Highlights:
- Program reauthorized for $310 billion1 and intended to be more widely distributed
- Bad news for venture capital and private equity
- Good news for hospitals and gaming
- Renewed focus on the “necessity’ of the aid
Today, President Trump signed an increased authorization to the CARES Act to allow for up to an additional $310 billion in aid to be made available under the Paycheck Protection Program (PPP).2 Including the original $349 billion, the program is now authorized to approve loans totaling up to $659 billion. Also today, the Small Business Administration (SBA) published additional guidance under an interim final rule to clear up some of the common questions and misconceptions about the PPP, including eligibility and process. In some cases, the SBA expands the PPP; in other ways it closes the door.
As a reminder, the CARES Act was enacted earlier this month to provide small businesses, individuals and families affected by COVID-19 with immediate assistance. As part of the CARES Act, the SBA is charged with administering the PPP, which is a new guaranteed loan program for small businesses, independent contractors and sole proprietors with not more than 500 employees (See Manatt Client Alert “An Updated Practical Guide for Small Businesses to Obtain a Paycheck Protection Loan Under CARES Act,” April 4, 2020).
Loans made under the Paycheck Protection Program are eligible for forgiveness by the SBA, subject to certain terms and conditions. CARES Act II signed today does little to expand the universe of eligible borrowers, other than to permit agricultural enterprises with no more than 500 employees to apply. The act also allocates up to $30 billion of PPP loans to (i) banks and credit unions with between $10 billion and $50 billion in capital, and (ii) smaller banks and community development financial institutions (including minority depository institutions), in an effort to more equitably and widely distribute the funds among true small businesses in need.
The SBA release was issued in order to meet lenders’ and borrowers’ needs for clarity concerning requirements under the Paycheck Protection Program.
Requirements for Promissory Notes and Authorizations
The interim final rule reiterates that lenders are not required to use a promissory note provided by the SBA and may use their own promissory note or an SBA form of promissory note. In order for these critical Paycheck Protection Program loans to be distributed as quickly and efficiently as possible, lenders are not required to use a separate SBA authorization document to issue Paycheck Protection Program loans. However, lenders must execute an SBA Form 2484 (the Lender Application Form – Paycheck Protection Program Loan Guaranty) in order to issue a Paycheck Protection Program loan and must receive a loan number for each originated Paycheck Protection Program loan.
Clarification Regarding Eligible Businesses
The interim final rule clarifies the types of businesses and entities that are eligible for a Paycheck Protection Program loan.
- Hedge Funds and Private Equity Firms. Hedge funds and private equity firms3 are ineligible to receive Paycheck Protection Program loans as they are primarily engaged in investment or speculation, according to the rule. These types of businesses are generally ineligible for 7(a) loans under existing SBA regulations. “Investment” and “speculation” had not been defined in the SBA regulations until now.
Portfolio companies of hedge funds and private equity funds (e.g., the companies in which these funds invest) are not ineligible but must apply the affiliation test to determine if the applicable investment firm must be made a co-applicant as an affiliate. See “Affiliation Rules” below. Also, a new cautionary statement is issued regarding the representation that current uncertainty makes the aid necessary. See “Certification Safe Harbor” below.
- Hospitals Owned by Governmental Entities. Hospitals owned by a state or local government will not be ineligible for a Paycheck Protection Program loan if the hospital receives less than 50% of its funding from state or local government sources, exclusive of Medicaid. The 500-employee maximum size rule still applies, so query whether this will be of any use to most hospitals.
- Businesses That Receive Revenue From Legal Gaming. If a business meets the eligibility requirements for a Paycheck Protection Program loan, it will not be considered ineligible due to its receipt of legal gaming revenues. However, this does not affect businesses that receive illegal gaming revenues, as they remain ineligible for Paycheck Protection Program loans. This is a direct repudiation of SBA regulations that prohibit such businesses from receiving guaranteed loans.
- Businesses Involved in Bankruptcy Proceedings. An applicant or owner of an applicant that is a debtor in a bankruptcy proceeding at the time it submits an application or anytime before a loan is distributed is ineligible to receive a Paycheck Protection Program loan. An applicant must notify the lender if it becomes a debtor in a bankruptcy proceeding after submitting a loan application and before the loan is distributed.
Affiliation Rules
The SBA’s affiliation rules apply to portfolio companies of a private equity firm in determining whether they will be eligible for a Paycheck Protection Program loan. However, under the CARES Act, the affiliation rules are waived if a borrower receives financial assistance from an SBA-licensed Small Business Investment Company (SBIC) in any amount. A footnote in the release makes it clear that any form of assistance—loans, equity, debt with equity features, or guarantees—is an acceptable form of SBIC assistance.
Affiliation rules will not be triggered for businesses that participate in an employee stock ownership plan (ESOP); a business’s participation in an ESOP will not result in affiliation between the business and the ESOP. Under an ESOP, a business contributes stock to a plan for the benefit of its employees, and the plan maintains an account for each employee who participates in the plan. The employee will receive the shares in his or her account only upon the end of his or her employment with the company, whether through retirement, disability, death or termination.
Certification Safe Harbor
On the Paycheck Protection Program loan application, borrowers must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” A borrower that applied for a Paycheck Protection Program loan prior to April 24, 2020, and repays it in full by May 7, 2020, will be considered by the SBA to have made the required good faith certification in good faith. This safe harbor was created to ensure that borrowers promptly repay a loan that was obtained based on a misunderstanding or misapplication of the required certification standard.
Borrowers with ample cash or access to funds are cautioned against applying for the PPP since the program was designed to help those in need continue operations in the near term. The CARES Act does waive the traditional SBA requirement that the borrower has exhausted other avenues of obtaining financing. But borrowers should be prepared to demonstrate, and should document, that at the time of the loan they actually needed financial aid to continue operations, or that very uncertain business prospects hinged on unknown information that made the loan necessary. We also think companies can borrow in good faith if it will stave off significant layoffs or allow for rehiring of furloughed workers, or if the funds are to be used to ensure continuation of normal business activity. Documentation of the uncertainty and need will help defend against any claims under the False Claims Act or otherwise that the borrower failed to meet the criteria for borrowing under the PPP.
Earlier this week, the SBA cautioned public companies with access to the capital markets, albeit at reduced valuations, that they should reconsider whether they qualify under the necessity rep, and that if loans are repaid by May 7, they will be deemed to have acted in good faith. This was in response to widespread publicity of large restaurant chains borrowing tens of millions of dollars while many smaller businesses were shut out.
1 Congress also increased the authorization under the Economic Injury Disaster Loan program (EIDL) to $20 billion from $10 billion.
2 The bill is titled the “Paycheck Protection Program and Health Care Enhancement Act.” For more information, see Manatt’s summary of the legislation. The bill also contains a $75 billion allocation for increased healthcare and testing supplies, payments to healthcare providers for lost income, funding for states and localities, and increased funding for the CDC and NIH.
3 We assume the SBA means to include venture capital firms since they are structured and operate similarly to private equity funds.
