Paycheck Protection Program Loans & M&A
One of the signature accomplishments of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) that was signed into law on March 27, 2020, was the enactment of the Paycheck Protection Program (PPP).
While a detailed overview of the PPP is outside the scope of this article, at its core, the program provided U.S. Small Business Administration (SBA) loans to small and midsize businesses at favorable interest rates and provided that if the businesses spent the funds on certain qualifying expenses, e.g., payroll, rent, interest, utilities, etc., during the qualified period (originally eight weeks but then extended to 24), then the loans were eligible to be forgiven (with lenders generally being responsible for rendering such a determination). The CARES Act specifically provided that any forgiven loans wouldn’t be characterized as taxable income to borrowers.
However, while the loan forgiveness isn’t taxable, the IRS has ruled that absent clear congressional direction to the contrary, the corresponding expenses that were paid for with PPP loan funds are nondeductible for U.S. federal income tax purposes on the basis that deducting expenses that were paid for with income that’s nontaxable amounts to a “double dip.” Just as double-dipping is discouraged at parties, the IRS discourages taxpayers from double-dipping with respect to income and expenses. While various Congress members have said they intended for PPP borrowers to receive a double dip, Congress itself hasn’t yet overruled the IRS on this point.
One area that many tax advisors have had to grapple with is how to address outstanding PPP loans when businesses are being acquired or sold. Below are a few common issues that should be addressed in the context of merger and acquisition (M&A) transactions:
- Asset or equity deal – The legal form of the transaction will determine if a buyer inherits an outstanding PPP loan. In an asset deal, buyers may choose which assets to acquire and which liabilities to assume. In an equity deal, the buyer generally inherits all the liabilities of the target company. Therefore, in an asset deal, it’s possible to leave behind a PPP loan with the seller, while in an equity deal, the PPP loan is generally assumed by the buyer as part of the acquisition.
In an equity deal, generally the only way for the buyer to avoid assuming an outstanding PPP loan is to use part of the sales proceeds to repay it at close. Sellers may resist this, particularly if they have a high degree of confidence the loan will be forgiven because the target company has incurred enough qualifying expenses. As part of their diligence procedures, buyers may review the target company’s loan forgiveness application and supporting calculations to assess the reasonableness of the sellers’ representations.
- Purchase agreement considerations – Due to their nature as being forgivable, PPP loans may be difficult to characterize in the context of purchase agreements. Clearly, if the loans are never forgiven, they should be characterized as any other debt-like item and deducted from the purchase price. But given the expanded 24-week covered period, many buyers are closing transactions in which the target company won’t receive notification from its lenders and the SBA on the status of forgiveness until a later point in time.
Our recommended approach for dealing with PPP loans is for the buyer to escrow sales proceeds equal to the outstanding loan balance and only release such escrow upon receipt of notification of forgiveness from the lender and the SBA, less the tax liability corresponding to the nondeductible expenses (as described above), along with any interest due and professional fees incurred in pursuing forgiveness.
- Consent requirements – Certain PPP loans include a provision stating that an event of default occurs if the borrower undergoes a change of control without first obtaining lender consent. There has been a great deal of confusion around this point. Some lenders have taken the position that the SBA must ultimately consent to any change of control. The SBA hasn’t issued any guidance on this point even though its own standard loan note form includes a provision requiring lender consent if the borrower “reorganizes, merges, consolidates, or otherwise changes ownership or business structure without lender’s prior written consent.”
The SBA also hasn’t issued any guidance on what constitutes a change of control. For example, assume an operating company receives a PPP loan and the operating company is wholly owned by a holding company. If the holding company is acquired, must the operating company obtain consent (assuming its PPP loan requires it)? If the lender included the change of control language from the SBA’s standard loan note above, it would appear a change of control at the holding company level wouldn’t require lender consent due to the lack of reference to indirect ownership changes, but this is one of several areas that are unclear to borrowers.
There’s also uncertainty as to whether acquiring a company that has an outstanding PPP loan disqualifies the acquirer from receiving an Employee Retention Credit (ERC), which is outside the scope of this article but is a separate CARES Act benefit that provides certain payroll tax credits to employers. Taxpayers that received a PPP loan are precluded from receiving ERCs, but it’s unclear whether a taxpayer that receives ERCs because it didn’t receive a PPP loan, and subsequently acquires a company that did receive a PPP loan, continues to qualify for ERCs (or whether a sponsor-owned company that receives ERCs continues to qualify if its sponsor acquires another company in its portfolio that received a PPP loan).
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