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PPP Standing in the Way of Healthcare Mergers and Acquisitions

fhlfhealthcaretransactionsduringpandemicBy: Susan St. John

The trend that we are seeing affects both buyers and sellers in the health care sector with respect to entities that have received cash infusions from the Paycheck Protection Program (“PPP”) created pursuant to the CARES Act in response to COVID-19. Mergers and acquisitions can come to a significant slowdown, standstill or be terminated altogether if careful planning is not performed to account for the impact the PPP funds received by a healthcare target or seller will have on an anticipated merger or acquisition.  While tax and legal considerations have typically followed along with the merger or acquisition and these considerations are important aspects of any merger or acquisition, they have taken a forefront position when it comes to planning for a change of ownership when the healthcare target or seller has received PPP funds.

As we learned earlier, health care entities requested and received PPP funds to sustain them during the public health emergency caused by COVID-19, allowing them to avoid a virtual economic shut-down. These funds were a welcome relief to keep health care entities afloat financially, providing a way to cover certain expenses such as a) payroll costs, b) rent, c) interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation), and d)  utilities. Using the PPP funds on these expenses allows for a recipient of the PPP funds to qualify for loan forgiveness under the PPP. That all seemed like welcome relief at the time.

However, if a recipient of PPP funds decides it wants to sell its business, whether in whole or in part, there will be a few hoops to jump through to obtain approval from a PPP lender and/or the Small Business Administration (“SBA”). Under the PPP, a change of ownership occurs if 20 percent or more of an entity’s common stock or other ownership interest is sold, conveyed, or otherwise transferred. Thus, if only one or a handful of owners whose interest total 20 percent or more wish to sell their ownership interest, it will trigger the definition of a “change of ownership” under the PPP. Further, it doesn’t matter that the stock or ownership interest will be acquired by another owner or affiliate of the recipient entity or that the transfer of 20 percent of the interests may be accomplished over a series of transactions; the change of ownership definition will still be triggered. and approval of the change of ownership must be obtained prior to closing the transaction.

Similarly, if a recipient of PPP funds wishes to sell 50 percent or more of its assets in one or more transactions, the change of ownership definition is triggered. Merger of a PPP borrower into another entity, even if an affiliate entity, will also invoke “change of ownership” status. So, how do you go about gaining approval for a change of ownership for a recipient of PPP Funds?

SBA Procedural Notice No. 5000-20057, which was effective October 2, 2020, and expires October 1, 2021, steps you through what must be accomplished to gain approval from a PPP lender or SBA prior to closing a transaction that results in a change of ownership for a PPP recipient entity.

First, the PPP recipient must notify the PPP lender of the proposed transaction to sell or transfer stock or assets prior to the closing. If necessary, the PPP lender will notify and submit certain documents to the SBA for consideration in approving the change of ownership transaction. If a decision is needed from the SBA, parties to a proposed merger or acquisition need to be aware that the SBA may take up to 60 days to provide a determination as to the proposed transaction.

PPP Lender Approval Required

If certain criteria with respect to the change of ownership transaction are met, the PPP lender has authority to approve the change of ownership pursuant to the PPP. If the PPP funds have been fully repaid prior to closing, there will not be any restrictions by the PPP lender or SBA of the contemplated transaction. Further, if the recipient has submitted the loan forgiveness application and the SBA has remitted funds to the PPP lender in full satisfaction of the borrowed funds, or the recipient has paid the remaining balance on the borrowed PPP funds, there will not be any restrictions on the contemplated transaction. However, restrictions will come into play if the PPP funds are not fully repaid to the PPP lender.

