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Certain provisions of the Coronavirus/Covid-19 economic stimulus legislation are subject to the issuance of government regulations and other government action, thus certain details regarding the legislation may be clarified or added.
One of the critical components of the Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act”) is a new type of US Small Business Administration (SBA) loan program known as the Paycheck Protection Program (the “Program”). This program, which has been added as a new program under Section 7(a) of the Small Business Act, encourages employers to keep employees on the payroll and keep the doors open by providing loans (called “covered loans”) with several attractive features:
Notably for lenders, loans made under the Program are eligible to be sold in the secondary market consistent with rules under the current SBA Section 7(a) program, and the CARES Act mandates a zero percent risk-weight of these loans for purposes of banking regulators’ risk-based capital requirements. The CARES Act also has provisions regulating lender compensation upon loan origination.
Prior to the CARES Act, the SBA was authorized to provide loans in an original principal amount not exceeding $2,000,000 to small businesses with fewer than 500 employees (“disaster loans”) as part of the Disaster Loan Program. In addition to the Program described in this Alert, the CARES Act also expands the SBA’s existing Disaster Loan Program. Covered loans and disaster loans may be applied for at the same time, but a borrower is only permitted to close one of the loans.
This alert provides guidance on the following topics relating to the Program:
What is a covered loan?
A covered loan is a loan by an authorized SBA 7(a) lender to an eligible recipient made during the “covered period.” The “covered period” began on February 15, 2020 and extends until June 30, 2020. Covered loans must be originated by June 30, 2020 and, considering that 7(a) lenders may face a flood of applications, every effort should be made to apply for a covered loan as soon as possible. We anticipate that businesses will be able to apply for a covered loan approximately a week after the CARES Act becomes law.
Who is an “eligible recipient”?
Eligible recipients include any business concern, non-profit organization, veterans organization, sole proprietor, independent contractor, and self-employed individual, among others (each a “subject business”). Each subject business is eligible to receive a covered loan provided that it employs not more than the greater of 500 employees (includes full-time, part-time, and those employed on other bases) or if applicable, the size standard in number of employees established by the SBA for the industry in which the business operates. While the CARES Act does not specifically address the SBA’s maximum revenue requirements, we expect that the SBA may limit some businesses eligibility based on revenue in accordance with the SBA’s existing revenue requirements for the industry in which the business operates (please see the SBA sizing tool based on number of employees and revenue). Additionally, the CARES Act is silent on whether or not the existing list of ineligible types of businesses for SBA 7(a) loans (as outlined in 13 C.F.R. §120.110) remain applicable to the PPP. We expect to hear further guidance on this issue from the SBA in the coming week. For businesses in the hospitality and dining industries (NAICS Class 72) with more than one physical location, if the business employs 500 or fewer employees per location, the business will be an eligible business.
The SBA Section 7(a) program of which the Program is now a part contains affiliation and common control rules (found in 13 CFR §121.103) that will in many circumstances cause the employees of any particular business to be aggregated with the employees of all other businesses that are deemed to be under common control with that business. This will be particularly important for portfolio companies of investment funds and will disqualify some otherwise needy businesses from eligibility under the Program. However, the SBA affiliation rules are waived for businesses in the food service sector (NAICS Class 72), certain franchises, and businesses receiving financial assistance from a company licensed under Section 301 of the Small Business Investment Act.
What expenditures count toward the amount of loan forgiveness?
Consistent with the purposes of the CARES Act to help keep businesses open and employees on the payroll beginning as soon as possible, the expenses outlined below that count toward loan forgiveness are those that are incurred during the eight-week period immediately following the date the covered loan is originated. The amount of any loan forgiveness will not be considered gross income under the Internal Revenue Code, although state and local taxing authorities may or may not follow this rule. Note that the eight-week period may run past June 30, 2020 as long as the covered loan is originated before that date.
The following expenditures (“Qualifying Expenditures”) incurred during the eight-week period count toward loan forgiveness:
Notably, “payroll costs” exclude compensation, prorated for the eight-week period, of employees and independent contractors to the extent that compensation exceeds $100,000.
Use of Covered Loan Proceeds.
