Section 363 Sale.”
Bankruptcy Code Section 363 permits such sales with the approval of the bankruptcy court in order to maximize whatever amounts can be received for the assets in order to pay for the administrative expenses of the bankruptcy process, attorney and other expert fees, and creditors.
Time will tell how these rules may impact borrowers in bankruptcy, and whether the SBA will promulgate rules to facilitate helping failed borrowers get a fresh start.
We will continue to do our best to understand and explain the labyrinth of rules, regulations, and procedures that continue to develop and complicate the lives of businesses struggling to survive during very difficult times.