SBA’s Paycheck Protection Program and Other SBA Relief for Small Businesses Provided in CARES Act

On Friday, March 27, 2020, the President signed into law The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which provides up to $2 trillion to address the severe economic dislocation caused by the virus. This alert addresses a portion of the CARES Act whose key provisions are intended to provide small businesses with accelerated access to desperately needed liquidity during these unprecedented times. This part of the CARES Act is aptly named the “Keeping American Workers Paid and Employed Act.”

Paycheck Protection Program

The $349 billion Paycheck Protection Program (the “PPP”) expands the U.S. Small Business Administration’s (the “SBA”) guaranteed Section 7(a) lending program for eligible small businesses. Under the PPP, eligible small businesses may borrow up to $10 million from participating banks and other financial institutions through June 30, 2020.  PPP loans are to be used to fund payroll and other operating business expenses. A key feature of the PPP is that such loans will be forgiven dollar for dollar to the extent that proceeds are used for payroll support (including salaries, group health costs and insurance premiums, mortgage interest or rent payments, utility payments and interest on certain other debt obligations) during the eight-week period following the origination of the PPP loan. The entire principal amount of the PPP loan is eligible for forgiveness. In essence, the federal government will pay the cost of a qualified business’s employees during the specified period of several months.

Eligible Business. To qualify for a PPP loan, a business must be (a) a business entity, nonprofit organization, self-employed individual operating as sole proprietorship, or independent contractor, in each case that has not more than 500 employees during the period from February 15 to June 30, 2020 (the “Covered Period”), or (b) a Small Business Concern.”[1]  Thus, even if a business has more than 500 employees, it may still qualify for a PPP loan if during the Covered Period the number of employees is less than the number of employees established by the SBA for the industry in which the business operates. For those businesses with more than 500 employees click here for the size standards the SBA has identified by NAICS codes.

Rules for Calculating the Number of Employees. The calculation of the total number of employees must include all full-time and part-time direct employees plus those indirectly employed through a temporary employee agency, professional employer organization or leasing business. The SBA will consider the totality of the circumstances, including the criteria used by the IRS for federal income tax purposes, in determining whether individuals are employees of a business.

To substantiate eligibility, self-employed individuals, sole proprietors and independent contractors are required to submit payroll tax filings reported to the IRS, IRS Forms 1099-MISC and other income and expense documentation as may be required by the SBA.

Affiliation Issues. The SBA 7(a) loan program, of which the PPP is now a part, generally requires taking into account the employees of “affiliates.” The determination of “affiliate” status is a fact intensive inquiry. Under the SBA rules, entities are “affiliates” when one controls or has the power to control the other, or a third party controls or has the power to control both, whether or not control is actually exercised. A person or entity that owns, or has the power to control, 50% or more of a concern’s voting stock, or a block of voting stock, controls or has the power to control the concern. However, the SBA will deem a minority shareholder to be in control if that individual or entity has the ability, under the concern’s charter, by-laws or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders. In determining whether affiliation exists, the SBA will consider the totality of the circumstances and may find affiliation even though no single factor is sufficient to constitute affiliation.

Affiliation issues may be particularly troublesome to portfolio companies of private equity and venture capital funds, as affiliation may result from common investments where the same individuals or firms together own a substantial portion of multiple concerns in the same or related industry, and such concerns conduct business with each other, or share resources, equipment, locations or employees with one another, or provide loan guaranties or other financial or managerial support to each other. In such case, the employees of all affiliated entities are aggregated and the total number of all such employees must not exceed the greater of (a) 500 and (b) the number of employees in the NAICS code (i) for the industry in which the applicant is primarily engaged or (ii) for the industry in which the applicant and its affiliates are primarily engaged. While there is a specific exemption from the affiliation rule for portfolio companies owned in whole or substantial part by investment funds licensed by the SBA as small business investment companies (“SBICs”) the exemption does not apply to other investment funds.