Covered loans are a variant of conventional Section 7(a) loans, so proceeds of covered loans under the Program may also be used for working capital, refinancing existing debt, purchases of equipment, and other uses permitted for Section 7(a) loans generally. However, to the extent proceeds of covered loans are not utilized for Qualifying Expenditures during the eight-week period following the origination of the covered loan, loan forgiveness is unavailable. Borrowers applying for covered loans under the Program must certify that “funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments,” but the statute does not specify what portion of the funds must be so utilized. Regulations may provide guidance on this question.
How is the amount of loan forgiveness calculated?
The maximum principal amount of a covered loan is the lesser of (i) $10,000,000 and (ii) 2.5 times the average monthly payroll during the 12-month period ending on the date the covered loan is made (different formulas apply for (A) seasonal employers and (B) employers not in business between February 15, 2019 and June 30, 2019). This spreadsheet indicates the maximum principal amount of a covered loan available to a borrower (other than those described in (A) or (B) above) for various employee headcounts and average annual payrolls. Up to 100% of this maximum amount can be forgiven by utilizing the covered loan proceeds solely for Qualifying Expenditures during the aforementioned eight-week period following the origination of the covered loan. However, loan forgiveness is subject to two additional limitations, one based on reduction in number of employees (the “Headcount Adjustment”), the other based on compensation reduction (the “Compensation Adjustment”), each computed with reference to certain specified measuring periods.
The Headcount Adjustment reduces the amount of forgiveness to an amount equal (a) to the amount otherwise available for forgiveness multiplied by (b) a fraction, the numerator of which is the average number of full time equivalent employees (FTEs) during the eight-week period immediately following the origination of the covered loan, and the denominator of which is the average number of FTEs per month during, at the borrower’s election, either (i) the period February 15, 2019 through June 30, 2019, or (ii) the period January 1, 2020 through February 29, 2020.
The Compensation Adjustment reduces the amount of forgiveness otherwise available by the aggregate amount of salary reductions (determined on an employee-by-employee basis) effectuated during the eight-week period to the extent a reduction exceeds 25% of an employee’s salary or wages during the most recent full quarter prior to the commencement of the eight-week period. Employees who are compensated at a rate in excess of $100,000 per year are not considered, that is, no amount of salary reduction for employees earning over $100,000 per year has the effect of reducing loan forgiveness.
The reductions in loan forgiveness attributable to the Headcount Adjustment and the Compensation Adjustment can be mitigated, or even eliminated, to the extent that (i) in the case of a headcount reduction occurring during the period that began on February 15, 2020 and ends April 26. 2020, the borrower reverses that reduction by June 30, 2020 (for example, by re-hiring furloughed employees or hiring new employees), and/or (ii) in the case of a salary reduction occurring in that window period that began on February 15, 2020 and ends 30 days after the enactment of the CARES Act, the reduction is similarly reversed by June 30, 2020. In other words, to the extent that loan forgiveness would otherwise be reduced by a Headcount Adjustment and/or a Compensation Adjustment, the borrower can mitigate the effect of each by re-hiring employees and restoring salary cuts, respectively, before June 30, 2020.
For purposes of computing the Headcount Adjustment and the Compensation Adjustment, independent contractors are not considered employees.
How is a covered loan obtained and loan forgiveness granted?
To obtain a covered loan, a borrower applies to a participating lender, who generally will be the same lenders who currently offer SBA Section 7(a) loans. We recommend that businesses contact their existing banks as soon as possible to see if they offer SBA Section 7(a) loans as many lenders have indicated that their existing customers will receive priority on their applications. Following disbursement of a covered loan and expiration of the eight-week measuring period, the borrower submits to the lender certain required documentation along with a certification outlining the amount requested to be forgiven together with proof of payment of qualified expenditures and a certification that the application documentation is true and correct whereupon, within 60 days thereafter, the lender should issue a formal decision forgiving the portion of the covered loan set forth in the application.
 See "Who is an eligible recipient."
To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. Use of this article does not create an attorney-client relationship between you and Lowenstein Sandler. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney. In addition, the information in this article may change based on guidance by the SBA or Treasury as well as a change in law.
