By Corrie Thrasher, partner, Starfield & Smith PC
This article originated on the blog of the legal firm of Starfield & Smith
As discussed previously in my first article, many uncertainties exist when the owners of a business who received a Paycheck Protection Program (“PPP”) loan wish to transfer their business to a purchaser. Without formal guidance from SBA, these “changes in ownership” transactions pose unprecedented challenges for 7(a) lenders. In this article, I will examine some key considerations for SBA lenders as they seek to manage their existing PPP loans and/or seek to finance change in ownership when the seller has an outstanding PPP loan.
Lender issues arise when 1) the lender is the PPP loan holder, and 2) when the lender is financing a business acquisition / change in ownership by virtue of a new 7(a) loan.
Consent of SBA to the Change in Ownership:
SOP 50 57 2 and SBA Procedural Notice 5000-19009 indicate that changes to ownership of a Borrower within twelve (12) months of final disbursement of an existing SBA 7(a) loan (which includes a PPP loan) require SBA’s prior approval. It is unclear whether this requirement applies to any “change of ownership” either by transfer of equity or asset sales. Regardless, many PPP lenders and 7(a) lenders are now faced with the decision if, when and how to submit to SBA for “approval” on change in ownership transactions when the seller received a PPP loan.
However, guidance has been scarce on what form these requests or approvals should take.
Lenders complying with the existing “prior SBA approval” rule, may well do a serious disservice to small businesses by delaying closing until SBA approval is received, which would be in clear violation of SBA’s mission to support small businesses. However, proceeding without prior SBA approval, but in a prudent manner, while achieving the goals of the Agency, may subject lenders to scrutiny by SBA’s Office of Credit Risk Management and possibly, to the loss of its SBA Loan Guaranty, and possibly impact the borrower’s ability to obtain forgiveness.
Possible Default due to Nondisclosure:
Under the standard Form 147 SBA Note (used in many PPP loans), it is considered a default on the loan when a Borrower fails to obtain the consent of the lender to any change in ownership transaction. Specifically, it is a default when a Borrower “reorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender’s prior written consent.”
Loan Assumptions and Considerations:
Many PPP lenders are now faced with servicing requests from existing PPP borrowers to allow and document in the case of an asset purchase or a stock purchase, an approval of a change of ownership and possibly an assumption of the PPP loan by the new buyer,.
SBA has indicated informally that it will allow changes in ownership upon request, but it will not review or approve the form of assumption agreements, underwriting, or any other documentation. It is unclear to what extent the PPP lender needs to underwrite the buyer who assumes a PPP Loan. There is also no indication whether the existing borrower can be released from its obligations – prudent lending may dictate that PPP lender maintain the existing PPP borrower’s obligations with respect to the PPP loan until forgiveness is decided by SBA. There is also no indication of whether PPP lenders are expected to perform a “full” 7(a) underwriting of a buyer, or a more modest PPP-level of underwriting, or some level in between. Since PPP lenders were allowed to rely on the certifications of borrowers as to their eligibility at the time the PPP loan was made, it seems unreasonable to hold PPP lenders to a higher underwriting standard for the buyer.
This is further complicated by the fact that many lenders made the decision to only lend PPP monies to existing customers in order to streamline the underwriting process under the CARES Act (i.e., KYC). But new buyers of these businesses may not be existing customers of lender; hence, the assumption transaction would require at least a commercially reasonable level of underwriting by the PPP lender, which is, by definition, more than was required of the original PPP loan. It is also unclear whether a PPP lender can charge any fees for their time processing these servicing requests.
Given the thousands of PPP loans extended nationwide, it is critical for anyone buying or selling a business, and their advisors and lenders, to ask about outstanding PPP loans as part of initial underwriting.
Next, lenders need to consider all possible scenarios, taking into account the amount of the PPP loan, the anticipated closing date, whether forgiveness has been applied for/received, and the facts of the particular transaction, in order to adequately allocate risks among the parties and avoid disputes after closing.
For a PPP Lender, dealing with a stock purchase or asset purchase prior to forgiveness processing, informal SBA guidance has been to escrow an amount covering the entire PPP loan. Depending upon the circumstances, the escrow may be for either the benefit of buyer or seller, depending on who will bear the most risk and who should be entitled to the benefit of the forgiveness. However, while escrow will work in most cases, there will be situations, particularly when the size of the PPP loan is larger than the sales price for the business, when the escrow solution will not. In these situations, GP processing may be the best alternative.
The bottom line for all parties is that, in the absence of formal, detailed and reasonable guidance, the goals for lenders are to protect the SBA guaranty and assist small businesses. SBA is working diligently to resolve these issues, but it will take time to address all concerns as these scenarios continue to evolve. Lenders, whether PPP lenders or 7(a) lenders, should consider their policies and procedures, communicate with SBA and consider escrowing the PPP loan payoff at the time of sale/financing, in order to protect the guaranty and mitigate risks.
Corrie is a partner in the Atlanta, Georgia office of Starfield & Smith PC. She specializes in government guaranteed lending, commercial real estate, and banking.