Client Alert

M&A Considerations Regarding CARES Act Loan Programs and Other Relief

08 May 2020

In recent weeks Congress has authorized funding for a number of programs intended to provide relief to small- and medium-sized businesses and certain particularly hard-hit industry sectors, as well as to American businesses more generally. The parties to a potential M&A transaction must be careful to ensure that their transaction activities do not inadvertently alter eligibility status for federal programs or otherwise run afoul of program requirements. For acquirors, thorough M&A due diligence in this environment must include a review of pre-acquisition loan, tax, and compensation activity connected to these relief packages. In addition, the parties to an M&A transaction should clearly allocate the risks related to altered eligibility status and other risks related to these programs in their definitive transaction documentation. This client alert will provide an overview of the type of government assistance that is available, and implications in the context of M&A activity.

The CARES Act Generally

The initial U.S. Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law on March 27, 2020. This sweeping legislation created the Paycheck Protection Program (“PPP”), a loan program available to small businesses and those with fewer than 500 employees; authorized additional funding for the Small Business Administration (SBA) Economic Injury Disaster Loan (EIDL) program; and introduced additional loan programs for specific industries (including air carriers, transportation services, and critical national security businesses) (the “Specified Treasury Loan Program”) and for other eligible businesses (the “Joint Treasury/Federal Reserve Program”). In addition, the CARES Act provided various forms of tax incentives for companies. In some instances, a company must elect to obtain a PPP loan or take advantage of tax relief—it cannot do both.

On April 23, 2020, a second relief package was enacted, to add an additional $310 billion in funding to the PPP program, to increase the funds available for EIDLs, and to provide additional funding for hospitals and other select programs.

PPP and EIDL Loan Programs

In order for a company to be eligible for a PPP loan, it must be a small business under SBA regulations or have fewer than 500 employees whose principal residence is in the United States. For purposes of calculating the number of employees, the company must include all affiliates under the SBA’s affiliation rules at 13 C.F.R. 121.301(f). This means the company must include in its employee count the number of employees of any parent with more than 50% stock ownership, any investor with certain controlling minority rights (including commonly held rights of private equity and venture capital investors), and any company with overlapping management or an “identity of interests,” such as familial relationships or business relationships that tie the entities together (more on this later). Certain types of companies are exempt from these affiliation rules for purposes of the loan program, including businesses in the accommodation and food service industries, franchisees, and businesses that receive financial assistance from a Small Business Investment Company.

PPP loans come with several restrictions. At least 75% of PPP loan proceeds must be used for payroll costs. The remaining 25% can be used for rent, utilities, or interest on a mortgage or any other pre-existing debt. Borrowers can receive forgiveness of the portion of the PPP loan principal and interest equaling the authorized costs incurred or paid during the eight-week period following loan origination. The forgiveness amount will be reduced if the borrower reduces salaries or wages or fails to maintain the pre-loan average number of full-time equivalent employee positions during the eight-week period following the origination of the PPP loan.

The PPP loan application includes several certifications that the borrower must make under penalty of violation of the federal false statements and false claims statutes, including that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” In guidance that followed several highly publicized situations of well-capitalized and even public companies taking out PPP loans, SBA, and Treasury have indicated that:

Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.

SBA and Treasury have also commented that private equity-backed companies should also carefully consider this certification.

In addition to the various certifications, some other situations disqualify companies from eligibility, including if an owner is incarcerated, on probation or on parole, subject to indictment, or has been convicted of a felony in the past five years, or if the company or any owner has ever defaulted on a federally-backed loan (including student loans). Certain types of businesses, as identified in 13 CFR 120.110, are ineligible for PPP loans. These include, for example, financial institutions, passive investors, and illegal or speculative businesses.

EIDLs have very similar eligibility criteria as for PPP loans. Unlike PPP loans, EIDLs cannot be forgiven, although EIDL borrowers can receive a one-time emergency grant of up to $10,000. EIDL loans can be used for any working capital purpose. Borrowers can take out both an EIDL and a PPP loan, but they must be used for different purposes.

