(For Information on PPP forgiveness that is written specifically for borrowers, please find our borrower’s guide and checklist).

After much anticipation, the Small Business Administration (“SBA”) issued a formal Paycheck Protection Program (“PPP”) Loan Forgiveness Application and accompanying Interim Final Rules (“IFRs”). Both parts of the IFRs can be found here and here.

This alert, in addition to highlighting a number of key elements of the new guidance, will review Treasury Secretary Steven Mnuchin’s latest comments on the PPP loan forgiveness process to shed some light on the expected loan forgiveness process—which we expect will continue to evolve as the SBA continues to finalize rules surrounding the program.

The application includes a number of benefits and additional clarity for PPP borrowers as they move towards the forgiveness period. Important provisions of the application include:

• Paid and Incurred. The existing language of the CARES Act and various PPP guidance documents issued by the SBA, including the FAQs, suggested that expenses during the eight-week forgiveness calculation period would need to be both “paid” and “incurred.” This led many small business owners to prepare to or to issue off-cycle payrolls to maximize PPP forgiveness. Two significant changes were written into the application: (i) The application allows the borrower to choose to use the 56-day period following the receipt of the PPP loan proceeds, which is referred to as the “Covered Period,” or to select the “Alternative Payroll Covered Period,” a 56-day period that coincides with the payroll schedule of the borrower, if it is bi-weekly or more frequently; and (ii) the application allows a borrower to pay payroll costs incurred but not paid during the borrower’s last pay period of the Covered Period (or Alternative Payroll Covered Period) if paid on or before the next regular payroll date. It is important to remember that payroll costs are considered incurred on the day that the employee’s pay is earned.
• Broader Definition of Rent and Mortgage. The forgiveness application clarifies that Eligible Nonpayroll Costs can include rent obligations for leases of real or personal property in force before February 15, 2020. Similarly, a business mortgage interest payment includes interest paid on loans for real and personal property incurred before February 15, 2020.
• Broader Definition of Utilities. The forgiveness application clarifies that Eligible Nonpayroll Costs can include utility expenses, which include “electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.”
• Reduction in Employees. The PPP continues to include penalties for reductions in the number of employees. However, the application now expands upon FAQ #40 (which provided an exclusion for borrower’s good faith attempts to rehire employees) and now excludes from these reduction calculations those employees who “(a) were fired for cause, (b) voluntarily resigned, or (c) voluntarily requested and received a reduction of their hours.”
• Calculating Reductions in Full-Time Equivalent Employees (FTEs). Two methods can be employed to calculate FTEs. The first method is a “per employee” basis. Under this method, for each employee, the borrower will calculate the average number of hours paid per week, divide by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0. A simplified method is also available that assigns a 1.0 multiplier for each employee working 40 or more hours. Each employee working fewer hours is assigned a 0.5. The borrower’s average weekly number of FTEs during the Covered Period (or the Alternative Payroll Covered Period) is compared against the chosen reference period (either (i) February 15, 2019 to June 30, 2019; (ii) January 1, 2020 to February 29, 2020; or (iii) in the case of seasonal employers, either of the preceding periods or a consecutive twelve-week period between May 1, 2019 and September 15, 2019).
• June 30, 2020 “Safe Harbor” Mechanism. The June 30, 2020 safe harbor operates separately for reductions in FTE counts and reductions in wages and salaries. The application contains one provision that allows a borrower to “cure” the reduction in wages and salaries by June 30, 2020 (see Step 2(c)). Similarly, there is a mechanism for a borrower to cure its FTE total count by June 30, 2020 (see Section titled “FTE Reduction Safe Harbor.”) Clearing up an ambiguity in prior guidance, it appears that a borrower can cure one forgiveness reduction and not the other.
