Provisions of the Paycheck Protection Program of the Coronavirus/COVID-19 economic relief legislation remain subject to change. On Thursday, April 2, 2020, the SBA issued a 31-page interim final rules to update and clarify the existing requirements. The content of this article is current as of Tuesday, April 7, 2020.

Current Situation

On Friday morning, April 3, 2020, the SBA Paycheck Protection Program opened for business. As reported, the $349 billion SBA Paycheck Protection Program (“PPP”) is the emergency lending facility administered by the Small Business Administration (“SBA”) under its 7(a) disaster lending program. It is being billed as a revenue replacement program to provide sufficient capital, in the form of forgivable loans, to small businesses to cover their operating expenses during this crisis and provide an inducement for employers to retain their employees.

There are a few things worth noting on the eve of the PPP unveiling. First, the PPP is still evolving with the SBA making changes right up until the program went public. It was only mere hours before the PPP went live that the SBA issued its 31-page interim final rule to facilitate the implementation of the PPP (the “Interim Rule”).¹ In the words of a local CRE lender with a regional bank, “they’re flying the plane while building it.” While the U.S. Treasury Department was encouraging small businesses to apply and receive approval on the same day, participating banks were left scurrying around with only a mere five days to implement this monumental program. Based on the lack of guidance and the short preparation period, it is easy to see how the authorized SBA lenders are not quite yet enamored with the program.

Second, the funds available in the PPP are capped at $349 billion. It has been reported that there may be more than $1 trillion of requests made for these funds, which, if true, means the demand is three times the availability. In the end, there will be winners and a lot of losers. The Interim Rule confirms that PPP money will be released on a first come, first served basis. Consequently, every small business interested in the PPP will be knocking on the doors of their lenders, with each lender not knowing how much of the $349 billion will be allocated to their banks. This begs the question as to whether this program will have the economic impact it is intended to have. On top of this, only authorized SBA lenders can participate in this SBA program. This does not bode well for those businesses that do not bank with an SBA lender. The Interim Rule has expanded the definition of an authorized lender to include federally insured banks, credit unions, and Farm Credit system institutions in an effort to meet the demand. These institutions will be not be ready to participate until they are accepted into the program.

Finally, while there is all this confusion and uncertainly, there may be some hope on the horizon. It is being reported that discussions are currently going on between the White House and Congress to pass Phase IV legislation based on the stark realization that $349 billion of relief is not enough. The U.S. Secretary of the Treasury indicated last week that the White House may request additional funding from Congress.

I. THE PPP LOAN

The Paycheck Protection Program provides eligible applicants a maximum loan amount equal to two months of a business’s average monthly payroll costs from the past 12 months plus an additional 25% of that amount of the employer’s average monthly payroll costs or $10 million, whichever is less. The measurement period for purposes of calculating the average monthly payroll still contains ambiguity, with the guidance stating that borrowers should use the “aggregate payroll costs from the last 12 months” while lenders are instructed to “confirm the dollar amount of average monthly payroll costs for the preceding calendar year.” The specific amount of the loan is based on a covered period from February 15, 2020 through June 30, 2020. Payroll costs are defined broadly to include wages, salaries, retirement contributions, health care benefits including insurance premiums, covered leave (vacation, parental, family medical, or sick leave), and state and local taxes assessed on payroll and other expenses. An applicant cannot count independent contractors as employees for purposes of calculating the loan. Independent contractors are required to apply for their own PPP loan.

With respect to sole proprietors, independent contractors, and self-employed individuals, all payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year, as pro-rated for the covered period, will constitute payroll costs for the purposes of this program.

Here is an easy method put forth by the SBA to calculate an applicant’s maximum PPP loan amount:

1. Aggregate all payroll costs from the last 12 months for employees who are US residents.
2. Subtract all compensation in excess of an annual salary of $100,000;
3. Divide the total by 12 to determine average monthly payroll;
4. Multiply the average monthly payroll by 2.5; and
5. Add the outstanding amount of any Economic Injury Disaster Loan made between January 31, 2020 and April 30, 2020, less the amount of any advance under an EIDL COVID-19 loan.

As for the PPP loan specifically, the terms of the loan include the following:

(i) Interest rate will be at 1% per annum. This is an increase from the 0.5% rate announced earlier in the week. The reason for the increase was to make the loans a bit more appealable to lenders.

