A Deeper Dive into the Paycheck Protection Program under the CARES Act
Sullivan recently issued a client alert that explores the law and lore of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). Additional details regarding the Paycheck Protection Program ("PPP") instituted under the CARES Act and the loans available to small businesses thereunder are set forth below. The Small Business Administration (the "SBA") issued interim final rules on April 2, 2020, and Sullivan anticipates additional guidance regarding PPP loans to be available in the coming days, so stay tuned for important updates. As additional guidance is released, our views and recommendations may change.
The PPP is the program created under the CARES Act that is of greatest interest to most small businesses. The CARES Act permits the SBA to provide through the PPP loans backed by the federal government to help qualifying small businesses pay certain costs as further described below. These loans will be processed or underwritten by banks and other SBA approved lenders and are forgivable if certain conditions are met.
Loan Amount: The maximum amount available to any business under this program is the lesser of:
- 2.5 times the average total monthly payroll costs incurred in the one-year period prior to the making of the loan (or for seasonal employers, the average total monthly payroll costs incurred in the twelve weeks beginning February 15, 2019 or from March 1, 2019 to June 30, 2019) plus any outstanding amounts under a loan obtained through the SBA’s Disaster Loan Program between January 31, 2020 and the date on which such loan may be refinanced under the PPP;
- For businesses that were not in existence during the period from February 15, 2019 to June 30, 2019, 2.5 times the average total monthly payroll costs incurred in the period from January 1, 2020 to February 29, 2020 plus any outstanding amounts under a loan obtained through the SBA’s Disaster Loan Program between January 31, 2020 and the date on which such loan may be refinanced under the PPP; or
- $10 million.
There was an informal statement by an industry expert made during an American Bar Association program on April 2, 2020 (prior to the release of the SBA’s interim final rules) that suggested the 2.5 multiplier in the calculations above may be reduced to 2.25 in an attempt to ensure that more businesses have access to the funds, but as of the date of this writing Sullivan has not been able to confirm whether the multiplier will in fact be adjusted (that said, the interim final rules use a 2.5 multiplier). Similarly, while it is clear under the CARES Act that the payroll costs for the purposes of the calculations above are capped at $100,000 per employee, it is not clear if the definition of “payroll costs” for this purpose consists of salary only or if it includes additional costs, such as health benefit costs and retirement benefits for each employee (note: even if the payroll costs for the purposes of calculating the $100,000 cap do not include these additional costs, as discussed further below, the loan proceeds may be used to pay these additional costs). In the same April 2, 2020 American Bar Association program, an industry expert asserted that the $100,000 cap applies to the sum of salary and additional benefits costs.
Terms of the Loan: The U.S. Treasury has provided guidance that all loans made under the PPP will have the same terms. The CARES Act provides that the interest rate of such a loan may not exceed 4% , and the SBA and the U.S. Treasury have since confirmed that the interest rates will be 0.5% and will have a maturity of two years; however, Treasury Secretary Mnuchin on April 2, 2020 indicated that the rate might instead be 1%, and the interim final rules issued on April 2, 2020 in fact confirm that such rate will be 1%. The loans are not required to be secured by any collateral or personally guaranteed. The loans are not subject to any prepayment penalties, and the SBA generally has no recourse against any individual or owner of an eligible business for non-payment so long as the business uses the loan proceeds as permitted under the CARES Act (as described below). SBA guidance provides that neither the government nor lenders will charge businesses any fees for these loans; however, anecdotally, Sullivan is aware that certain banks have considered imposing upfront fees on borrowers. In addition, according to U.S. Treasury guidance, all payments under these loans are deferred for 6 months, but interest will continue to accrue over this period.
How to Qualify:
Good-Faith Certification: In order to qualify for a loan under the PPP, a business must submit to its bank a good-faith certification: (1) that the uncertainty of current economic conditions makes necessary the loan to support the ongoing operations of the eligible recipient; (2) acknowledging that the funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments and utility payments; and (3) that during the period from February 15, 2020 to December 31, 2020, the applicant has not and will not receive another loan under the PPP.
Also, each applying business will have to supply certain information required by the PPP loan application (as of this writing, the form of PPP loan application is available here), including, without limitation: (1) payroll information; (2) employee information (and 1099s for employees and independent contractors that would otherwise be employees); (3) health insurance premiums paid; and (4) retirement plan funding.