We have been sharing client alerts about the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) created by the CARES Act. Below are some frequently asked questions and answers with respect to the PPP that we hope will help you understand this program.
What is the Paycheck Protection Program?
The PPP is a loan program that allows eligible borrowers to obtain loans on favorable terms to cover payroll and other eligible expenses (rent, utilities, certain health care benefits and health insurance premiums, and certain interest expense). This loan program is for the specific purpose of helping eligible borrowers affected by the coronavirus pandemic to keep paying employees and to keep their doors open for business. To the extent the PPP loan is promptly used to pay payroll, rent, mortgage interest and utilities, the loan never has to be repaid (“terms and conditions apply,” naturally).
The first wave of PPP funding was exhausted on April 16, 2020. The government approved $310 billion of new funding for the PPP on April 24, 2020. On April 27, 2020, the SBA resumed accepting PPP applications from participating lenders. About one fifth of the new PPP funding is earmarked for smaller banks, smaller credit unions, and community financial institutions that provide financing to underserved and economically disadvantaged communities.
The CARES Act was substantially amended on June 5, 2020, with the enactment of the Paycheck Protection Program Flexibility Act of 2020 (the “Flexibility Act”). The Flexibility Act updated many aspects of the PPP. As suggested by its name, the law is intended to give PPP borrowers more flexibility in when and how they spend their PPP funds. Flexibility Act updates are included below.
UPDATE: On July 4, 2020, the Paycheck Protection Program Extension Act (the “Extension Act”) was enacted. The Extension Act extends the PPP application deadline from June 30 to August 8, 2020. According to the SBA, as of June 30, 2020, about $137.5 billion of PPP funding remained.
Who is eligible for a PPP loan?
You are eligible for a PPP loan if you employ fewer than 500 employees (full-time and part-time) who live in the United States, AND you were in operation on February 15, 2020, AND you either (1) paid salaries and payroll taxes for employees or (2) paid independent contractors.
Some businesses may qualify under other applicable tests. Please check with your lender or advisor about eligibility on other grounds.
Be aware that two or more businesses under common control could be “affiliated” under SBA rules. “Affiliated” employers are lumped together in determining the 500-employee limit. This determination often requires detailed analysis. Check with your attorney even though you may think your organization stands 100% alone.
Do independent contractors count as employees for purposes of PPP calculations?
No. Independent contractors can apply for a PPP loan on their own; the entities that engage them cannot count them for purposes of a PPP loan application.
I don’t have employees. Can I still qualify?
Yes. The rules issued under the CARES Act state: “You are also eligible for a PPP loan if you are an individual who operates under a sole proprietorship or as an independent contractor or eligible self-employed individual . . . .” In that case, you must submit documents such as payroll processor records, payroll tax filings, Forms 1099-MISC, income and expenses from a sole proprietorship, or other documents sufficient to demonstrate the qualifying loan amount.
Can I apply for a PPP loan if I am receiving unemployment assistance?
Yes, but proceed with caution. There is no restriction on receiving both benefits, but you cannot use the PPP loan to cover your own compensation while at the same time receiving unemployment benefits. If you are receiving unemployment benefits, you can use your PPP for other business expenses, such as other employees’ compensation, rent, or utilities.
At least 60% of the forgiven amount must be used for payroll costs; if you use all or most of your loan for non-payroll expenses, therefore, the forgivable amount may be low.
How do I apply for a PPP loan?
You should contact your existing lender or lending institution where you maintain your bank accounts. Many participating lenders are accepting applications only from existing customers. Most lenders are accepting applications through their own online portals. If your existing bank is not participating in the PPP program or is no longer accepting applications, you may wish to apply with a community bank such as Northeast Bank, Kabbage, or Old Dominion Bank, or FinTech company such as PayPal. If you need additional help finding a qualified lender, this SBA search tool will identify lenders near you.
When can I apply?
Applications will be accepted through August 8, 2020, or until the funds for this program are exhausted, whichever is sooner. This program is supposed to operate on a “first come, first served” basis. APPLY AS SOON AS YOU CAN.
What is the maximum amount I can borrow?