• Eight-Week / Twelve-Week Rule. The PPP contains a mechanism to reduce the forgiveness amount on a dollar-for-dollar basis where an employee’s pay was reduced by more than 25%. In earlier guidance, this calculation implied that the employee’s salary during the first quarter of 2020 (January 1 to March 31) would be compared against pay during the eight-week forgiveness period. Many commentators noted that this calculation would compare pay during a 12-week period against pay during an eight-week period—inherently a 33% reduction. This apparent flaw has been corrected in the forgiveness application, and the calculation involves comparing the “average annual salary or hourly wage” during the first quarter against the “average annual salary or hourly wage” during the Covered Period (or Alternative Payroll Covered Period).
• New Certification. Many borrowers have questioned whether they can use PPP loan proceeds for other purposes and simply forego the forgiveness mechanism. Though guidance has not been provided as to this issue, the forgiveness application requires a borrower to certify that the borrower “understand[s] that if the funds were knowingly used for unauthorized purposes, the federal government may pursue recovery of loan amounts and/or civil or criminal fraud charges.”
• Timing Obligations for Lenders. Per the text of the CARES Act, lenders will have 60 days after receipt of the forgiveness application to issue a decision on the application. SBA will, thereafter, have 90 days from the date of the determination of the forgiveness amount to pay the amount of forgiveness plus any accrued interest through the date of payment.
• Required Documentation. The SBA has provided a schedule of items that a borrower must submit in order to supplement the borrower’s forgiveness application. We note that these documentation requirements will include significant lender review. In light of the 60-day lender review period, the lender should consider communicating to borrowers clear processes and forgiveness checklist requirements to ensure accuracy and completeness in the initial filing to avoid delays during the review process. Consideration should be given to the following documents:
  • Documentation verifying the eligible cash compensation and non-cash benefit payments from the Covered Period or the Alternative Payroll Covered Period consisting of each of the following: (i) bank account statements or third-party payroll service provider reports; (ii) tax forms including Form 941 and state quarterly business and individual employee wage reporting and unemployment insurance tax filings; (iii) payment receipts, cancelled checks, or account statements documenting the amount of any employer contributions to employee health insurance and retirement plans.
    • We note that because many tax forms lack the actual time of expense incurred, utilization of these forms of documentation could delay the lender’s receipt of forgiveness requests. Ideally, we will see additional guidance regarding this timing issue.
  • Documentation showing the average number of FTEs on payroll per month employed by the Borrower during the reference period for the reduction calculation.
  • Documentation verifying existence of the obligations/services prior to February 15, 2020 and eligible payments for mortgage interest, rent, and utility costs.
    • This could include a lender amortization schedule for interest payments, a copy of the applicable lease agreement, plus copies verifying the actual payments made. For utility payments, similarly, utility bills and accompanying payment verification will be required.
• Continued Warning for Lenders. Similar to demographic data collected in other federally sponsored programs, PPP borrowers are encouraged to self-report certain demographic data regarding each of the business’s principals. The demographic criteria to be collected for each business principal includes: (i) veteran status, (ii) gender, (iii) race, and (iv) ethnicity.
  • Presumably, this could be used for investigating the repeated assertions regarding fair lending violations or CRA reporting. This growing concern regarding fair lending risks associated with the PPP was echoed during Secretary Mnuchin’s Senate testimony on May 19, 2020. Senator Doug Jones (D-AL) asked the Secretary about reports of discrimination in the PPP. Secretary Mnuchin emphasized that “in the forms that the lenders are required [sic], there is demographic information. We’ve been advised to make that optional and not mandatory, but we very much hope that people provide that. And let me just say, we’re very much committed to make sure that we serve the underserved communities with the money we have left.” Given this concern, lenders should consider including additional data requirements in connection with forgiveness requests to help gather this data.

In conjunction with the application, the IFRs clarify a number of important issues. Important provisions of the IFRs include:

