Any potential merger partner or buyer of a recipient of a PPP loan should confirm such recipient’s eligibility for its PPP loan and appropriately allocate the risks of audit and non-compliance.
If possible, any potential merger or acquisition involving one or more PPP loan recipients should attempt to obtain forgiveness of the PPP loans prior to the consummation of the transaction to minimize potential complications.
The consummation of an M&A transaction could create a conflict if one party has received a PPP loan and the other party an Employee Retention Credit.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), passed on March 27, 2020, provided forgivable loans of up to $10 million for qualifying small businesses under the Paycheck Protection Program (PPP). We provided an introduction to the Paycheck Protection Program in this alert, discussed modifications thereto in this alert and provided an overview of forgiveness considerations in this alert and this alert. Businesses that have received PPP loans and potential merger partners or investors should consider at least the following issues when negotiating merger or acquisition agreements.

  1. Due Diligence Should Confirm Eligibility and Proper Loan Use. The Paycheck Protection Program is only available to businesses that are eligible based on (A) size and (B) economic necessity at the time of application.

    The “affiliation” rules of the Small Business Administration (SBA), which are applicable to the PPP, require that a PPP applicant base its size eligibility on not just the number of employees (or revenue, if applicable) of the applicant itself, but also the number of employees (or revenue) of all other businesses controlled by or under common control with the applicant. Some recipients of PPP loans may not have considered the SBA’s affiliation rules, discussed here—including the impact of existing plans to merge, discussed below—and diligence in connection with any merger or acquisition involving a PPP loan recipient should identify all affiliates and the aggregated “size” of the affiliate group.

    PPP applicants were required to certify, in their loan applications, that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Application.” As we discussed here, there was widespread confusion over this certification, and the SBA released guidance on it only after many businesses applied for PPP loans. Therefore, any potential target that is a PPP loan recipient should provide documentary evidence of economic necessity and their inability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to their business.

    In addition, PPP loans may only be used for certain payroll, rent, utilities and mortgage interest expenses during a specified period of either eight weeks or 24 weeks. At least 60% of a PPP loan must be used to cover eligible payroll expenses. Any counterparty to a PPP loan recipient should confirm that PPP loans have been used only for permitted expenses.
  2. Size Ineligibility due the Existence of an Agreement in Principle. One twist on the SBA’s affiliation rules relates to agreements in principle (such as a memorandum of understanding or letter of intent). Such agreements are deemed to have “present effect.” We discussed the “present effect” rule here. This means, for example, that if a PPP loan recipient had entered into, and had not terminated, a letter of intent with a potential target or buyer at the time of its loan application, the PPP loan applicant would have to have aggregated its number of employees (or its revenue, if applicable) with that of the other part to the letter of intent to determine its PPP eligibility. When negotiating an acquisition or merger involving a party that has received a PPP loan, the PPP loan recipient should disclose any agreements in principle in effect at the time of its loan application.1 However, the consummation of an acquisition itself would not render a PPP loan recipient ineligible if it was eligible at the time of application.
  3. A Change of Control Could Impact Forgiveness Considerations and Trigger a Repayment Obligation. As PPP loans must be used for payroll and other eligible expenses of the recipient, if a recipient undergoes a change of control or merges with another entity before its PPP loan has been used on eligible expenses, such recipient might encounter difficulties demonstrating its use of proceeds if expenses such as payroll, utilities and rent are comingled with that of another business following the consummation of a transaction. A PPP loan recipient should endeavor to use all PPP loan proceeds before any merger or other change of control but, at a minimum, continue to keep its PPP loan segregated from all other business expenses.
  4. Indemnities and Post-Closing Covenants Should Reflect PPP Loan Risks. Treasury has indicated that any recipient of a PPP loan in an amount greater than $2 million will be targeted for audit. Any merger or acquisition agreement involving a PPP loan recipient should appropriately allocate (A) responsibilities with respect to seeking loan forgiveness and responding to any audits or other investigations and (B) the risks associated with any potential audit and finding of non-compliance with the PPP rules.
  5. Conflict with the Employee Retention Credit. The CARES Act offers eligible employers a refundable tax credit against certain employment taxes equal to 50% of up to $10,000 in qualifying wages paid to employees between March 13 and December 31, 2020 (Employee Retention Credit). This Employee Retention Credit is available to businesses of any size that were significantly negatively impacted by COVID-19. However, the CARES Act provides that a recipient of a PPP loan (and possibly other businesses under common control with the recipient) cannot also claim the Employee Retention Credit, regardless of the size of the PPP loan, unless such PPP loan had been repaid in full by May 18, 2020. A buyer that expects to receive a significant amount in Employee Retention Credit should take into consideration that the acquisition of a target that has received a PPP loan may render it ineligible for the Employee Retention Credit.
  6. Reputational Risk Considerations. Congress, Treasury and the Department of Justice, in addition to the media, likely will continue to scrutinize recipients of PPP loans. Certain private equity and venture capital investors have blocked their portfolio companies from seeking PPP loans for fear of public scrutiny. An M&A transaction involving a PPP loan recipient has the potential to invite such scrutiny.

Additional Resources

Pillsbury attorneys can help clients interpret the foregoing requirements and determine whether to apply for an SBA loan. We will continue to monitor guidance regarding the Paycheck Protection Program and other programs under the CARES Act. In the meantime, please refer to the client alerts referenced in this alert for more information: COVID-19 Relief: Understanding SBA Loan Opportunities Under the CARES Act, COVID-19 Relief: Small Business Loan Forgiveness under the CARES Act, COVID-19 Relief: Understanding Affiliation Rules Regarding Paycheck Protection Loans, Key Changes to Paycheck Protection Program and SBA Issues Long-Awaited Paycheck Protection Program Forgiveness Regulations.

Pillsbury is closely monitoring and analyzing the global legal, economic, policy and industry impacts of COVID-19. For our latest insights, visit our COVID-19 and Economic Impact Resource Center.

1 Please note that, though not required by the SBA, some lenders have required PPP loan recipients to also certify as to their eligibility at the time of loan disbursement.

These and any accompanying materials are not legal advice, are not a complete summary of the subject matter, and are subject to the terms of use found at: https://www.pillsburylaw.com/en/terms-of-use.html. We recommend that you obtain separate legal advice.