ANALYSIS

The Paycheck Protection Program Under the CARES Act

Title I of the recently enacted CARES Act provides for the Small Business Administration’s (SBA’s) Paycheck Protection Program (PPP) to assist eligible borrowers with loans to cover certain operational costs. Distinguishing features of the new loan program that depart from loans previously available under Section 7(a) of the Small Business Act are: (1) no individual guarantees are required; (2) no collateral is required; (3) there is no requirement that the borrower must have attempted to get other financing and failed; and (4) these loans have a forgiveness feature as described below.

The situation is ever-evolving as SBA provides periodic guidance, and regulations are anticipated to be issued in the coming days and weeks. The following is a current snapshot of pertinent aspects of the program.

Eligible Borrowers

In addition to for-profit companies, the CARES Act and related guidance provide that PPP funding can be obtained by eligible non-profits, sole practitioners and independent contractors that, in all cases, were operating on February 15, 2020. Generally speaking, companies with less than 500 full- and part-time employees can apply for PPP funding, though companies with certain NAICS codes have a higher employee-count threshold, and entities that meet the SBA’s alternative size standard criteria may also be eligible. Important to note, however, are the affiliation rules described below that carry over from the original Small Business Act and have not been waived by the CARES Act.

Affiliation Rules

The SBA affiliation rules require the applicant to include the employees of “affiliates” when considering employee count for purposes of eligibility for the loan. Some of the affiliation rules are specific in nature and tie to the equity ownership of the applying borrower. For example, Company X is 100% owned by Company Y. Company Y also has 75% ownership stakes in Company A and Company B. Companies Y, A and B are all considered affiliates of Company X. For PPP purposes, Company X’s employee count is deemed to be the aggregate number of employees of Companies X, Y, A and B. Other factors that determine what constitutes an “affiliate” are more general in nature and include concepts such as economic dependency on other companies, cross-control of other companies by directors, officers and others who control the applicant, and reliance on other companies for contractual obligations. In such instances, those other companies might be deemed to be an “affiliate” of the applicant. The SBA has typically interpreted the affiliation rules in an expansive manner. Even as to stock ownership, just last week in a direct call with an SBA representative, we were informed that when an applicant is a member of a larger family of companies, the SBA generally looks to the entire family of companies as affiliates for purposes of employee count. It is hoped that forthcoming guidance and regulations will clarify whether the affiliation rules will remain applicable or will be scaled back for the PPP loan program, but in the interim, these rules should be considered.

Loan Amount

Qualified borrowers can borrow the lesser of (a) 2.5 times the average monthly employee payroll costs based on the prior 12-month rolling period or (b) $10,000,000. Payroll costs to be included in the calculation are set out in the statute, and there is a cap of $100,000 per employee for purposes of the calculation.

Loan Proceed Uses

The loan proceeds may be used for a limited list of purposes, including certain payroll costs, utility payments, rent payments and interest on certain existing debt.

Applications and Timing

SBA published a sample application on its website last week, but an applicant should utilize the application form obtained from the lender to which it is applying. The application period ends on June 30, 2020. Due to the complexity of processing and regulatory requirements on banks, including but not limited to the “know your customer” requirement, many banks are prioritizing their existing customers who, at a minimum, have an established account with the bank. Late last week, SBA expanded the scope of entities that can serve as agents for PPP loans; that list now includes credit agencies and certain non-bank lenders.

Forgiveness

An amount equal to the first eight weeks of eligible payroll costs and other eligible expenses incurred by the borrower may ultimately be forgiven as an incentive for borrowers to maintain staff and use the proceeds for qualified expenses. The eight-week time period starts with funding of the loan. Since the focus of the program is payroll costs, non-payroll costs that are eligible for forgiveness will be capped at 25%, according to current guidance. It is unclear what the application for forgiveness will look like, and no applications will be taken until after June 30, 2020.

Loan Terms

The current position by SBA is that to the extent it is not forgiven, PPP debt will be a loan with a maturity date of up to 2 years and with interest at the fixed rate of 1%. Debt service payments and fees could be deferred for a period of six months to a year, with no prepayment penalties or fees.

Further Issues for Consideration

As you analyze the option of a PPP loan and determine next steps, keep the following final thoughts in mind:

• Do you have existing debt that would preclude you from obtaining this type of loan? For example, your current credit facility may have a covenant prohibiting or limiting the incurrence of additional debt. Alternatively, you might be bound by certain financial covenants or ratios that need to be maintained throughout the duration of the loan term, and the incurrence of a PPP loan could put you in a position where you have breached that financial covenant. If such is the case, you will want to determine whether to forgo the PPP loan possibility or approach your lender for a waiver or modification of the prohibitive covenant(s).
• If you furlough or intend to furlough employees, consider the impact this will have on the amount of your PPP loan that might be forgiven.
• Plan to be patient as the system works itself out. The number of stimulus loans (PPP and others) SBA will process in the next 2-3 months is expected to be a staggering 14 times the agency’s record annual amount. The magnitude of loans is unprecedented, especially in such a short amount of time.
• Lastly, stay tuned. As noted throughout this summary, the landscape is ever-changing. What is accurate about the program today might be modified tomorrow, so anticipate the fluid nature of the facts and circumstances.