Other CARES Act Loan Programs

Businesses that receive assistance under the Specified Treasury Loan Program must agree to the following conditions:

  • During the term of the loan and for twelve months thereafter, not to purchase shares of its or any parent company’s equity securities that are listed on a national securities exchange, unless a contractual obligation to repurchase shares was in effect on the date of enactment of the CARES Act;
  • During the term of the loan and for twelve months thereafter, not to pay dividends or make other capital distributions with respect to the common stock of the eligible business;
  • During the term of the loan and for twelve months thereafter, to comply with various limitations on executive compensation; and
  • To maintain, during the period commencing on March 24, 2020, and ending on September 30, 2020, at least 90% of the eligible business’s employment levels in place on March 24, 2020 (applicable only to a specific subset of loans for air carriers and national defense borrowers).

The Joint Treasury/Federal Reserve Loan Program now includes three different loan facilities under the global “Main Street Lending Program” (MSLP): (1) the Main Street New Loan Facility, which is designed to facilitate new lending to businesses, (2) the Main Street Priority Loan Facility, which is designed to facilitate new lending to businesses with greater leverage, and (3) the Main Street Expanded Loan Facility, which is meant to enable the expansion of term loans from eligible lenders to eligible borrowers originated before April 8, 2020. The programs will be available to businesses with a maximum of 15,000 employees or with no more than $5 billion in 2019 annual revenue. Participating businesses must have been created or be organized in the United States or under the laws of the United States prior to March 13, 2020, with significant operations and a majority of its employees based in the United States. Similar to PPP loans, certain types of businesses, as identified in 13 CFR 120.110(b)-(j) and (m)-(s) (as modified by the regulations implementing PPP), are not eligible for MSLP loans. Loans under the MSLP program are not eligible for loan forgiveness.

Under the MSLP loan facilities, a borrower must:

  • Commit to refrain from repaying other debt of equal or lower priority, with the exception of mandatory principal and/or interest payments, unless the borrower has first repaid the Main Street loan in full;
  • Not seek to cancel or reduce any of its outstanding lines of credit;
  • Certify that it has a reasonable basis to believe that, as of the date of origination of the loan, it has the ability to meet its financial obligations for at least the next 90 days and does not expect to file for bankruptcy during that time period;
  • Represent that it “requires financing” due to the COVID-19 pandemic;
  • Make commercially reasonable efforts to maintain its payroll and retain its employees during the time the loan is outstanding;
  • Confirm that it meets the EBITDA leverage condition specifying required features of the loans;
  • Attest that it will follow compensation, stock repurchase, and capital distribution restrictions that apply to direct loan programs under section 4003(c)(3)(A)(ii) of the CARES Act (see more in our related FAQs and client alert), provided that a borrower that is a tax pass-through entity may make distributions to the extent reasonably required to cover its owners’ tax obligations in respect of the borrower’s earnings; and
  • Certify that the entity is eligible to participate in the facility and is not precluded from participation in light of the conflicts of interests prohibition outlined in section 4019(b) of the CARES Act, as outlined above.

Importantly, businesses that have taken advantage of the PPP may also participate in the MSLP. However, MSLP borrowers may not (1) participate in more than one MSLP facility, or (2) participate in the Primary Market Corporate Credit Facility that was also recently announced by the Federal Reserve Board.

Tax Considerations

In addition to establishing these loan programs, the CARES Act and the Families First Coronavirus Response Act (“FFCRA”) included other benefits such as refundable tax credits to cover the costs of paid sick and family leave required to be paid by businesses with fewer than 500 employees, refundable payroll tax credits for qualifying wages paid by businesses who do not receive PPP loans and have experienced a suspension of activities or a significant decline in revenue for businesses, and payroll tax deferral for employers who do not have a PPP loan forgiven.[1] The CARES Act also relaxes limitations on the use of net operating losses and the deduction of business interest expense, which may allow corporations to lower their 2020 tax liability and potentially receive tax refunds for prior years. When drafting an agreement’s tax provisions it will be important to define pre- and post-closing taxes to reflect any available credits or taxes deferred.

What Does All This Mean for M&A Activity?

From the outset of a potential M&A transaction, an acquiror should consider the impact the acquisition might have on any CARES Act relief a target is seeking or has already received.

Affiliation Issues for PPP and EIDL Loans

For PPP and EIDL (SBA-sponsored) loans, the parties should consider whether the M&A transaction creates an “identity of interest affiliation.” Under 13 C.F.R. 121.301(f)(2), also known as SBA’s “present effect rule,” SBA treats planned transactions, stock options, and convertible securities as though they have present effect:

Affiliation arising under stock options, convertible securities, and agreements to merge.