• Payroll Cost Calculation. The IFRs provide clarity as to the timing for payroll cost calculations. According to the IFRs, payroll costs are considered paid on the day the paychecks are distributed or the borrower originates an ACH credit transaction. Payroll costs are generally incurred on the day the employee’s pay is earned. For employees who are not working but are still on the borrower’s payroll, payroll costs are incurred based on the borrower’s established schedule (i.e., the day the employee would have worked). Payroll costs for furloughed employees, bonuses, and hazard pay are eligible for forgiveness, subject to a $100,000 annualized restriction.
• Owner-Employees and Self-Employed Individuals. Loan forgiveness for compensation paid to owner-employees and self-employed individuals is capped at the lesser of 8/52 of 2019 compensation or $15,385 per individual across all businesses. Owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health care contributions made on their behalf. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit. General partners are capped by the amount of their 2019 net earnings from self-employment (reduced by certain enumerated deductions) multiplied by .9235. No additional forgiveness is provided for retirement or health insurance contributions for self-employed individuals, including Schedule C filers and general partners.
• Counting Employees. The SBA previously noted that employees that refused to be rehired would not count against the borrower for the forgiveness reduction calculation. The IFRs clarify that this exclusion is available if: (i) the borrower made a good faith, written offer to rehire such employee or, if applicable, restore the reduced hours of such employee; (ii) the offer was for the same salary or wages and the same number of hours as earned by such employee in the last pay period prior to the separation or reduction in hours; (iii) the offer was rejected by the employee; (iv) the borrower has maintained records documenting the offer and its rejection; and (v) the borrower informed the applicable state unemployment insurance office of such employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer. Additionally, the IFRs expanded this safe-harbor protection to include employees who were fired for cause, voluntarily resigned, or voluntarily requested a reduced schedule during the Covered Period (or Alternative Payroll Covered Period). If these safe-harbor protections are employed, it is imperative that borrowers keep good records of the reasons for the termination.
• Mortgage Interest Payments. Though there are limited provisions for the payment of incurred, but unpaid payroll, the IFRs clarified that a borrower cannot pay mortgage interest in advance.
• SBA’s Review of Individual PPP Loans. While the SBA has previously indicated that it will review and likely focus on all loans in excess of $2 million, be aware that the IFRs make it clear that the SBA can investigate any application, regardless of amount, for potential violation of the certifications. According to the guidance, the SBA can review any loan “as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.” The Administrator clarified that it will review borrower eligibility, including compliance with the CARES Act provisions, compliance with SBA rules and guidance, and compliance with the borrower’s loan application. The loan amounts and use of the proceeds are also subject to review, including proper calculation of the loan amount and proper use of the loan proceeds. Further, the loan forgiveness amounts may be individually reviewed to determine whether a borrower is entitled to forgiveness and the calculation of the forgiveness amount.
• Loan Review Procedures for Lenders. The rules clarify that for all forgiveness applications, each lender shall: (i) confirm receipt of the borrower certifications contained in the loan forgiveness application form; (ii) confirm receipt of the documentation borrowers must submit to aid in verifying payroll and nonpayroll costs, as specified in the forgiveness application instructions; and (iii) confirm borrower’s calculations on the forgiveness application. Although borrowers attest to the accuracy of its reported information and calculations, lenders are expected to perform a good-faith review of the borrower’s calculations and supporting documents concerning amounts eligible for forgiveness. The rules specifically provide that in the event the lender identifies “errors in the borrower’s calculation or material lack of substantiation in the borrower’s supporting documents, the lender should work with the borrower to remedy the issue.”
• Lender Fees. Lenders must submit SBA Form 1502s in order to obtain their processing fees. The deadline to submit the form is May 29 or 10 calendar days after the loan is disbursed or canceled (whichever is later). The agency reiterated that that lender processing fees may be clawed back within a year after disbursement if the SBA later determines the borrower to be ineligible, although this determination will not affect the SBA guaranty for the loan, provided the lender “has complied with its obligations under section III.3.b of the First Interim Final Rule and the document collection and retention requirements described in the lender application form (SBA Form 2484).”