Waiver of Affiliation Rules. Under the PPP loan program the affiliation rules will not apply to any business that (a) is operating one or more hotels, restaurants, bars and other hospitality businesses identified in NAICS code 72, (b) operates as a franchise assigned an identifier code by the SBA, or (c) receives financial assistance from an SBIC.  Private equity and venture capital funds whose portfolio companies are ineligible for PPP loans because of the affiliation rules should consider a small investment from an SBIC to benefit from this waiver.  In addition, business with the hospitality industry NAICS code that have more than one physical location and no more than 500 employees at each location are eligible to receive a PPP loan.

Maximum Loan Amount. The maximum loan amount for PPP loans is the lesser of: (a) 2.5 times the average total monthly payroll costs incurred in the one-year period before the loan is made (or for seasonal employers the average monthly Payroll Costs for the 12 weeks beginning on February 15, 2019, or from March 1, 2019, to June 30, 2019) plus the outstanding amount of a loan made under the SBA’s Section 7(b)(2) Economic Injury Disaster Loan Program (the “EIDL Program”) between January 31, 2020, and the date on which such loan may be refinanced as part of this new program; (b) for businesses that were not in existence during the period from February 15, 2019, to June 30, 2019: (i) 2.5 times the average total monthly payroll payments from January 1, 2020, to February 29, 2020, plus the outstanding amount of a loan made under the EIDL Program between January 31, 2020, and the date on which such loan may be refinanced as part of this new program; or (c) $10 million.

“Payroll Costs” include the sum of salaries, wages, commissions; payments for vacation, parental, family, medical or sick leave; allowance for dismissal or separation; payment required for the provisions of group health care benefits, including insurance premiums; payments of any retirement benefit; and payments of state or local tax assessed on the compensation of employees—but excludes the compensation of an individual employee in excess of an annual salary of $100,000, any compensation of an employee whose principal place of residence is outside of the United States, and qualified sick leave or family leave wages allowable towards tax credit.

Use of Proceeds. The proceeds of a PPP loan may be used for (a) Payroll Costs, (b) rent, (c) utilities, (d) interest (but not principal) on any mortgage obligation, (e) interest on any other debt obligations that were incurred before February 15, 2020, and (f) any other permitted use of a SBA 7(a) loan, including working capital, plant acquisition, construction, conversion, or expansion, including the acquisition of land, material, supplies and equipment.

Other PPP Loan Provisions. The interest rate will not to exceed 4%. The loan is 100% guaranteed by the SBA. Unlike most SBA 7(a) loans, no collateral or personal guaranty is required. There is no recourse to the owners of the eligible business unless the loan proceeds are used for an unauthorized purpose.

In administering PPP loans, in addition to determining whether the proposed borrower is an “eligible business,” banks and other participating financial institution lenders are to determine eligibility for a loan based solely on whether the proposed borrower (a) was in operation on February 15, 2020, and (b) had employees for whom the borrower paid salaries and payroll taxes or paid independent contractors, as reported on a IRS Form 1099—MISC.

The SBA 7(a) loan guarantee fee, generally 3% to 3.75% of the SBA-guaranteed amount, is waived, as is the requirement for an eligible business to be unable to obtain loans elsewhere.

Loan Forgiveness

A PPP borrower may have the principal amount of the loan be forgiven, not to exceed the total principal, in an amount equal to the sum of the cost incurred and paid during the eight-week period beginning with the disbursement of the PPP loan (the “Forgiveness Period”) for (a) Payroll Costs, (b) rent, (c) utilities and (d) interest payments on mortgages. The obligation to pay rent, utilities and interest on a mortgage must have been in existence before February 15, 2020. Any principal amount of a PPP loan forgiven will be excluded from gross income for income tax purposes.

