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Four Things You May Have Missed about the PPP Change of Ownership Notice

As previously discussed, on October 2, 2020, the SBA published Procedural Notice 5000-20057 addressing Paycheck Protection Program Loans and Changes of Ownership. Based on a review of memos on the subject by other law firms and accounting firms, four items stood out as not being regularly addressed (in addition to some expressing the mistaken belief that buyers have to assume the PPP loan in any asset transaction).

1. Any Merger Triggers the Procedural Notice. 

The definition of a change of ownership includes any merger of the PPP borrower with or into another entity.  Even if the PPP borrower is the surviving entity and there is no change in shareholder ownership, it would appear to be pulled into the SBA Procedural Notice. Accordingly, either internal reorganizations or acquisitions could trigger the obligations of the Procedural Notice if structured as a merger.

2. Stock Transfers Between Existing Shareholders Can Trigger Procedural Notice. 

Stock transfers to affiliates and existing owners are covered, not just sales to new owners. Any change in shareholder composition that results in a greater than 50% change since the receipt of the PPP loan triggers a change of ownership of ownership under the Procedural Notice.

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SBA Confirms Impact of PPP Flexibility Act on Outstanding Promissory Notes

On October 7, 2020, the Small Business Administration and Treasury Department updated their Frequently Asked Questions on the Paycheck Protection Program with FAQ 52. As reflected in the question, the PPP Flexibility Act made certain changes to the terms of loans made under the Paycheck Protection Program, including an extension of the deferral period before any payments would be required. FAQ 52 confirms that these changes automatically applied to all outstanding PPP loans, and that lenders are required to give immediate effect to the statutory extension. While no formal modification of the promissory note is required (thus avoiding any need to re-execute the promissory note or an amendment), the FAQ provides that lenders “should” give notice to borrowers of the changes caused by the PPP Flexibility Act.

As the changes of the PPP Flexibility Act were 100% in the favor of the borrower, this is consistent with the approach that Bryan Cave Leighton Paisner LLP recommended to PPP lenders in advance of the publication of the new FAQ. In addition to the extension of the deferral period, the PPP Flexibility Act also provided for a permissible extension of the covered period for potential forgiveness from 8-weeks to 24-weeks, and a reduction in the percentage of forgiveness that must be used for payroll expenses.

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SBA Provides Guidance on Changes of Ownership of PPP Borrowers

On October 2, 2020, the SBA Office of Capital Access published Procedural Notice 5000-20057, which provides a framework to address whether SBA pre-approval is required for various changes of ownership under the Paycheck Protection Program, as well as the process for seeking that approval if needed. Any Paycheck Protection Program borrower looking at a potential change in control, whether via actions of the shareholders or direct action by the PPP borrower needs to be familiar with this guidance. In addition, anyone looking to acquire control of a PPP borrower should also review the guidance. While the guidance makes clear the possibility of preserving the potential for forgiveness of the PPP loan through a change of ownership, the Procedural Notice sets forth various approaches to obtain SBA pre-approval for the transaction (or to avoid the need for SBA pre-approval.)

Before outlining the key elements of the SBA guidance, we must note that this guidance is being published almost six months after the first PPP loans were issued, and two months after the SBA advised that guidance on changes of ownership would be issued “soon.” While one might hope that such delay at least allowed for clear and complete guidance to be published, I’m afraid the guidance may result in more questions than answers.

General Rule

Without expressing a basis for such obligation, SBA Procedural Notice provides that prior to the closing of any “Change of Ownership” transaction, the “PPP borrower must notify the PPP Lender in writing of the contemplated transaction and provide the PPP Lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction.”

While only specifically requiring notification (as opposed to application or consent), this requirement would seem inconsistent with the SBA’s Frequently Asked Questions and Interim Final Rule permitting lenders to use their own promissory note and to include any terms not inconsistent with Sections 1102 and 1106 of the Cares Act, the PPP Interim Final Rules and Guidance, and SBA Form 2484. While the SBA general form of promissory note does require lender’s prior consent if a borrower “reorganizes, merges, consolidates, or otherwise changes ownership or business structure,” these terms were not defined and lender’s were expressly permitted to use other forms of note.