  • (i) In determining size, SBA considers stock options, convertible securities, and agreements to merge (including agreements in principle) to have a present effect on the power to control a concern. SBA treats such options, convertible securities, and agreements as though the rights granted have been exercised.

Note however, that:

  • (ii) Agreements to open or continue negotiations towards the possibility of a merger or a sale of stock at some later date are not considered “agreements in principle” and are thus not given present effect.
  • (iii) Options, convertible securities, and agreements that are subject to conditions precedent, which are incapable of fulfillment, speculative, conjectural, or unenforceable under state or Federal law, or where the probability of the transaction (or exercise of the rights) occurring is shown to be extremely remote, are not given present effect.

SBA Office of Hearing and Appeals (OHA) case law makes clear that if a letter of intent (LOI) between two concerns contemplating an acquisition or merger is an agreement in principle, those two concerns are considered affiliated for SBA purposes. For a buyer then, entering into such an LOI may have significant implications as it may render the target concern ineligible for small business relief, including as relevant here, PPP and EIDL loans.

OHA previously has discussed some of the factors that determine whether an LOI triggers SBA’s “present effect rule” and creates an affiliation between negotiating parties. At bottom, affiliation comes down to the extent to which an LOI is binding or has sufficient contingencies. In Size Appeal of Telecommunications Support Services, Inc., SBA No. SIZ-5953 (2018), OHA determined that the LOI did not create an affiliation, instead finding that the LOI was merely “an opportunity to evaluate an opportunity,” and had discussed only the general terms and conditions under which the buyer would be willing to purchase the seller. This determination was based on several factors, including that the price was conditioned on the seller meeting certain financial targets and that consummation of the transaction was conditioned on an extensive diligence process. Moreover, the LOI allowed either party to withdraw from the agreement. In finding an absence of affiliation, OHA concluded, based on the totality of the circumstances, that “it would confound logic to hold that an agreement in principle existed at the time to determine size, yet that same agreement could fall apart after the date to determine size based on the unilateral actions of one of the parties.”

By contrast, in Size Appeal of Enhanced Vision Systems, Inc., SBA No. SIZ-5978 (2018), OHA found that the LOI there did create affiliation between the parties and drew several distinctions between the Telecommunications Support Services fact pattern. In determining that there was an agreement in principle that triggered the present effect rule, OHA considered the fact that negotiations had begun weeks or months prior to the LOI being signed and that the parties had negotiated a firm price before signing the LOI. The LOI also required only a confirmatory due diligence review, and consummation of the transaction was not dependent on the results of diligence.

The parties to a potential M&A transaction should consider whether these affiliation rules result in the target (or the acquired business) being deemed to have 500 or more employees and therefore ineligible for a PPP loan.

Structure Considerations

As noted previously, businesses that receive assistance—whether through PPP and EIDL loans or under the Specified Treasury Loan Program, the Joint Treasury/Federal Reserve Loan Program, and the MSLP—are subject to a number of conditions and restrictions, such as a prohibition on dividends and limits on executive compensation. The applicable restrictions, and whether they will apply to affiliates of the borrower such as an acquiror, vary depending on the type of assistance. In any M&A deal where one of the parties has availed itself of these loan programs, the parties must carefully consider the restrictions described above in structuring the transaction.

A direct merger will result in the surviving entity—and thus the non-borrower’s business—being subject to the restrictions described above. On the other hand, where a transaction is structured as an indirect merger or a stock and/or asset purchase, such that the borrower remains a separate legal entity, it is unlikely that the acquiror would, as a result of the transaction, be prevented from paying dividends or taking other actions that are prohibited of the borrower by the Specified Treasury Loan Program, the Joint Treasury/Federal Reserve Loan Program or the MSLP. Of course, the borrower itself will still be subject to these restrictions, so the acquiror must take them into account for its M&A, financial, and integration planning. For example, the acquiror may be entering into the transaction with a view to distributing cash out of the target—either currently or on an ongoing basis—which may no longer be possible as a result of the target having obtained CARES Act relief. As for share repurchases, the restrictions on conducting buybacks under the Specified Treasury Loan Program, but not the MSLP, apply to affiliates of a borrower, such that a parent company that acquires a target that has accessed the Specified Treasury Loan Program would not be permitted to conduct buybacks of its own stock during the term of the loan and twelve months thereafter.