It’s a formula amount: 2.5 times your average monthly payroll expenses for either (1) the 12 months before you apply for the loan or (2) calendar year 2019 (the bank to which you apply may require you to use (2), which many applicants who use payroll services will find more convenient anyway).
The Treasury Department has released guidance to help general partnerships, sole proprietors, and independent contractors calculate payroll. See Paycheck Protection Program: How to Calculate Maximum Loan Amounts – By Business Type, for complete instructions.
If you are a seasonal business, you can borrow 2.5 times average monthly payroll costs from: (1) February 15 to June 30, 2019, (2) March 1 to June 30, 2019, or (3) during any consecutive 12-week period between May 1, 2019 and September 15, 2019, whichever generates the best result.
If you are a startup business that did not exist between February 15 and June 30, 2019, you can calculate your average monthly payroll costs based on payroll from January 1 to February 29, 2020.
Salary and wages above $100,000 per employee are excluded from the calculation of average monthly payroll, but all benefits the business pays on behalf of such employees (e.g., health insurance, retirement benefits) are counted in the payroll calculation. If you already have an Economic Injury Disaster Loan, please inform your lender or lawyer.
Finally, there’s an absolute cap of $10 million on every PPP loan, and each borrower can get only one such loan.
What information should I gather in order to apply for a PPP loan?
You should have evidence of paying payroll or self-employment taxes. Any or all of the following information may be required by your lender for the relevant period; check before applying:
What can I use the loan proceeds for?
The loan proceeds can be used for:
When will I have to repay the loan?
Flexibility Act Update: You now will not have to start making payments on the loan until after you submit your forgiveness application and the SBA pays the forgiveness amount to the lender. Interest will not accrue during this time. For PPP loans made before the enactment of the Flexibility Act, the full amount will be due within 2 years of when you received the money. If you receive your PPP loan after the enactment of the Flexibility Act, you will have 5 years to repay the loan. Existing PPP loans can be extended up to 5 years if the lender and borrower mutually agree. If you want to pay earlier, there are no penalties for pre-payment.
Are there any other PPP loan terms I should know about?
Will all or a portion of my PPP loan be forgiven?
Flexibility Act Update: The loan amounts will be forgiven so long as:
(Before the enactment of the Flexibility Act, to qualify for full forgiveness borrowers had to spend the funds over the 8-week period after the loan was made. The Flexibility Act gives borrowers the option to spend the funds over a longer period. Borrowers whose PPP loan was approved prior to the enactment of the Flexibility Act may keep the original 8-week period if they choose. Most businesses will find the 24-week period preferable, but some may wish to retain the original 8-week period so as to submit the forgiveness application as soon possible.)
Originally, the SBA indicated that at least 75% of the forgiven amount had to be used for payroll costs. The Flexibility Act reduces this percentage: PPP borrowers are now eligible for loan forgiveness so long as they use at least 60% of loan proceeds for payroll expenses, with no more than 40% of loan proceeds going to eligible non-payroll expenses.
Reductions to Forgiveness: Forgiveness is reduced based on headcount reductions and salary reductions. Both are hard to work through and may require the assistance of legal counsel.
Note that some reductions in workforce will not count against you for the purpose of loan forgiveness. Loan forgiveness will not be impacted if:
Is loan forgiveness automatic?
No. You will need to submit an application for forgiveness directly to the lender that provided your PPP loan. On June 16, the SBA released a revised 7-page loan forgiveness application that incorporates changes to PPP loan forgiveness requirements made by the Flexibility Act. On the same date, the SBA also released a simplified 3-page “EZ” loan forgiveness application for borrowers who can satisfy any of the following requirements:
Is the amount forgiven taxable?
No. The amount of any loan forgiveness will not be considered gross income under the Internal Revenue Code, although state and local tax authorities may or may not tax the forgiven amount.
What happens if PPP loan funds are misused?
If you use PPP funds for unauthorized purposes, the SBA will direct you to repay those amounts. If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud. If one of your shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA will have recourse against the shareholder, member, or partner for the unauthorized use.
Can I apply for more than one PPP loan?
To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.
© Lowenstein Sandler LLP, 2020