Changes of Ownership Defined

For purposes of the SBA Procedural Notice, “Changes of Ownership” are defined to consist of the following transactions:

  • an aggregate change in 20% or more of the ownership interests in the Borrower since date of SBA approval of the SBA loan (but for public companies, only need to include sales or transfers resulting in one person owning at least 20%) (stock transfers);
  • sale or transfers of 50% or more of the fair market value of the assets of the Borrower (asset sales); and
  • mergers with or into another entity (mergers).
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GAO Report Highlights Need for Additional PPP Forgiveness Guidance

On September 21st (do you remember?), the U.S. Government Accountability Office released a report on the Federal Government’s COVID-19 response, including with respect to the Paycheck Protection Program. The GAO report provides additional statistical breakdown of the PPP loans, addresses some of the SBA’s oversight plans, and then addresses the need for further guidance on the PPP forgiveness process.

Updated Statistics

The GAO Report notes that most of the largest PPP loans (those over $2 million), were made during the first phase of the program, between April 3rd and April 26th. 75% of the loans for more than $2 million were approved in the first phase, with the report noting that this may have been due to increased scrutiny from the public, Treasury and SBA.

The vast majority of PPP loans were made to borrowers with 10 or fewer employees (73.6% of the loans) while the majority of PPP loan dollars went to businesses with 100 or fewer employees (67.6%). While borrowers with more than 500 employees were granted limited access to participate in the program, less than 0.1% of borrowers had more than 500 employees.

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PPP: Does a Borrower need its Lender’s Consent to a Change in Control Transaction?

Nothing in the CARES Act, Interim Final Rules, or Frequently Asked Questions currently requires Lender’s Consent in connection with a change in control transaction. However, the specific terms of the PPP Note signed by the borrower may require the Lender’s consent in a variety of situation.

(Note: This is one post in a series of posts regarding questions about the Paycheck Protection Program and Loan Forgiveness. A list of questions addressed so far is also available on our PPP Resources page. These questions and our answers are based on discussions with colleagues and clients, both lenders and borrowers. Our intention is to cover issues that, while potentially frequently asked, are not explicitly addressed in official FAQs or directly in Interim Final Rules. Our answers may ultimately be subject to change as additional guidance is provided, but reflect our view of the regulations at the time of posting.)

Update October 4, 2020: The SBA has published a Procedural Notice outlining when and how SBA pre-approval of a Change of Ownership is required. The Procedural Notice provides, among other things, that a PPP borrower must notify its Lender in writing of any contemplated change of ownership transaction and provide the Lender with copies of the transaction documents. The Procedural Notice provides certain situations where the PPP Lender may approve the Change of Ownership without SBA pre-approval, and other situations where the PPP Lender may not unilaterally approve the Change of Ownership. Read our summary of the SBA Procedural Notice on Changes of Ownership under the Paycheck Protection Program.

Consistent with SBA PPP FAQ #19, no specific form of PPP note was required to be used by lenders. Each lender was authorized to use their own promissory note or an SBA form of promissory note. Many, but by no means all, PPP lenders ultimately used the SBA Standard Loan Note on Form 147 as the base of their PPP promissory notes.

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PPP: Who is subject to Owner-Employee Compensation Forgiveness Limitations?

Self-employed Schedule C (and Schedule F) filers, general partners, and other PPP borrowers that utilized 2019 IRS Form 1040 Schedule C line 31 net profit amount in calculating the amount of their PPP loan are clearly subject to these limitations. However, the SBA guidance also indicates that owner-employees of C-Corporations, S-Corporations and LLCs are subject to the owner-employee compensation limits, and the SBA guidance is silent on limited partners.

