In the wake of the initial months of the COVID-19 pandemic, many practitioners have started to see a notable uptick in healthcare M&A activity through the third quarter of 2020. Such activity spans from consolidation transactions in certain medical practice segments, accretive acquisitions in the hospice and home health space, business combinations to expand telemedicine offerings, and a growing interest in value-add healthcare real estate opportunities. In most cases, the seller parties that have weathered the COVID-19 storm have done in so in part through the lifelines of funding provided by the U.S. Small Business Administration (SBA) through the CARES Act, and in particular Paycheck Protection Program (PPP) loans. However, as the healthcare M&A deals initially inked in Q3-2020 now shift to closing mode in Q4-2020, these PPP loans are presenting new challenges for both sellers and buyers. The following highlights some of the key issues.
Forgiveness. The headlining attribute of PPP loans is the potential forgiveness of such loans by the SBA. Such loans were initially issued to qualifying borrowers in the spring of 2020 and the loan forgiveness process is now underway and will continue over the next several months. In order to receive forgiveness of a PPP loan, the borrower must submit a forgiveness application to its lender which will in turn submit such application to the SBA. The SBA generally has 90 days from receipt of an application to make its decisions on forgiveness (which could relate to all or only a portion of the PPP loan) and key determinants of forgiveness include compliance with applicable SBA regulations, the validity of the original PPP loan application and the accuracy of the calculations contained therein, the proper use of the PPP funds by the borrower, and the continued (and current) employment of the individuals whose payroll has been supplemented through the PPP funds.
Debt Classification. Despite the promise of potential forgiveness, it is important to note that PPP loans do represent debt (just like any other debt on the borrower’s balance sheet) until forgiven. Therefore, if a forgiveness decision remains outstanding at closing, the parties to a healthcare M&A transaction must address which party will assume that debt and the associated repayment risks post-closing. Until just recently (as further discussed below), the SBA has provided little guidance on this issue, resulting in concerns that an M&A closing might trigger an event of default under the PPP loan and thus compromise the viability of a future forgiveness decision by the SBA.
Change of Ownership. Per SBA regulations, the SBA must be notified of a “change of ownership” of the PPP loan borrower occurring prior to loan forgiveness and such notice requirement generally extends for the 12-month period following the date on which the PPP funds were originally received by the borrower. Until the recent SBA guidance discussed below, conventional wisdom indicated that such change of ownership notice must be provided to the SBA (as with the forgiveness application, the notice is actually provided by the borrower’s lender to the SBA) prior to an M&A closing and, to avoid a potential loan default scenario, SBA approval of such change of ownership must also be obtained pre-closing. Closely tied to these notice/approval requirements is a similar exercise with the borrower’s lender, in order to also avoid an event of default under the loan agreement and/or note instrument that evidences the actual PPP funding from lender to borrower. Here, conventional wisdom has assumed that lender approval will always be conditioned upon SBA approval, with such conditional approval resulting in added stress on M&A closings from a timing perspective.
M&A Considerations. For a buyer in a healthcare M&A transaction, there are several tools for identifying the risks associated with a seller’s PPP loan (due diligence, representations and warranties, pre-closing covenants, indemnification, etc.). Accordingly, these considerations are now moving to the top of most due diligence processes and M&A practitioners are quickly becoming conversant on the new PPP-related provisions that are increasingly prevalent (and detailed) in acquisition agreements. As buyers, sellers, and their legal counsel work through these evolving items, the more challenging discussion involves risk allocation. On the one hand, buyers tend to view PPP loans (until forgiven) as traditional debt, which means they must be paid off at closing (for debt-free transactions) or they must be assumed by buyer (raising concerns over whether a change of ownership will compromise future forgiveness outcomes). On the other hand, sellers tend to view the SBA’s pending forgiveness decision as to their PPP loans as a fait accompli and, accordingly, are reluctant to accept a potentially negative consequence in connection the transaction closing (be it in the form of reduced purchase price or an enhanced post-closing indemnity package).
New SBA Safe Harbors to the Rescue? On October 2, 2020, the SBA finally offered some potential relief for M&A parties struggling to resolve the obstacles to closing presented by seller PPP loans. As further detailed in a separate posting (see SBA Procedural Notice Summary – Changes of Ownership), this new guidance from the SBA addresses several different fact patterns involving a seller/borrower change of ownership (equity sales, assets sales, etc.) and provides a potential path forward with respect to SBA notice/approval requirements and the timely consummation of a healthcare M&A transaction (such as excluding transactions where less than a majority of the borrower’s equity is being transferred, and allowing parties to proceed with a closing if an escrow has been established in the amount of the outstanding PPP loans). As with most safe harbor regulation, this SBA guidance does not necessarily represent the only viable option for healthcare M&A parties to address PPP loan concerns, but it should be anticipated that these safe harbors will effectively become the rule unless one of the parties can negotiate a differing risk allocation result as to such PPP loan concerns.