Due Diligence and Representations and Warranties

Given the rapid and continuing development of these loan and tax relief programs and related guidance from the government, many acquirors have not yet fully incorporated requests for information about a prospective target’s use of any of the CARES Act lending programs or other benefits into their standard diligence procedures and checklists. However, it is important for an acquiror to know whether the target has received a loan (PPP, EIDL, MSLP, or otherwise) or has availed itself of CARES Act tax relief. If so, and especially with the PPP and EIDL programs, it is essential for the acquiror to confirm that the target was in fact eligible for the relief requested. As part of this analysis, the buyer should confirm that the target correctly performed an affiliation analysis based on SBA rules regarding stock ownership and minority investor rights and other bases of affiliation. For PPP loans specifically, the buyer must ensure that the company used the loans for only the permissible purposes, took all steps to ensure that loan forgiveness is still available, and made its certification that the loans were necessary to support the company’s ongoing operations in good faith and with a reasonable—and ideally, documented—basis. For MSLP and other loans, diligence should include confirmation that all loan conditions have been met.

An acquiror can bolster its information gathering process described above by requesting CARES Act-related representations and warranties from the target in the definitive transaction document. These representations and warranties might cover: whether the company has availed itself of any CARES Act-related lending programs or other benefits; if so, the company’s eligibility to have done so; the company’s process for determining its eligibility (including whether its certification as to necessity was undertaken in good faith and with a reasonable basis); and the satisfaction of the conditions to any CARES Act borrowings by the company. Including these types of representations not only forces the target to engage in a self-diligence, and, if necessary, scheduling exercise, but it also serves to allocate risk between the parties. In a transaction where the buyer has negotiated for indemnification protection from the seller post-closing, a breach of the CARES Act-related representations just described could give rise to a claim for indemnification for any losses the buyer might suffer, thus shifting risk from the buyer to the seller. Especially in transactions where the acquiror’s diligence has raised cause for concern, an acquiror can go a step further by requesting a special indemnity from the seller, as discussed below.

Special Indemnities and Post-Closing Covenants

An acquiror should also consider whether a special indemnity is appropriate to allocate the risk of non-forgiveness of PPP loans, a retroactive determination of ineligibility for any of the various CARES Act lending programs, a failure to satisfy loan conditions, and any related adverse monetary or legal consequences suffered as a result of the foregoing by the acquiror or the business post-closing. The structure of a special indemnity will obviously vary from deal to deal, but it might involve direct payment or reimbursement by the seller of any PPP loans required to be repaid as a result of non-forgiveness (especially if the seller somehow received the benefits of the loan proceeds), any other CARES Act loans required to be disgorged, the amount of any civil or criminal fines or penalties (including treble damages under the False Claims Act), and any fees and expenses incurred by the acquiror in connection with the foregoing.

While a special indemnity is typically uncapped and not subject to limitations, a seller in turn may request the establishment of some parameters either with respect to the special indemnity itself or in post-closing covenants applicable to the acquiror. For example, what if the acquiror or the acquired business takes certain action post-closing that has the effect—whether intended or not—of triggering any of the payments required under the special indemnity? Potential post-closing covenants of the acquiror could include: an obligation to maintain the separate legal existence of the borrower entity; an agreement to comply (and to cause the borrower to comply) with the applicable terms of the relevant loan program and in particular the restrictions on share repurchases and dividends, among others; and a general catch-call prohibition on taking any action reasonably expected to result in non-forgiveness, a determination of ineligibility or other specified adverse outcomes.


Acquirors and sellers alike must carefully consider the potential impact of a target’s past or prospective acceptance of CARES Act relief in the current M&A environment. Specifically, acquirors must carefully focus on a target’s use of CARES Act programs during the course of diligence and allocate risk appropriately in the definitive transaction documentation as a result of their diligence. This may include additional representations and warranties regarding the target, indemnification coverage from the seller, and covenants to address post-closing risks. Sellers should be prepared to engage proactively with acquirors on the use of CARES Act programs, given the potential ramifications of non-forgiveness of PPP loans or a retroactive ineligibility determination to all parties.

[1] A detailed analysis of the impact of the CARES Act tax provisions is beyond the scope of this client alert.



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