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Changes in Ownership May Change Reporting Requirements for Paycheck Protection Loans

Change of ownership may change reporting requirements on PPP loans

On October 2, 2020, The Small Business Administration issued Notice 5000-20057 outlining specific reporting procedures that are required for entities that have received Paycheck Protection Program (PPP) funds and also have certain changes in ownership.

Who is affected?
The requirements are effective for transactions on or after October 2, 2020. Business owners who received a PPP loan, and who have transferred an interest in their company (this includes but is not limited to sale or gift) that exceeds 20 percent of the interest in the aggregate; sold 50 percent or more of the assets of the company in the aggregate; or, merged with another entity should speak with the SBA Task Force to determine notification requirements. Business owners who transfer any ownership or assets should review their PPP loan documents as they may have to get approval from the bank or risk default.

While the Notice establishes reporting requirements if certain change in ownership thresholds are met, it should be noted that this has no effect on the requirements in the loan document itself. In other words, if the PPP loan document requires bank approval of any ownership change, the borrower must comply or risk default. This could potentially include gifts of interests.

A deeper look “Change of Ownership”
There must be a “change of ownership” for the Notice to apply. A “change of ownership” occurs when:

  1. at least 20 percent of the common stock or other ownership interest of a PPP borrower is sold or transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity,
  2. the PPP borrower sells or otherwise transfers at least 50 percent of its assets (measured by fair market value), whether in one or more transactions, or
  3. a PPP borrower is merged with or into another entity.

It is important to reiterate that the test looks at transactions in the aggregate, not transaction-by-transaction. For example, someone could gift 10 percent of their interest in one transaction and sell 15 percent in another transaction, which would mean that the first test was met and there has been an ownership change. One question here is what happens if one of the transactions happened before the effective date, but another happened after the effective date? Also, should both transactions be disclosed or just the one that caused the “ownership change? Say for instance one gifted 10 percent before October 2, 2020, which is clearly under the threshold, but later sells 15 percent, does this meet the definition of an ownership change? If yes, do I need to report both transactions? Further guidance from the SBA is needed to address these questions.

The Notice further provides that regardless of any change of ownership the PPP borrower remains responsible for (1) performance of all obligations under the PPP loan, (2) the certifications made in connection with the PPP loan application, including the certification of economic necessity, and (3) compliance with all other applicable PPP requirements. Additionally, the PPP borrower remains responsible for obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing those forms and supporting documentation to the PPP lender or lender servicing the PPP loan or to SBA upon request.

If there is an ownership change, the PPP borrower must notify the lender of the transaction in writing and provide the lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction. Note that this could stall transactions as banks may be worried that if they approve a transaction and the SBA finds not all requirements are met, the SBA could deny reimbursement for the loan.

Transfer Size Matters
There are different procedures depending on whether the PPP note is fully satisfied as well as the size of the transfer.

If the PPP note has been fully satisfied: then there will be no restrictions on a change of ownership, if, prior to the closing, the PPP borrower has: (1) repaid the note in full; or, (2) completed the forgiveness requirements, and either the SBA has remitted funds to the PPP lender in satisfaction of the note, or the PPP borrower has repaid any remaining balance on the PPP loan. ISSUE: if you are on the sell-side, take into consideration the tax implications of applying for forgiveness (i.e., no deduction for expenses paid with PPP funds).

If the PPP note has NOT been fully satisfied: then the borrower needs to determine if SBA approval is required before the transaction can close based on the analysis below. Generally, the determination of whether the sale is subject to SBA approval comes down to whether the transfer involves more than 50% of the interest in the entity or the sale of more than 50% of its assets, and whether the PPP borrower has applied for forgiveness.

If there has been a transfer of interest or a merger, then SBA approval of the transactions will NOT be required if: (a) the sale or other transfer is of 50% or less of the common stock or other interest of the PPP borrower; or (b) the PPP borrower completes a forgiveness application reflecting it use of all of the PPP loan proceeds and submits it, together with any required documentation, to the PPP lender, and an interest-bearing escrow account controlled by the PPP lender is established with funds equal to the outstanding balance of the PPP loan (the funds will be released to pay any remaining PPP loan balance). There are a number of issues here especially if the sale is an installment sale – a seller will want to make sure they get enough cash to pay the income tax liability. Not knowing how long it will take banks to approve a sale could be an issue if the sale occurs at the end of the year. Also, the rule here is basically, if you transferred 50% or less of the interest, you have to notify the bank. If you transfer more, the SBA will get involved. Again, even if the PPP borrower transfers less than 20% of the interest in the entity in the aggregate, they should still review their loan documents to see if they are required to get bank approval.

If there has been a change in ownership structured as an asset sale, then a PPP borrower may sell 50 percent or more of its assets WITHOUT the prior approval of the SBA only if the PPP borrower completes a forgiveness application reflecting its use of all of the PPP loan proceeds and submits it, together with any required supporting documentation, to the PPP Lender, and an interest-bearing escrow account controlled by the PPP Lender is established with funds equal to the outstanding balance of the PPP loan.

SBA approval IS required if the conditions listed above are not met – meaning more than 50 percent of the interest is being sold, or if there is an asset sale, the forgiveness application has not been submitted. If SBA approval is required, the PPP borrower must submit additional documentation. As we enter the fourth quarter, business owners may decide to sell or gift ownership hoping to close their deals before the end of the year. If SBA approval is required, the sale may be delayed. Sales that push into the new year may present different tax obligations should there be new tax legislation passed that increases tax rates.

The Bottom Line
If you have a transaction that involves a transfer of ownership of an entity (or the assets of an entity), it’s important to make sure you are in compliance with these reporting requirements. If you have questions or would like additional information, please contact a LaPorte professional.