Paycheck Protection Program Borrowers and Lenders Should Stop And Think About This…

It is the responsibility of both the business and the bank to determine whether a PPP loan will violate existing loan agreements or other debt arrangements then binding on the business if bank consent is required but not obtained. Irrespective of whether a PPP loan would violate such agreements absent bank consent, there may be other applicable contractual provisions in loan documentation to consider. Some require the proceeds of any new debt (i.e., the proceeds of a PPP loan) to only be used to fund a mandatory prepayment against the existing debt – not to satisfy short term working capital needs. Others may require that the PPP loan be included in the calculation of ongoing financial covenants. In those cases, it might be appropriate for the bank consent to include either a waiver of any applicable mandatory prepayment requirement or an adjustment to financial covenant levels or calculations, as the case may be.

An initial, cursory review of the most recent financial statements of the business should disclose whether it has an existing line of credit, term loan or other debt arrangement³ that would likely (i) prohibit the business from incurring new debt (such as a PPP loan), (ii) require a mandatory paydown of existing debt with the proceeds of the PPP loan, (iii) result in a violation of one or more financial covenants (if the PPP loan is included in the calculation thereof) and/or (iv) dictate the treatment of any new debt (such as a PPP loan) in the context of existing debt and how it may impact the interests of competing creditors under existing intercreditor and subordination agreements. However, beyond existing debt arrangements, there may be other contractual arrangements to consider. The bylaws, operating agreement, shareholder agreement and/or investor rights agreement of the business may also prohibit, restrict or limit new debt from being incurred without the prior consent of certain persons, committees or entities.

Engaging legal counsel to conduct a diligent review of existing debt and other contractual arrangements and, more importantly, the specific documentation governing them (as well as the implications of whether the PPP loan is later forgiven), should be the logical next step. And in most cases, the process of seeking and/or issuing a formal consent, or formally amending or waiving certain applicable provisions binding on the business, should either be prepared by, or with the benefit of guidance from, legal counsel.

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^{[1] The Paycheck Protection Program was recently rolled out by the federal government pursuant to the Coronavirus Aid, Relief and Economic Security (CARES) Act.}

^{[2] Customary exclusions, such as ordinary course trade payables, purchase money financing and other debt owing to the bank, may exist. If a PPP loan is provided by the same bank that provided the existing debt, due consideration should be given to cross-default and cross-collateralization provisions in the existing loan documents which may potentially implicate the PPP loan or vice versa.}

^{[3] The business may also have subordinated debt or mezzanine financing that is subject to a subordination or intercreditor agreement then in effect.}

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