Update (8/24/20): The Treasury and SBA published a new Interim Final Rule that confirms the initial guidance did not include any exception based on the owner-employee’s percentage of ownership. However, the new rule also provides that “an owner-employee in a C- or S-Corporation who has less than a 5 percent ownership stake will not be subject to the owner-employee compensation rule.” While limited partners are not addressed in the new rule, we note the original Interim Final Rule which limited owner-employees only referenced general partners; accordingly presumably no formal exception for limited partners is necessary. This would also be consistent with the reasoning for less than 5% shareholders, as limited partners would generally “have no meaningful ability to influence decisions over how loan proceeds are allocated.”

(Note: This is the third in what we anticipate to be a series of posts regarding questions about the Paycheck Protection Program and Loan Forgiveness. A list of questions addressed so far is also available on our PPP Resources page. These questions and our answers are based on discussions with colleagues and clients, both lenders and borrowers. Our intention is to cover issues that, while potentially frequently asked, are not explicitly addressed in official FAQs or directly in Interim Final Rules. Our answers may ultimately be subject to change as additional guidance is provided, but reflect our view of the regulations at the time of posting.)

The current Paycheck Protection Program Forgiveness Application asks all borrowers to certify as follows:

  • if a 24-week Covered Period applies, the forgiveness amount requested  does not exceed 2.5 months’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $20,833 per individual; and
  • if the Borrower has elected an 8-week Covered Period, the forgiveness amount requested does not exceed 8 weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.

While the concept of owner-employee compensation was initially used by the SBA to calculate the amount that a small business with no employees was eligible for, with the expansion of the eligible covered period, the Treasury and SBA have also added restrictions on the use of compensation to “owner-employees” in calculation of the amount of payroll costs eligible for forgiveness. See, for example, the “Interim Final Rule on Revisions to Loan Forgiveness Interim Final Rule and SBA Loan Review Procedures Interim Final Rule” and the Frequently Asked Questions about Loan Forgiveness.

Unfortunately, to date, neither the Treasury nor the SBA has meaningfully defined what constitutes an “owner-employee” or provided any guidance as to whether borrowers need to limit W-2 compensation paid to an employee that happens to have an ownership interest (however small) in the borrower. The Frequently Asked Questions “defines” an owner-employee as “an owner who is also an employee.”

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(Final?) PPP Loan Approval Statistics through 8/8/2020

Barring further legislative action, the approval window for new Paycheck Protection Program Loans came to a close on August 8, 2020. Since the original launch on April 3rd following the CARES Act, 5,212,128 small businesses have borrowed $525 billion under the Paycheck Protection Program. On August 11th, the SBA published a Paycheck Protection Program Report with additional details.

The overall average loan size under the Paycheck Protection Program was $101 thousand, and this average steadily fell during the lifetime of the Paycheck Protection Program. But even that average number emphasizes the statistical differences between median and mean. While the average loan was just over $100 thousand, over 68% of the loans were for $50 thousand or less (and over 81% of PPP loans were smaller than the average PPP loan).

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PPP: Can Forgivable Payroll Costs Exceed Loan Amount?

Yes, in completing a Paycheck Protection Program loan forgiveness application, we believe a borrower can appropriately report actual payroll costs during the applicable covered period in excess of the original PPP loan amount. While actual forgiveness is ultimately limited to the amount of the PPP loan, the calculations provided for in the loan forgiveness application allow payroll costs to exceed the amount of the PPP loan, thereby permitting borrowers to potentially obtain full forgiveness even if the borrower is subject to FTE and/or salary/hourly wage reductions.

(Note: This is a first in what we anticipate to be a series of posts regarding questions about the Paycheck Protection Program and Loan Forgiveness. A list of questions addressed so far is also available on our PPP Resources page. These questions and our answers are based on discussions with colleagues and clients, both lenders and borrowers. Our intention is to cover issues that, while potentially frequently asked, are not explicitly addressed in official FAQs or directly in Interim Final Rules. Our answers may ultimately be subject to change as additional guidance is provided, but reflect our view of the regulations at the time of posting.)

