On March 27, 2020, the President signed into law a financial relief package called the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). One of the most significant provisions of the CARES Act is the Paycheck Protection Program (“PPP”), which provides the potential for loans to small businesses that can be forgiven in many circumstances. Businesses may apply for these loans up to $10 million, which will be administered by the Small Business Administration (“SBA”). Any qualifying business may apply for a PPP loan through June 30, 2020, or until funds made available for the PPP have been exhausted, whichever is first. Congress has made $349 billion in aid available under the PPP on a first-come, first-served basis. PPP loans are primarily designed to allow businesses
to meet payroll expenses and keep workers employed. Forgiveness of the loan depends, in large part, on keeping employees on payroll during this critical pandemic period, and we expect the SBA will issue additional guidance on forgiveness in the coming days.
A summary of key aspects of the loan program is set forth below. In recent days, the Treasury Department and the SBA have been issuing new guidance with some frequency and certain issues have begun to emerge. These issues, dealing with access to a lender, the definition of affiliates, and application of the cap on payroll compensation, can be extremely important to certain borrowers.
General Requirements for a PPP Loan
Who is eligible:
- Businesses of up to 500 employees.
- Businesses with more than 500 employees qualify in certain circumstances, such as when NAICS industry code defines a larger number of employees as a small business in that industry.
- Unlike other loans, the borrower does not need to show that it is unable to find credit elsewhere.
- Requires a good faith certification that businesses will use the loan funds to retain workers and maintain payroll and other debt obligations.
Determining the Loan Amount:
- Max Loan Amount is theoretically $10M, but most borrowers will qualify for significantly less based on payroll costs.
- Loan amount is based on average monthly payroll costs:
- 2.5x the average monthly payroll costs during the one-year period before the date on which the loan was made;
- average monthly payroll costs can include expenses for paid sick leave, health care and other benefits;
- employee compensation is capped at $100,000 [see discussion below]; and
- only employees whose principal place of residence is the United States may be included in payroll costs.
- Interest Rate
- No payments for six months, although interest will still accrue during that period.
- No personal guarantee or collateral is required.
- No guarantee fees, servicing fees, or prepayment fees.
Use of Loan Proceeds:
- Loan proceeds can be used to pay costs incurred by a company for the eight-week period following receipt of the funds.
- 75% of the proceeds must be for payroll costs.
- The other 25% may be used for payments for mortgage obligations, rent and utilities, provided that such obligations were in place on or before February 15, 2020.
- Provided that loan proceeds are used for this purpose, there is no recourse against individual shareholders, members, or partners for non-payment.
- Forgivable types of expenses
- Payroll costs up to the cap amount of $100,000 in employee compensation;
- mortgage and rent obligations (including interest) provided the lease was in force before February 15, 2020;
- utility payments;
- health care benefits for employees, including group health insurance premiums and other costs;
- other benefits reflected on payroll, including paid sick leave, vacation, retirement benefits, and health care coverage; and
- payment of state and local taxes assessed on compensation of employees.
- Forgivable expenses are only those that are incurred within eight weeks following issuance of the loan.
Reduction in Loan Forgiveness:
- Although we are anticipating additional guidance regarding forgiveness, current indications are that loan forgiveness will be reduced pursuant to certain factors, such as:
- Workforce reduction for the first eight weeks following the loan;
- wage reduction following the first eight weeks of the loan for employees who make less than $100,000 by 25% or more; and
- if you hire back employees, you can earn back some of the guarantee/forgiveness; currently, the forgiven amount disregards reductions made between February 15, 2020 and April 26, 2020, to the extent eliminated by June 30, 2020.
Tax Benefit of Loan Forgiveness:
- Any amount forgiven that would ordinarily be includible as gross income to the borrower for federal tax purposes is excluded from gross income.
Overview of Issues Arising from the Commencement of the Loan Program
- Delays in Guidance and Processing: the SBA began accepting applications on April 3, but the program got off to a rocky start because many financial institutions were not yet ready to begin processing applications. Various public comments about the PPP suggested that the PPP would be over-subscribed and loans would be processed on a first-come, first-served basis, which caused enormous pressure and demand on the opening day.
- The SBA issued guidance late on April 2, which answered some questions but added others. For example, the new SBA guidance seems to indicate that 75% of any PPP loan must be used on payroll costs.
- Additional guidance was issued on April 5 regarding the affiliate rules which clarified certain issues but will likely create additional confusion.
- Defining payroll costs has been subject to some uncertainty.
Delay and Lender Capacity
Demand for the loan program was expected to be quite heavy, and, in fact, the demand has apparently outstripped the supply of available lenders. Numerous news articles have covered the difficulty facing many small businesses who do not have established lending relationships with an SBA qualified lender. Financial institutions have been triaging the loan demand by favoring existing loan customers, or, in some cases, by limiting to business checking account holders. This situation has left many borrowers scrambling to find a lender willing to accept the application. It remains to be seen whether the size of the loan program will be increased in the next week, or whether the willingness of existing lenders to expand coverage will increase once
processing has been completed for the initial surge of customers. Consumer watchdog groups and reporters, such as Stephanie Ruhle of NBC News, have seemingly tried to affect that demand by indicating that they intend to report on the names of those who apply for a PPP loan and call out those they deem unworthy.
Complexities of the Affiliate Rule
The affiliate rule seemed simple in concept but has proven troublesome. Generally speaking, related parties are treated as a single entity for purposes of the loan application. But this has been unworkable for certain entities such as religious institutions. For this reason, the Treasury issued additional guidance over the weekend that spends a number of pages on the affiliate rule and specifically exempts religious
institutions from the coverage of the rule.
Another problem in the affiliate rule relates to independent contractors. The concept is that independent contractors are supposed to be filing their own applications. However, the legal distinction between employees and independent contractors is an extremely tricky legal issue in certain situations and this will likely carry over into the processing of applications for the loan program (note the ongoing battle that has raged for years over whether Uber drivers are employees or contractors).
Law firms may face their own issues relating to contract employees who may under certain regulations be defined as employees and under others be defined as contractors (compare state ethics rules on conflicts of interest with tax or other regulatory guidance).
The Cap on Employee Compensation
Guidance from the
Treasury Department has been ambiguous as to how to interpret the cap on employee compensation. What is clear is that an employee’s cash compensation is capped at $100K for purposes of the loan program. What is less clear is how to treat benefit payments for an employee made by an employer, such as health insurance and retirement contributions. The PPP Information Sheet for Borrowers provides as follows:
Payroll costs include:
- Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee).
- Employee benefits including costs for vacation; parental, family, medical, or sick leave; allowance for separation or dismissal; payments required for the provisions of group health care benefits including insurance premiums; and payment of any retirement benefit.
- State and local taxes assessed on compensation.
What is interesting about this language is that it clearly seems to apply the cap only to salary and other cash compensation, and not to benefits. But other sections of the guidance seem to apply the cap to all payroll costs. This is an uncertainty that will likely be sorted out in the coming days.
The SBA’s Interim Final Rule, issued on April 2, seems to indicate that one should first aggregate all payroll costs, inclusive of salary and benefit, and then subtract compensation amounts in excess of an “annual salary” of $100,000. Thus, given the exemplars using the word “salary,” it is still unclear.