There is a significant likelihood that M&A transactions in the next year may involve PPP loans. Here are several deal components that should be considered in light of PPP.
In Vermont, as of May 30, 2020, approximately 11,000 businesses had received a Paycheck Protection Program (the “PPP”) loan from the U.S. Small Business Administration (the “SBA”) under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). These companies are now operating to spend the loan proceeds before seeking loan forgiveness. Effective on June 5, 2020, the Paycheck Protection Program Flexibility Act of 2020 (the “Flexibility Act”) expanded the covered period for PPP loans from eight to twenty-four weeks, thereby extending the period during which PPP loans may become intertwined in corporate M&A transactions. Even after the covered period expires and a loan forgiveness application is filed, it could be months more before a final loan forgiveness determination is made. The process for review of a loan forgiveness application could take up to five months (if not longer). Presently, there is no way to expedite review of a loan forgiveness application. Consequently, there is a significant likelihood that M&A transactions in the next year may involve PPP loans.
Critical aspects of PPP loan forgiveness remain uncertain and subject to promised, but delayed, SBA rules. Perhaps of even greater consequence, the SBA has aggressively saber-rattled its audit and enforcement authority resulting in many borrowers’ relinquishment of loan proceeds under the threatened loss of forgiveness eligibility and potential criminal and/or civil liabilities and penalties. All of this uncertainty underscores the importance of risk/benefit allocation between parties to any M&A transaction that includes a PPP loan. Over the next year, the novelty of the PPP, the significant sums that may be involved, and the vagaries of PPP implementation will influence transactions effecting the purchase and sale of businesses that borrowed PPP loans.
To protect against the uncertainty and risks of PPP forgiveness, purchasers should require additional diligence, and both parties may seek special representations, and/or indemnity provisions from the other. Mutual consideration should be given to deeming the PPP loan like any other indebtedness that is to be repaid in full at closing, but in that scenario, the seller’s relinquishment of forgiveness value may also influence the purchase price. In any event, buyers and sellers will both need to carefully consider the allocation of PPP loan benefits and risks, and the process of future loan forgiveness. In turn, such consideration will influence the negotiation and drafting of M&A transaction documents. Deal components that should be considered in light of PPP include:
Purchase Price Adjustment; Escrow. A purchaser may consider negotiating for an adjustment to the purchase price for any loan amount not forgiven, including interest. The PPP loan may need to be a separate component for adjustment taking into account the potential prolonged period that may be required to determine whether the PPP loan will be forgiven, and if so, in what amount. Purchasers might also request a separate escrow in the amount of the PPP loan principal and interest, to be released upon forgiveness.
Indemnification. If an adjustment for any unforgiven PPP loan amount is not included in the purchase price adjustment section, purchasers might seek seller’s indemnity to that effect. Even if the parties agree to an adjustment to the purchase price in respect of the loan amount, purchasers might seek a specific indemnity in respect of costs and expenses of an audit and/or litigation, and any criminal and/or civil liabilities and penalties, especially if such liabilities arise from seller’s earlier certifications and use of loan proceeds.
- Use of Loan Proceeds.
If any PPP loan proceeds remain unused or are to be spent while closure of the corporate transaction remains pending, purchaser may seek to negotiate interim operating covenants governing use the PPP loan proceeds. For example, such covenants might allow PPP funds to be used by seller only for forgiveness-eligible purposes to maximize the prospects of loan forgiveness. Sellers may also consider that negotiating post-closing covenants governing the buyer’s use of PPP loan proceeds after closing might limit potential future liabilities and enforcement risks. The parties may also consider the mutual benefits of negotiating interim operating covenants concerning actions or communications that might increase the likelihood of scrutiny or liability with respect to the PPP loan or that could adversely affect the likelihood of, and the level of, forgiveness.
- Party Controlling Loan Forgiveness Application/Audit/Appeal.
If the seller is entitled to benefit from any loan forgiveness or has retained any post-closing PPP liabilities, the seller might seek a covenant allowing its control of the PPP loan forgiveness application process. Purchaser in turn might require its own review and consent to the loan forgiveness application prior to submission. Conversely, if purchaser controls the loan forgiveness application, seller might seek covenants which would limit any deleterious effect on the purchase price or other post-closing seller PPP liabilities.
Similarly, parties should consider including covenants concerning the control of any audit process or the use of appeal, including possibly the right to separate counsel, cost sharing or recovery, and rights of participation, decision making and settlement.
PPP loans may also present tax consequences that the parties should consider. For example, who benefits from the utilization of any Employee Retention Credit? Similarly, though the IRS has issued guidance precluding the deduction for expenses paid with PPP funds, there are public and political pressures to reverse such stance. If reversed, which party benefits from the newly allowed deductibility of PPP expenses whether incurred before or after closing?
Representations and Warranties.
The corporate purchaser may consider negotiating representations and warranties from seller to align with seller’s earlier PPP loan application and certifications. Separately, a seller might seek to have purchaser acknowledge and agree that the certifications made in the PPP loan application will not constitute a breach of any representation and warranty under the transaction documents, including those regarding a party’s financial or operating condition.
Effects of PPP Loan on Current and Future Financing.
Finally, the parties should consider the PPP impacts on current and future financing facilities. A buyer’s due diligence review should include a close review of the PPP loan documents to confirm the change of control, assignment, and sale of asset provisions and prohibitions. Typically, PPP loan documents will require the lender’s consent before entering into a transaction involving a change of management control or the sale of the business or substantially all of its assets. If the consent is not obtained, loan forgiveness eligibility may be imperiled. In such event, the loan should be repaid at closing. If it is not repaid, the consummation of the transaction may result in an event of default under the PPP loan, triggering default remedies for the lender, including default interest and immediate repayment. Unfortunately, there is no guidance governing when lenders may consent to a borrower engaging in any M&A activities. Equally unsettling, there is also no guidance on whether a borrower can continue to participate in forgiveness after obtaining the lender’s consent and consummating a M&A transaction.
The parties should also be mindful of existing covenants under other non PPP current debt facilities that might have been violated if consent for the PPP loan was not first obtained. Looking forward, any financing provisions and debt documents should be drafted to accommodate the PPP loan, including not only the amount of forgiveness, but, if necessary, servicing and repayment of the PPP loan.
Ultimately, the parties should work closely with each other, their legal counsel, and the PPP loan provider when assessing how a PPP loan will impact an imminent M&A transaction. As with anything PPP related, the answers won’t always be easy.