If the PPP funds are not fully repaid to the PPP lender, it may still be possible to avoid getting the SBA involved in the change of ownership transaction approval process. If the contemplated transaction transfers 50 percent or less of the common stock or other ownership interest of the PPP recipient, then the PPP lender has authority to approve the transaction. However, if more than 50 percent of the common stock or other ownership interests will be transferred in a proposed transaction, the PPP recipient will need to complete a forgiveness application and will need to set up an interest-bearing escrow account controlled by the PPP lender that contains funds equal to the outstanding balance of the PPP loan. It is not necessary that forgiveness be approved prior to closing the transaction. Once forgiveness is obtained, the escrowed funds must be used to pay off any remaining balance of the PPP loan prior to being disbursed to the recipient of the PPP funds or the purchaser, depending on the agreement between the parties to the transaction.

The transfer of 50 percent or more of a recipient entity’s assets also requires submittal of a PPP loan forgiveness application and escrowing of the remaining balance of the PPP loan to avoid needing the SBA approval of the change of ownership transaction. The PPP lender must notify the SBA of amount of funds in escrow and the location of the escrow account.

SBA Approval Required

The SBA must be involved in approving a transaction if a recipient cannot fully repay or escrow the PPP funds prior to the closing date of the transaction. This may be a fairly heavy burden on the transaction, possibly stopping it in its tracks. If a PPP recipient cannot pay or escrow the PPP funds, it must give a reason it cannot do so, provide details of the transaction, provide a copy of the executed PPP note, provide the LOI and purchase and sale agreement, disclose if the buyer also has an existing PPP loan, and a list of all owners with a 20 percent or more interest in the entity. For asset purchases, the buyer must assume responsibility of the PPP loan and this will need to be set forth in the transaction documents. If the SBA requests additional information or documentation related to the transaction and information about the parties, that could extend the 60-day time period for turning around a decision on the change of ownership. Additionally, the SBA could place additional demands on the parties to the transaction to mitigate potential risk of loss on the PPP loan obligation.

Conditions Related to a Purchase and Sales Transaction

The PPP recipient or the PPP recipient’s successor in a merger, remains responsible for all obligations of the PPP loan. In other words, the obligations follow the entity that received the PPP funds. If the new owners use the PPP funds for unauthorized expenses or purposes, the SBA will have recourse against the new owner(s).

If the new owners of the stock or other ownership interest also have PPP loans, this must be disclosed to the SBA after the transaction closes and the different PPP loans must be segregated and separately accounted for: the PPP loans of the successor owners may not be combined with PPP loans of the acquired recipient entity. Further, the PPP lender is duty-bound to disclose the transaction’s closing within 5 days of the closing date. New owners, their ownership percentages, and tax ids of owners with a 20 percent or more equity interest in the acquired business must be submitted to the SBA. If escrow is required, location and amount of escrowed funds must also be disclosed to the SBA.

Why Go Through the Process to Approve the Change in Ownership

Obtaining approval for a change of ownership keeps a PPP recipient from being in default of the PPP loan and losing the ability to obtain loan forgiveness for funds used for authorized purposes under the PPP. However, some assessment should be done on the cost-benefit of a purchase and sale transaction being slowed down, put on hold, or canceled all together when it comes to seeking PPP loan forgiveness. While forgiveness of the PPP loan is one of the things that made the program attractive to many entities, forgiveness also has tax implications. Forgiveness of the PPP loan is exempt from taxation; however, if the PPP loan is forgiven, any expenses that an entity paid with the PPP funds it received are not deductible as an expense for income tax purposes. Thus, taxable income may be higher due to the loss of deductibility of expenses paid with PPP loans that were forgiven. The increase in taxable income should also be considered when seeking PPP loan forgiveness. Fully repaying the PPP loan will allow for any expenses paid with the PPP loan proceeds to be deductible. Any contemplated purchase and sale transaction needs to take this into account during the due diligence period or in preparing pro forma financials for future periods.

With the burdens placed upon stock or asset sales transactions, including mergers, some entities are choosing to fully repay the PPP loans so as not to lose out on a promising transaction where the benefits outweigh the cost of repaying the PPP loan. If the parties to a transaction still desire to obtain approval of a change of ownership, advanced planning is a must. Adding two months to the time frame to complete a transaction would be prudent to ensure that there is available time to obtain approval of the change of ownership.