In order to incentivize the retention of employees, the amount of loan forgiveness is subject to reduction (but not increase) to an amount equal to the total amount determined by the paragraph above multiplied by a fraction, the numerator of which is the average number of full-time equivalent employees (“FTEEs”) per month, calculated by the average number of FTEEs for each pay period falling within a month, during the Forgiveness Period, and the denominator of which is, at the election of the borrower, either (a) the average number of FTEEs per month employed from February 15, 2019, to June 30, 2019, or (b) the average number of FTEEs per month employed from January 1, 2020, until February 29, 2020.

Forgiveness amounts will also be reduced for any reductions in employee wages. For reductions in wages, the forgiveness reduction is equal to the amount of any reduction in total employee wages during the Forgiveness Period that is in excess of 25% of the employee’s wages during the most recent full quarter before the Forgiveness Period. For this purpose, an “employee” is limited to any employee who did not receive wages during any single pay period during 2019 at an annualized rate of pay over $100,000.

In order to incentivize the rehiring of employees and the reversal of any recent salary reductions, PPP loan forgiveness will be determined without regard to the reduction in the number of FTEEs of a loan borrower and any reduction in employee wages of a PPP borrower, in each case between February 15, 2020, and April 26, 2020, that is eliminated prior to June 30, 2020.

Borrowers seeking loan forgiveness must submit to their lender (a) documentation verifying FTEE on payroll and pay rates, (b) documentation on covered costs (e.g., verifying mortgage, rent and utility payments), (c) certification from a borrower representative that the documentation is true and correct and that forgiveness amounts requested were used to retain employees and make other forgiveness-eligible payments, and (d) any other documentation the SBA may require. The SBA has until April 26, 2020, to issue regulations on these forgiveness provisions.

Loan Deferral and Repayment. Lenders are required to defer payments on PPP loans, including interest, principal and fees, for between six months and one year, with the SBA to issue deferment guidance to lenders by April 26, 2020.

To the extent that the entire principal of a PPP loan is not forgiven, the PPP loan will have a maximum maturity of 10 years from the date on which the borrower applies for loan forgiveness.

How to Apply for a PPP Loan. To apply for a PPP loan, a small business should contact a bank or other financial institution currently participating in the SBA 7(a) loan program. The bank or financial institution can assist an applicant in determining whether your business qualifies for a PPP loan.

To determine the maximum amount that may be borrowed under a PPP loan, an applicant will need to provide documentation verifying the Payroll Cost for the relevant period, such as payroll legers, payroll tax filings, invoices substantiating group healthcare and retirement benefits.

In addition, the applicant will be required in good faith certify (a) that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the applicant; (b) acknowledge that funds will be used to retain workers and maintain payroll or make mortgage, lease or utility payments; (c) that the applicant does not have an application pending for an SBA 7(a) loan for the same purpose and duplicative of amounts applied for or received under a PPP loan; and (d) during the period beginning on February 15, 2020, and ending on December 31, 2020, that the applicant has not received amounts under a SAB 7(a) loan for the same purpose and duplicative of amounts applied for or received under a PPP loan.

Emergency Economic Injury Disaster Loan Program

Section 1110 of the CARES Act expands the SBA’s 7(b)(2) EIDL Program by making $10 billion available for emergency loans (“Emergency EIDL Loans”).  Under the EIDL Program, eligible small business may borrow from participating banks and other financial institutions up to $2 million during the period January 31 through December 31, 2020. The proceeds of an Emergency EIDL Loan can be used for working capital, payroll and other expenses that the applicant could have paid had the disaster not occurred, but not to replace lost profits or to finance business expansion. Furthermore, the proceeds of an Emergency EIDL Loan must not be used to duplicate any cost or expense covered by a PPP loan. The interest rate on an Emergency EIDL Loan will be 3.75% (but 2.75% for non-profits) and repayment can be over up to 30 years.  An eligible business may seek an Emergency EIDL Loan after the proceeds of its PPP loan is exhausted.

