Updated: Apr 2, 2021
Depressed Merger Activity
The COVID-19 pandemic crushed early 2020 merger activity. 2,064 M&A transactions worth a combined $106.4 billion were announced in the U.S by the end of Q2 2020. Compared with 2,895 deals valued at $622.9 billion for the same period in 2019, this represents an 83% decline. However, recent merger announcements appear to indicate a busy second half to the year. August saw the announcement of multi-billion dollar deals including the likes of Teledoc Health (TDOC) and Livongo Health (LVGO) (merger), and Intercontinental Exchange (owner of the NYSE) and Ellie Mae (acquisition).
Some call the uptick in M&A activity a sign of an economic rebound. Others who recall a similar increase in activity just prior to the dotcom crash consider it an alarm signal. Whatever economic interpretation you prefer, there's an element unique to 2020 M&A transaction that require consideration: Payroll Protection Program (PPP) Loans, and their forgiveness.
The Payroll Protection Program (PPP)
In March 2020, Congress passed a $2.2 trillion stimulus bill called the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act provided relief to the millions of businesses and organizations affected by the COVID-19 coronavirus (and government responses thereto). One of the vehicles of relief was forgivable loans administered through the Small Business Administration (SBA). These loans (and their pending forgiveness) present a quagmire of potential issues for organizations entering the mergers and acquisitions space with PPP Borrowers and Lenders.
Administered by the SBA, the PPP loans are considered 7(a) loans. With 7(a) loans, the borrower works with a (usually local) lender, and the SBA participates by guaranteeing a portion of the loan. PPP loans are therefore subject to the same regulations and guidelines that govern 7(a) loans.
What Does This Means For M&A Transactions?
Among the 7(a) guidelines are restrictions on certain activities for lenders and borrowers. One such restriction is requiring the Lender to obtain SBA consent before the Borrower is permitted to engage in a "change of ownership" within 12 months of final disbursement of the loan.
This is where mergers and acquisitions are affected.
Importantly, although SBA regulations do not explicitly address asset acquisition, the SBA has informed PPP Lenders that it does not distinguish between asset and equity acquisition for "change of ownership" purposes. This means that targets of equity or asset acquisition with a PPP loan should carefully navigate 7(a) requirements whether the contemplated activity is an asset or equity acquisition.
Considerations for Lenders, Borrowers, Buyers, & Sellers
As mentioned above, obtaining the SBA's consent for a Borrower's "change of ownership" is the Lender's obligation. The Lender's failure to obtain this consent ahead of any merger or acquisition can result in the Lender losing the SBA's guarantee of the subject loan.
The only meaningful way for the Lender to control any "change of ownership" process is to require the Borrower to obtain the Lender's consent before any merger or acquisition can be effective. This could presumptively render any change absent Lender consent void or voidable, or offer the Lender some future legal indemnity or other relief.
However, that ship may have already sailed. The pro forma SBA form PPP loan promissory note contains restrictions regarding changes to the business and its ownership without Lender consent. However, Lenders were not required to use this form. They were permitted to create and use their own. Accordingly, if a Lender opted to use a form that failed to include similar prohibitive language (the SBA form recognizes instances where a Borrower "reorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender's prior written consent"), there is no SBA guidance that will operate in its place to prevent a Borrower from effectuating a "change of ownership" without the Lender's approval. This would consequently deprive the Lender of the opportunity to make their approval conditional on the consent they require from the SBA.
If a PPP Lender used their own form promissory note, the Lender should review the terms of the note to confirm whether it contains "change of ownership" prohibitions similar to the SBA note. If it lacks the requisite language, it would seem prudent that they check their list of Borrowers to assess the likelihood of them engaging in M&A activity for the purpose of determining potential liability, and contact the SBA for further guidance on how they can protect themselves.
Borrowers & Sellers
Simply put, if a PPP Borrower targeted for a merger or acquisition fails to obtain its Lender's consent to a merger or acquisition (if required by the loan note) before the completion of the transaction, it may result in the denial of the PPP loan forgiveness application, and immediate repayment of the loan.
If the Lender's consent to the transaction is required, then the SBA's approval will also be required. At the time of writing, SBA approval for "change of ownership" is estimated between 2 and 6 weeks following the Lender's request for such approval. It may take an indeterminate number of weeks before the Lender submits the consent application to the SBA, further extending that timeline. SBA approval is also not guaranteed.
Accordingly, if acquiring the consent of the PPP Lender or the SBA is impractical, difficult to obtain, substantially delayed, or presents an unacceptable risk to the transaction timeline, the parties to the transaction may consider delaying the transaction timeline for such duration as may be necessary to finalize the loan forgiveness prior to closing.
The Buyer in any merger or acquisition transaction involving a PPP Borrower should consider all of the above information (even more so if the target is a PPP Lender) so that they are not required to pay back any acquired loan proceeds due to a retraction of the SBA guarantee or a failure of loan forgiveness.
They also have independent considerations.
If the M&A transaction timeline provides for closing before the Borrower/Seller's PPP Loan is forgiven, the due diligence process should include a careful review of the loan note. If required by the note, evidence of the Lender's and SBA's consent to the transaction should also be acquired prior to closing.
Even where evidence of consent is acquired, however, prudence suggests that the transaction timeline be constructed to permit the Borrower time to submit the loan forgiveness application prior to closing. An escrow should also be set up to hold a sum equal to the full value of the PPP loan, with the expectation that the funds will be released upon successful loan forgiveness (or otherwise used to resolve loan liability in the event of partial or refused forgiveness). In constructing the transaction timeline, remember that a PPP Lender has 60-days to approve a forgiveness application before submitting their own forgiveness application to the SBA. The SBA then has 90-days to approve or reject the Lender's forgiveness application.
Finally, for Buyers, it is important to note that the SBA retains the right to review a PPP loan for originating eligibility issues and require repayment of the loan - even after the loan is forgiven. With this in mind, a Buyer should ensure that all eligibility criteria (and all documents, records, figures, and information proving eligibility) is secured and vetted prior to the completion of the M&A transaction.
Out-House Attorneys provides full asset and equity M&A transaction support, and corporate consulting services. We partner with your in-house legal team and/or outside counsel to deliver timely and affordable services, including contract review and preparation, discovery, due diligence, and closing support. Contact us today to speak with your new partners in law.
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