(ii) The term of each loan will be two years, which is below the 10 year limit set forth in the CARES Act.

(iii) Loan payments (principal & interest) are deferred for the first six months; however, interest continues to accrue during this period. This is less favorable than the 12-month deferral period authorized by the CARES Act.

(iii) No application, origination, service, or guaranteed fees.

(iv) No prepayment premium or penalty.

(v) No collateral requirements or personal guarantees, for all loans, regardless of size. However, if proceeds are used for a fraudulent purpose, the U.S. Government will prosecute.

The PPP loan proceeds are meant to cover the small business’s operating costs which include: (i) payroll costs, including, but not limited to, wages, salary, vacation and sick leave, and retirement benefits; (ii) group healthcare benefits; (iii) interest on mortgage obligations incurred before February 15, 2020; (iv) rent payments under lease agreements in force before February 15, 2020; and (v) utilities for services that began prior to February 15, 2020. Payroll costs are capped at $100,000 per year for any employee, prorated for the covered period.² The general rule is that at least 75% of the PPP loan proceeds must be used for payroll costs and the remainder may be used for health care benefits, rent, utilities, interest on mortgages, and certain other debts. The Interim Rule did not address some of the hotel-specific issues relating to PPP loans, including whether hotel borrowers can access and use loans to pay hotel employees supplied by third-party management companies. Although SBA has stated informally that it is aware of these issues, the Interim Rule does not say whether additional guidance on that subject will be forthcoming.

A question will undoubtedly come up in evaluating this program is whether a small business which is strong financially should apply for a PPP loan. While the business should counsel with its team of advisors, it is worth noting that the PPP does not require an applicant represent that it cannot obtain credit elsewhere but rather the uncertainty of current economic conditions makes the loan request necessary to support ongoing operations. The fact that a business believes it can withstand the current economic crisis has nothing to do with the economic damage (currently and potentially) done in the future.

A small business experiencing the effects of the coronavirus, may also want to consider applying for both the Economic Injury Disaster Loan (“EIDL”) and the $10,000 interest free, Emergency EIDL Grant as well as a PPP loan. If the borrower received an EIDL from January 31, 2020 through April 3, 2020, a PPP loan is still available. If the EIDL was not used for payroll costs, it does not affect eligibility for a PPP loan; however, if the EIDL loan was used for payroll costs, the PPP loan must be used to refinance the EIDL. Proceeds from any advance up to $10,000 on the EIDL will be deducted from the loan forgiveness amount on the PPP loan. However, for purposes of determining the percentage of loan proceeds used for payroll costs, the amount of a refinanced EIDL will be included in the 75% of the loan proceeds that must be used for payroll costs.

II. QUALIFICATION

Generally, businesses that currently qualify as small businesses under the SBA regulations qualify under PPP. The PPP is also available to any business whose principal place of business is in the U.S., nonprofit organization, veterans’ organization, or tribal business that has fewer employees (full-time, part-time, or employed on any other basis) than the greater of 500, or the size standard for employees set by the SBA for the organization’s applicable industry (revenue restrictions will not apply). What this means is that if the applicable SBA size standards for a business in a particular industry already permit greater than 500 employees, that larger number will apply. For those businesses in the accommodation and food services sector (NAICS 72), the 500-employee rule is applied on a per physical location basis. The loans are also available to sole proprietors, independent contractors, and eligible self-employed. The SBA announced on Saturday, April 4, 2020, that all faith-based organizations could participate in the PPP without restrictions based on their religious identity or activities so long as they met the other eligibility requirements.

The employee count restriction includes any affiliates of the borrower. The affiliation regulations will include any business under common control with the borrower. For this reason, the affiliation rules generally exclude from coverage any companies owned by private equity. However, the affiliation requirements have been waived for the following: (i) businesses with NAICS code 72 designation (accommodations and food services); (ii) franchise businesses with SBA franchisor identifier codes; and (iii) any business that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act (SBICs).

The Interim Rule did not ease or make any changes to existing SBA affiliation rules for purposes of PPP loans. However, it did include a statement that “SBA intends to promptly issue additional guidance with regard to the applicability of the affiliation rules at 13 CFR 121.103 and 121.301 to the Paycheck Protection Program.”