In light of the 24-week covered period and the PPP loan amount being based on effectively 10 weeks of payroll costs, we believe most PPP borrowers will ultimately have payroll costs that significantly exceed the amount of their PPP loan principal. This should not only facilitate full loan forgiveness, but also may ease the calculations under the forgiveness application and reduce the need to be aggressive with regard to questionable forgivable expenses, FTE calculations, or safe harbor certifications. (As reflected in the Forgiveness API FAQ, so long as lenders agree with the final total forgiveness amount, such applications can be submitted as being approved in full, even if there is disagreement on certain line items.)

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Analysis of PPP Borrowers: Who Returned Funds?

While a lot has been written and said about the “need” certification when it comes to the Paycheck Protection Program, particularly for public companies, the SBA and Treasury have been relatively quiet about how many borrowers that received PPP funds elected to to take advantage of the government’s subsequent safe harbor to return funds. In connection with the forgiveness process, the SBA has indicated that it will review all loans in excess of $2 million, but will deem all borrowers of $2 million or less to have made the required certification concerning the necessity of the loan request in good faith.

Based on our analysis below, 88% of public borrowers that received PPP loans elected to retain their PPP proceeds, and 75% of borrowers approved for PPP loans of between $5 and $10 million did the same. Based on our discussions with PPP borrowers throughout the country, we think this is consistent with the economic uncertainty that was created by the coronavirus.

SEC Filings

Based on a review of SEC filings, Bryan Cave Leighton Paisner identified over 850 borrowers who indicated that they had received PPP loan approvals. 107 of these borrowers, or roughly 12 percent, subsequently indicated that they either ultimately did not accept the loan, or returned the loan proceeds. About 25% of public companies who returned their loans had PPP borrowings that were less than the $2 million threshold for review indicated above.

Of the 759 public companies that elected not to return their PPP funds, approximately 73% received $2 million or less, while the remaining 27% had PPP loans of more than $2 million. About 8% of the public company recipients received less than $100,000, while over 55% received less than $1 million.

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The Unsafe Waters of the PPP Purported FTE Reduction Safe Harbors

On June 17, 2020, the SBA and U.S. Treasury published an updated form of application and instructions for borrowers seeking forgiveness of their Paycheck Protection Program loans, as well as a new “EZ” form of application and instruction. In both cases, these applications generally implement the statutory changes required by the Paycheck Protection Program Flexibility Act.

While the improved likelihood of full forgiveness due to the 24-week covered period is likely to draw the most attention, potential compliance with two of the safe harbors provided to avoid a loss of forgiveness in the event of a reduction in the number of Full Time Equivalent (FTE) employees comparing the applicable “covered period” with the applicable reference period. Under the CARES Act, while borrowers are generally eligible for loan forgiveness for certain expenditures during the covered period, actual loan forgiveness must be reduced if the borrower’s weekly average number of FTE employees during the covered period was less than during the borrower’s chosen reference period (generally, February 15, 2019 through June 30, 2019 or January 1, 2020 and February 29, 2020; or, for seasonal employers, any consecutive 12-week period between May 1, 2019 and September 15, 2019).

However, under the revised PPP loan forgiveness application, there are certain FTE reduction exceptions and two safe harbors. Each of these provide potential relief from a decrease in forgiveness due to a reduction in FTE levels… but they also provide enhanced risk for borrowers needing to rely on them. In addition, general eligibility for the use of the Form EZ loan forgiveness application is conditioned on compliance with the reduction exceptions or one of the safe harbors.

FTE Forgiveness Reduction Exceptions

As provided in the original forgiveness application, in calculating the average number of FTE employees during the covered period, borrowers are permitted to effectively add back the FTEs for: (1) any positions for which the employer made a good-faith, written offer to rehire, which was rejected, (2) any employees who were fired for cause, voluntarily resigned, or voluntarily requested and received a reduction in hours. (If the positions were re-filled during the covered period, than borrowers are required not to double-count such positions.)

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