Though the newly released guidance will provide borrowers and lenders with additional clarity, there remain a number of issues which have not been addressed and which have been the subject of criticism by various industry groups, including:

• “Use by Date.” Small businesses still seek clarity regarding whether the proceeds of PPP loans must be used by June 30, 2020 (or the end of the Covered Period). During an appearance before the Senate, Secretary Mnuchin was asked by Senator Rounds (R-SD) regarding this deadline. Secretary Mnuchin did not have an answer to this question. However, he offered “to follow up with [the Senator’s] staff and talk about where that fits into the bill.”
• 75/25 Rule. Many small business owners have challenged the SBA’s interpretation requiring that at least 75% of forgivable expenses be spent on payroll costs. Secretary Mnuchin continues to remain steadfast in this requirement. During an interview he noted:
  • So the program is pretty simple, you get two months of — of — of payment for your workers and you get an extra 25 percent for your overhead. And to and the extent you hire back your workers, you get that all forgiven. So the idea is that taxpayers would forgive the majority of the money that was going to the workers, which saves unemployment, in a — in a reasonable amount of overhead. I think 25 percent overhead is — is very fair.

    But this was not designed as a loan. It was really designed as a grant. And people who say, you know, they — they want to use more money for overhead, they can go out and borrow an EIDL loan. So there's another program that will have about $350 billion to small businesses of 30-year loans. Those loans aren't forgiven, but that's a lot of money that small businesses can borrow so that they have overhead.

    Maria Bartiromo, Fox Business, May 4, 2020. During his Senate testimony, Secretary Mnuchin was specifically asked about this issue by Senator Van Hollen (D-MD). In his response, Secretary Mnuchin stood by the strict interpretation of the 75/25 Rule and emphasized that the “program was designed for eight weeks plus, overhead.”

    The proposed Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act has already passed the House and is with the Senate. It would extend the PPP loan program to December 31 and place a minimum maturity at 5 years. The Act would extend the forgiveness period to 24 weeks and eliminate the 75/25 Rule.

• Extension Periods. Many small businesses that have been closed due to shelter-in-place orders have complained about the eight-week forgiveness period. In particular, restaurant owners meeting with President Trump have been seeking an extension to twenty-four weeks. During an interview on May 4, 2020, Secretary Mnuchin implied that the administration knows of these concerns, but “[t]his is the way the [Paycheck Protection] Program was designed by Congress. And we think it has the right intent to get the money to employees. So I — I don’t have the flexibility to change that.” Maria Bartiromo, Fox Business, May 4, 2020. Current congressional debates revolve around removing the 75% restriction or extending the period for forgiveness. The Senate’s proposed Reviving the Economy Sustainably Towards a Recovery in Twenty-twenty (RESTART) Act would extend the 8 week period to 16 weeks and create a new loan program that would cover payroll, benefits, and fixed operating expenses for up to six months for businesses that have experienced significant revenue hits during the pandemic.
• Taxation of PPP Proceeds. At present, any amounts forgiven by the SBA are not subject to taxation. At the same time, the borrower cannot claim any tax deductions for amounts spent on interest or payroll costs. A number of congressional representatives have expressed frustration over this restriction. When asked, Secretary Mnuchin noted that “the money coming in the PPP is not taxable. So if the money that's coming is not taxable, you can't double dip. You can't say you're going to get deductions for workers that you didn't pay for, that taxpayers didn't pay for. So this is just saying no double-dipping. And, again, if the — if the tax — if the PPP grants were taxable, then you'd get to have the deduction. But this is just a simple offset.” Maria Bartiromo, Fox Business, May 4, 2020. Industry groups are lobbying for the Small Business Expenses Protection Act of 2020, S. 3612, which is currently in the Senate Finance Committee. If enacted, S. 3612 would overturn that position and allow taxpayers to deduct covered expenses paid or incurred by an eligible recipient of a PPP loan that is forgiven.
• June 30, 2020 “Safe Harbor.” As noted above, the PPP contains a provision that allows a borrower to avoid penalties when the number of FTEs is “restored” by the June 30, 2020 safe harbor. It is unclear how this test will work and whether this simply means that an employee must be hired as of June 30, 2020—or if there is an alternative time requirement.
• Payments to Related Parties. To date, no guidance has been issued regarding payments to related parties. For example, to the extent that a borrower remits rent or mortgage interest payments to a related party, there is ambiguity as to whether the SBA will permit the payments to be included in the forgiveness calculation. There is no express prohibition, to date, on payments to related parties, but no guidance has been issued stating that this is acceptable.