As noted above, while the PPP expands borrower eligibility generally, the Interim Rule relies on the SBA’s exclusion of certain ineligible businesses from its Section 7(a) loan programs and this exclusion will apply to the PPP. The list of businesses ineligible for PPP loans includes: (i) financial businesses primarily engaged in the business of lending, such as banks, finance companies, and factors; (ii) passive businesses owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds; (iii) life insurance companies; (iv) businesses located in a foreign country; (v) pyramid sale distribution plans; (vi) businesses deriving more than one-third of gross annual revenue from legal gambling activities; (vii) businesses engaged in any illegal activity; (viii) private clubs and businesses that limit the number of memberships for reasons other than capacity; (ix) government-owned entities (except for businesses owned or controlled by a Native American tribe); (x) businesses principally engaged in teaching, instructing, counseling, or indoctrinating religion or religious beliefs, whether in a religious or secular setting; (xi) loan packagers earning more than one-third of their gross annual revenue from packaging SBA loans; and (xii) businesses with an owner of 20% or more of the equity of the applicant who is incarcerated, on probation or on parole, or has been indicted for a felony or a crime of moral turpitude.

III. LOAN FORGIVENESS

The primary objective of the PPP is to cover payroll costs for a period of eight weeks in order to encourage employers to retain their employees at their respective compensation levels. This inducement comes in the form of a forgivable loan. The general rule is that all of the PPP loan, both principal and accrued interest, may be forgiven. To state it another way, a borrower will be required to pay back the loan to its SBA lender if its uses the proceeds for anything other than payroll costs, mortgage interest, rent, and utilities for an eight-week period commencing on the date of the origination of the PPP loan.

PPP loan forgiveness equals the sum of payroll costs incurred during the covered 8-week period compared to the previous year or time period. A point worth noting is that payroll costs are capped at $100,000 on an annualized basis for each employee. The amount forgiven will be reduced, proportionally, by any reduction in employees retained compared to the prior year. Also, the amount forgiven will be reduced by the PPP loan forgiveness which equals the sum of payroll costs incurred during the covered 8-week period compared to the previous year or time period, proportionate to maintaining employees and wages. In addition, not more than 25% of the forgiven amount may be for non-payroll costs. Amounts forgiven may not exceed the principal amount of the loan. Additionally, any portion of the loan that is forgiven will be excluded from gross income for federal income tax purposes. It will not be deemed cancellation of indebtedness income.

However, in order for the borrower to qualify for loan forgiveness, the borrower must represent that it will not lay off workers or make large reductions in employees’ pay. Borrowers that have already laid off workers due to COVID-19 can rehire them and can still receive loan forgiveness. To encourage employers to rehire any employees who have already been laid off, borrowers that re-hire workers previously laid off will not be penalized for having a reduced payroll at the beginning of the period. Further, forgiveness is allowed for additional wages paid to tipped workers. The forgiveness amount is subject to reduction if there is a workforce reduction or a reduction in the salary or wages of an employee. The amount attributable to a workforce reduction will be equal to the initial forgiven amount multiplied by the quotient of average FTEs during the eight-week period divided by the average FTEs for the period from February 15, 2019 through June 30, 2019, or January 1, 2020 through February 29, 2020, as determined by the recipient. The amount attributable to a salary or wage reduction will be the amount of any salary or wage decrease in excess of 25% of the total salary or wages during the most recent full quarter where such employee was employed before the eight-week period. Only employees who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay in excess of $100,000 are included in this calculation. Reductions in the workforce, salaries, and wages that occur from February 15, 2020 to April 26, 2020, will be disregarded for purposes of reducing the forgiveness amount so long as the reductions are eliminated by June 30, 2020.

Each borrower must apply for forgiveness with the lender servicing the loan. An employer/borrower must supply its lender with certain documentation, including, but not limited to, proof of payroll tax payments, lease payments, mortgage payments (which shall not include any prepayment of or payment of principal on a covered mortgage obligation), and utility payments. Proof of payment can be a bank statement or canceled checks. As for sole proprietors and independent contractors, payroll tax filings, Forms 1099-MISC, and income and expenses statements will satisfy the proof of payment requirement. Lenders have 60 days to review and determine the equivalent amount on the loan to be forgiven. Borrowers must repay loan proceeds used for unauthorized purposes. If a borrower knowingly uses the loan proceeds for unauthorized purposes, the borrower will be subject to additional liability, such as charges for fraud. If a borrower’s shareholders, members, or partners use the loan proceeds for unauthorized purposes, the SBA will have recourse against the shareholder, member, or partner for the unauthorized use.