Eligible Business. To qualify for an Emergency EIDL Loan, a business must be (a) a business with not more than 500 employees, (b) an individual who operates under a sole proprietorship, with or without employees, or as an independent contractor, (c) a cooperative with not more than 500 employees, (d) an ESOP with not more than 500 employees, (e) a Small Business Concern, (f) a private nonprofit organizations, or (g) a small agriculture cooperative.

Streamlined Process. The EIDL Program waives (a) the requirement for personal guarantees of loans of $200,000 or less; (b) the “one year in business prior to the disaster” requirement (except the business must have been in operation on January 31, 2020); and (c) the requirement that an applicant be unable to find credit elsewhere. The EIDL Program allows lenders to approve applicants based solely on credit scores (without the submission of a tax return) or alternative methods appropriate for determining an applicant’s ability to repay.

Applicants for an Emergency EIDL Loan based on COVID-19 can request an emergency advance from the SBA of up to $10,000, which does not have to be repaid, even if the loan application is later denied. The SBA must verify an applicant’s eligibility for an advance by accepting a “self-certification.” Advances are to be awarded within three days of an application. If an applicant receiving an emergency advance subsequently borrows a PPP loan, the emergency advance amount will be reduced from any Payroll Cost forgiveness amounts.

All states and their subdivisions are deemed to have sufficient economic damage related to the pandemic to qualify for assistance under this loan program (rather than the current state declaration and certification approach).

Debt Relief Programs

Pursuant to Section 1112 of the CARES Act, the SBA is required to pay all loan payments, including principal, interest and fees, for six months on the following SBA loans outstanding before April 26, 2020, or made before October 26, 2020: all 7(a) loans other than PPP loans, microloans (up to $50,000 to help startups—see details of these loans here) and 504 loans (up to $5.5 million long-term fixed rate financing for property plant and equipment—see details of the microloan program here). Although such debt relief is intended to be self-executing, we suggest that any business with any such loans should follow up with their banker or SBA contact.

Steps To Take Now
  1. Most importantly, to take advantage of PPP loan forgiveness and to finance Payroll Costs and rent, mortgage and utilities for the next few months, determine if your business qualifies as an “eligible recipient.” Generally speaking, an “eligible recipient” is a business with (i) not more than 500 employees during the period February 15 to June 30, 2020, (ii) not more than 500 employees, on average for the immediately prior 12-month period, or (iii) no more employees than the number of employees set forth in the applicable NAICS.
  2. Contact a banker or other financial institution, preferably your current banker if they participate in the SBA loan program. A list of such lenders can be found here. They can assist you to determine whether you qualify for a PPP loan and to prepare and submit the required documents to apply for a PPP loan. An eligible business may secure only one PPP loan.
  3. Assemble information substantiating your eligibility for a PPP loan and to determine the maximum amount that may be borrowed under the PPP loan, your average total monthly payroll costs incurred in the one-year period before the loan is made. Documentation may include payroll legers, payroll tax filings, invoices substantiating group healthcare, and retirement benefits.
  4. If you have outstanding commercial loans, discuss with your lender financial accommodations such as interest and principal payment deferrals, waivers, emergency accordion facility, and maturity extensions.
  5. If you have any existing SBA 7(a), 504 or microloans outstanding, contact your bank or SBA contact to confirm the six-month deferment on all payments of interest, principal and fees.
  6. Strategize and plan with your SBA banker or professional adviser to maximize access to cash after the proceeds of the PPP loan have been exhausted. That could include a number of SBA programs, including Emergency EIDL Loan, a traditional 7(a) loan or microloan.

[1]  Under SBA regulations, “small business concerns” are for-profit, independently owned and operated entities that are not dominant in their field of operation and that meet the size restrictions under the relevant SBA program. We believe the principal difference between small business concerns and other PPP eligible businesses is that for small business concerns (a) the number of employees test is based on the average number of employees over the 12 months preceding the determination, and (b) eligibility for businesses with certain NAICS industry codes is based on the average annual receipts for the last three years.


Source: McCarter & English

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