As readers of this article are well aware, borrowers will sometimes engage in strategic transactions (e.g., mergers, asset sales, membership or stock redemptions, etc.). The Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan program (EIDL) require special attention when borrowers engage in strategic transactions. This article considers the role of the lender and the role of borrowers in strategic transactions involving these loan programs.
PPP provided short term financial assistance to small businesses dealing with the impact of the COVID-19 pandemic. The program originated in Congress in March 2020 as part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and was intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. PPP restarted on April 24, 2020, following the appropriation of new funding, and the PPP Flexibility Act of 2020 relaxed many PPP loan guidelines. The original deadline to apply for a PPP loan was June 30, 2020, but was extended through Aug. 8, 2020, by legislation signed on July 4, 2020.
The PPP loan forgiveness process has begun. Important changes to PPP loan forgiveness came with the PPP Flexibility Act of June 5, 2020. All or part of a PPP loan could be forgiven provided the borrower kept all full-time equivalent employees on the payroll or rehired them within 24 weeks of receiving the loan or by Dec. 31, 2020, whichever comes first. To be eligible for forgiveness, payroll costs must be 60% or more of the amount forgiven. Eligible non-payroll expenses may only constitute 40% of the amount forgiven, and forgiveness will not occur until the end of the 24-week period of employment following receipt of the loan.
PPP is one of two programs designed to help small businesses during the COVID-19 pandemic. In addition to PPP, the Economic Injury Disaster Loan program (EIDL) is also intended to help struggling businesses weather the COVID-19 pandemic. As opposed to being designed to help companies retain workers, EIDL helps small businesses overcome the loss of revenue during a declared disaster such as an extreme weather event, a fire, or recently become the case of the COVID-19 pandemic. The program was initially open only to agricultural businesses. The EIDL program reopened to eligible borrowers on June 15, 2020. Many small businesses were eligible for both loan programs subject to specific rules about the use of loan proceeds.
The impact of strategic transactions on PPP and EIDL loans
In addition to spending many long days entering application data into the portal, interpreting rules and regulations, and beginning the forgiveness process, many of the readers of this article have been contacted by borrowers about various transactions and the impact of having a PPP or EIDL loan. As can be expected, some borrowers under these programs have contemplated or engaged in mergers, asset sales, membership or stock redemptions and other transactions.
While there is no formal guidance from the SBA, PPP borrowers need to determine if a consent or waiver of default on the PPP loan is necessary when considering a strategic transaction. The PPP loan program is a product of the SBA’s 7(a) business loan program governed by Section 7(a) of the Small Business Act, the SBA Standard Operating Procedures, SBA regulations and SBA Procedural Notices. Many of these rules also apply to the PPP loan program, in addition to the rules established specifically for the PPP loan program. SOP 50 57 2 provides that, after the full disbursement of loan proceeds, certain actions will require SBA’s prior written approval. These actions include a “(c)hange in the ownership of a Borrower in the first 12 months after the final disbursement.” This requirement applies to “any adjustment to or change in the ownership of a Borrower, including a change in percentage of ownership, for 12 months after final disbursement on any loan.” Assumptions of PPP loans that release the original borrower also require SBA approval. In the absence of consent or a waiver of a default, a PPP borrower could potentially forfeit its ability to obtain loan forgiveness.
The EIDL loan program has been in existence for decades and is governed by Section 7(b) of the Small Busines Act and carries a different set of regulations from the Section 7(a) rules that govern PPP loans. Also, unlike PPP loans, which involve a private party lender, EIDL loans are funded and administered by the SBA. EIDL loans also have a loan term of up to 30 years, unlike the short-term PPP loans, making it more likely that a strategic transaction involving the borrower will arise during the life of the EIDL.
EIDL promissory notes provide that the borrower is in default if it “(r)eorganizes, merges, consolidates, or otherwise changes ownership or business structure without SBA’s prior written consent.” Also, the SBA requires collateral to secure all EIDLs over $25,000.00, often taking a blanket security interest in all of the borrower’s tangible and intangible personal property, in addition to any real estate collateral. The EIDL security agreement provides that the borrower “will not sell, lease, license or otherwise transfer (including by granting security interests, liens, or other encumbrances in) all or any part of the Collateral or Borrower’s interest in the Collateral” without SBA’s written approval. EIDLs under $200,000 do not require personal guarantees. Still, for transactions of $200,000 or more, under SOP 50 30 9, the addition or deletion of a guarantor is a material change to an EIDL that requires SBA’s approval and possibly a loan document modification.
All parties to a strategic transaction involving a small business with an outstanding PPP loan or EIDL, including the PPP lender, have a stake in ensuring the SBA has been notified of and has approved the transaction when required. As you might expect, the SBA has been overwhelmed with PPP loan and EIDL requests and forgiveness applications. Accordingly, contacting the SBA from the outset of a strategic transaction should be one of the first due diligence tasks engaged in by the parties to the transaction.
Matthew Kingery is of counsel with Lewis Glasser, PLLC, in Charleston, West Virginia. Matt devotes his practice to commercial transactions, lender representation, commercial development, distressed assets and real property matters with an emphasis on title, acquisitions, sales and financing issues. Matt has been recognized for his work in the legal industry and community and has received numerous awards, including being selected multiple times in Super Lawyers® in the practice area of real property law; named the 2010 West Virginia State Bar Young Lawyer of the Year; honored as a recipient of the 2009 Generation Next 40 Under 40 award by The State Journal, and named a Young Gun by the West Virginia Executive in 2017. He can be reached at firstname.lastname@example.org.