500 Employees Rule: As clarified by SBA guidance, the CARES Act permits any business with not more than 500 employees (including sole proprietorships, independent contractors and self-employed persons), private nonprofit organizations, veterans’ organization or tribal businesses affected by the COVID-19 pandemic to be eligible for a PPP loan. Full-time, part-time and other workers are included in this employee count; however, it is unclear at this time whether furloughed employees are included. The SBA guidance notes that businesses in certain industries who have more than 500 employees may be eligible if they meet the SBA’s size standards for those industries. In addition, businesses in the hospitality or dining industry (North American Industry Classification System ("NAICS") codes beginning with 72 that have more than one physical location may qualify if they employ not more than 500 employees per location. This means that hotels, restaurants and otherwise applicable stores of a single business may be eligible, without regard to its size.
The 500 Employee Affiliation Rule: Leaving aside the points just made, ownership and affiliate rules add additional complexity to the question of whether a business has more than 500 employees and, thus, if a business can qualify for certain benefits under the PPP. Businesses are generally required to include in their employee count the number of individuals employed by all of their "affiliates," as determined under the SBA rules and regulations. Accordingly, if a business is controlled by a private equity fund or any other entity or individual that also controls multiple other businesses, then the employee count for such business may include all employees in all other companies controlled by the private equity fund, entity or individual. It is unclear, however, whether the SBA will determine control through a 50% or more equity ownership threshold, a board/managing member or management control test – both of which have been used in prior SBA lending programs – or some other standard. Additional SBA guidance is necessary to clarify this point and to help numerous companies determine whether they would be ineligible for a PPP loan as a result.
It is important to note that this affiliation rule is waived under the CARES Act for any business with not more than 500 employees that, as of the date of the PPP loan, is assigned a NAICS code beginning with 72 (generally, those in the accommodation and food service industries, including hospitality and lodging), any business operating as a franchise that is assigned a franchise identifier code by the SBA and any business that receives financial assistance from a company licensed under Section 301 of the Small Business Investment Act of 1958. If a business is majority controlled by one or more outside investors or an investor group and does not fit within one of these exceptions, it must consider the affiliation rules. Certain individual waivers from the SBA regarding this rule may be available.
Foreign Owners: SBA regulations provide that businesses eligible for assistance from the SBA are businesses with a place of business located in the U.S. and that operate primarily within the U.S. or that make significant contributions to the U.S. economy through payment of taxes or use of American products, materials or labor. These regulations suggest that foreign ownership of a business would not alone exclude a business from being eligible for a PPP loan; however, the sample PPP loan application issued by the SBA suggests that a 20% foreign ownership might in fact disqualify otherwise eligible companies. Additional SBA guidance on this matter is required.
Liability: Initially, the CARES Act and the sample PPP loan application caused some concern among 20% owners of businesses, who must make certain certifications in the PPP loan application process that could be difficult, and SBA lenders about potential criminal liability if the PPP loan application contains misstatements or if the proceeds are not used in accordance with applicable requirements (see below). In response, the SBA, in the interim final rules, addressed some of these liability concerns by suggesting that the SBA will have recourse against a 20% owner only if that 20% owner (rather than the borrower) uses PPP loan proceeds for unauthorized purposes and by stating that SBA lenders may rely on borrower documentation and attestation supporting a borrower’s request for loan forgiveness (that is, the SBA will hold harmless any lender that relies on such borrower documents and attestation from a borrower).
Although these interim final rules reflect encouraging first steps, many SBA lenders and 20% owners (particularly funds) may require additional clarification before they are comfortable participating in the program; consequently, fund-backed companies in particular may need to engage their 20% owners as soon as possible to assuage any concerns about required certifications.
Use of Proceeds: The loan proceeds must be used for “payroll costs,” defined in the law to include salaries, paid leave, severance payments, health care benefit costs, payroll taxes and other costs, up to $100,000 per employee in one year (prorated as applicable), interest payments on mortgages incurred before February 15, 2020, rent payments under leases in force before February 15, 2020, utility payments for which service began before February 15, 2020 and interest payments on certain other existing debt obligations. Current guidance from the U.S. Treasury provides that payroll costs include (1) salary, wages, commissions and other “similar compensation” (it is not clear whether bonuses would be included) or cash tips, vacation, parental, family, medical or sick leave pay (other than any of the paid leaves for which a credit is claimed to cover the cost, severance type pay, certain costs to maintain group health care coverage (including insurance premiums), payment of any “retirement benefit,” the scope of which is not clear, state and local taxes assessed on compensation and, for a sole proprietor or independent contractor, wages, commissions, income, net earnings from self-employment or similar compensation, capped at $100,000 on an annualized basis for each employee. (See earlier comments about the present uncertainty around how the $100,000 cap might apply.)