Any amount not forgiven or repaid by December 31, 2020, will need to be repaid. The outstanding balance will convert automatically to a maximum 10-year loan at a maximum of 4% interest rate per annum. The loan will remain 100% guaranteed by SBA.

The Interim Rule states that SBA intends to issue additional guidance on loan forgiveness

IV. APPLICATION PROCESS

The application period is April 3, 2020 through June 30, 2020 or until the $349 billion is appropriated. Eligible applicants must apply for the PPP loan through authorized bank and non-bank lenders approved by Small Business Administration and U.S. Department Treasury for PPP program. Since each applicant is limited to one PPP loan, it is anticipated that each application will likely request the maximum amount. Consequently, considerable attention will be given to what constitutes a single borrower. The Interim Rule is clear that the SBA 7(a) borrower’s eligibility rules apply unless waived or superseded by the CARES Act or the Interim Rule.³

With respect to the timing of the application process, the Interim Rule states that small businesses and sole proprietors can apply loan proceeds to cover payroll and other expenses starting on Friday, April 3, 2020, which independent contractors and self-employed individuals can start applying on Friday, April 10, 2020. The application period ends on June 30, 2020, which means that the authorized SBA lender must have process the application by then.

As a condition of the loan, lenders will require each applicant to certify as to the following: (i) the uncertainty of current economic conditions makes the loan request necessary to support ongoing operations; (ii) the loan proceeds will be used to retain workers and maintain payroll and/or make mortgage lease, or utility payments; (iii) it does not have an application pending for a loan duplicative of the purpose and amounts applied for here; and (iv) from February 15, 2020 to December 31, 2020, it has not received a loan duplicative of the purpose and amounts applied for here. However, with respect to (iv) it may be possible to roll emergency loans made between January 31, 2020 and the date of this loan program into the PPP loan. The SBA will allow lenders to rely on certifications of the applicants to determine eligibility and use of proceeds of the PPP loan. Lenders must confirm receipt of documentation and the dollar amount of the average payroll expenses for the preceding calendar year by reviewing the documentation the borrower has submitted. For liability purposes, lenders are required to conduct some substantive underwriting to arrive at the permissible loan amount; however, they are allowed to rely on borrower certifications.

In evaluating an applicant’s eligibility, lenders are directed to consider whether the applicant was in operation before February 15, 2020 and had employees for whom they paid salaries and payroll taxes or paid independent contractors. As a result of the legislation waiving the SBA “credit available elsewhere” requirement, an applicant is not required to seek other sources of capital, including equity or debt investments from owners with liquid assets prior to obtaining this loan. The Interim Rule identifies the documentation to be used by lenders in issuing the PPP loan which includes the application form and the lender’s application for guaranty. The rule does not reference form loan documentation such as uniform notes or additional program documentation such as forgiveness claims forms, but the SBA may also be developing such documents.

In a time fraught with uncertainty, small businesses and their employees are especially susceptible and vulnerable. Now more than ever, small businesses need assistance and protection to keep their doors open and weather this storm. While the PPP is by no means perfect, it is an essential step in making sure these borrowers can make it to the other side of the crisis.

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¹The interim final rule for the Paycheck Protection Program (PPP), modifies, in part, prior Treasury Department guidance and portions of Title I of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Unlike other federal regulations that take effect 30 to 60 days after posting to the Federal Register, these rules are effective immediately upon post, without advance notice or comment, to provide the quickest support to small businesses.

²The interim final rule does not clarify the discrepancy between the CARES Act language stating that payroll costs are based on the 12-month period preceding the loan date and the SBA form application’s instruction providing that borrowers should use the average monthly payroll for 2019.

³A prior version of the application indicated that PPP loans are not available to entities owned 20% or more by individuals who are not US citizens or green card holders. This restriction was not in the CARES Act and appears to have been removed in the final application, which replaced a prior question regarding citizenship or green card status with a new question to confirm that all employees included in the payroll calculation are US residents.