The U.S. Treasury guidance makes clear that the U.S. government will pursue criminal charges against any business, and, as discussed above, potentially any 20% owner of such business, that uses the proceeds of these loans for fraudulent purposes.
Loan Forgiveness: If a business uses the loan proceeds in accordance with the requirements of the CARES Act (including for payroll costs, mortgage interest, rent and utility payments over the eight weeks after receiving the loan), the principal amount of the loan used for such authorized expenses, but not any associated interest, will generally be forgiven. According to U.S. Treasury guidance and the interim final rules issued on April 2, 2020, not more than 25% of the forgiven amount may be for non-payroll costs. If a business reduces its workforce or salaries after receiving a loan under this program, it may not qualify for loan forgiveness or may qualify for only partial forgiveness. According to guidance from the U.S. Chamber of Commerce, the reduced amount forgiven as a result of a headcount reduction is calculated by taking the payroll cost times the average number of full-time equivalent employees per month for the eight weeks beginning on the date the business received its loan and dividing by either (1) the average number of full-time equivalent employees per month from February 15, 2019 to June 30, 2019, (2) the average number of full-time equivalent employees per month from January 1, 2020 to February 29, 2020 or (3) for seasonal employers only, the average number of full-time equivalent employees per month from February 15, 2019 to June 30, 2019. According to the Chamber, the calculation of the reduced amount forgiven as a result of reduction in pay is the payroll costs minus, for any employee who did not earn during any pay period in 2019 wages at an annualized rate more than $100,000, the amount of any reduction in wages that is greater than 25% compared to their most recent full quarter. In addition, the Chamber guidance provides that reductions in employment or wages that occur during the period beginning on February 15, 2020 and ending 30 days after enactment of the CARES Act shall not reduce the amount of loan forgiveness so long as the business eliminates the reduction in employees or reduction in wages by June 30, 2020.
In order to apply for loan forgiveness, businesses will need to submit certain information and documents, including, among other things, payroll filings, proof of rent or mortgage payments and a certification from a professional, such as counsel to the business, that the documentation is true and correct and that the amount for which forgiveness is requested for employee retention and other operating expenses is as discussed. Amounts forgiven under this program are generally not treated as taxable income for federal income tax purposes. The interim final rules issued on April 2, 2020 indicate that the SBA will provide additional guidance on loan forgiveness under the PPP.
How to Apply: As noted above, the loans will be processed or underwritten by banks and other SBA approved lenders, so businesses can work directly with their banks to obtain loans. It is also expected that businesses may apply directly through the SBA beginning on April 3, 2020; however, as of the time of this writing, such direct application was not available. Each bank may have specific document requests and/or other requirements (we know of one large bank that will only process a PPP loan for existing clients with existing debt with the bank, but consider that banks may reassess this decision as a result of the liability protections discussed above) in addition to the good-faith certification discussed above, so businesses should be sure to call their loan officers to discuss. In addition, it is important to consider that any existing credit facilities of a business may contain restrictions on the incurrence of additional debt. Such existing credit facilities should be carefully reviewed and may need to be amended or applicable provisions waived by existing lenders. It is also important to note that proceeds under existing credit facilities, as well as other sources of cash, may be available for similar uses as loan proceeds under the CARES Act.
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Sullivan has developed a rapid response team of attorneys to help our clients and our communities cope with the impact of the COVID-19 pandemic and understand the implications of the CARES Act and other actions taken by state governments and the federal government. Please refer to Sullivan’s resource center at sullivanlaw.com/COVID19 for more information and for access to Sullivan’s library of related advisories.
Please know that Sullivan is focusing substantial efforts to provide assistance to businesses and individuals affected by COVID-19 and benefited by the CARES Act. If you have questions about how to move forward and navigate the novel legal issues raised by COVID-19 and/or the CARES Act, please contact your primary Sullivan attorney or send a message to CARES@sullivanlaw.com.