Since our last monthly alert, three federal COVID-19 laws were enacted.
- H.R. 6074: Coronavirus Preparedness and Response Supplemental Appropriations Act. Enacted March 4, 2020. Provided $8.3 billion in emergency funding for federal agencies to respond to the coronavirus outbreak related to developing a vaccine, medical supplies, grants for public health agencies, small business loans, and assistance for health systems in other countries. Allowed for temporarily waiving Medicare restrictions and requirements regarding telehealth services.
- H.R. 6201: Families First Coronavirus Response Act. Enacted March 18, 2020. Guaranteed free coronavirus testing, established paid leave, enhanced unemployment insurance, expanded food security initiatives, and increased federal Medicaid funding.
- H.R. 748: Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Enacted March 27, 2020. A $2 trillion coronavirus relief bill, which will send $1,200 to each American making $75,000 a year or less; add $600 per week to unemployment benefits for four months; give $100 billion to hospitals and health providers; make $500 billion of loans or investments to businesses, states, and municipalities; provide $32 billion in grants to the airline industry; and more.
The Families First Coronavirus Response Act was a big deal for nine days, until the $2.2 trillion CARES Act was signed. Since then, the CARES Act is about the only thing anyone cares about. A few general summaries of the CARES Act are here, here, here, and here.
Title I of the CARES Act, the Paycheck Protection Program (PPP), a $249 billion SBA loan guaranty program, offered the promise of relief to the broadest swath of the economy, and bankers, lawyers, and real people have been clamoring to figure it out. The initial questions – Do I qualify? Where do I apply? and How much can I get? – have shifted to How do I use this? Am I going to have to repay some of it? and What kind of lunatic wrote this?
The SBA said, here, that PPP funds were fully committed as of April 16, and that it isn’t processing more loans. The announcement added pressure on Congress to appropriate more for the PPP, which has stalled but which it absolutely will do, probably next week. (See here and here.)
There are plenty of summaries of the PPP, but below we give ours, along with some resources, highlights, and complaints.
Resources. Generally, we recommend relying on original sources for information and up-to-date guidance1 about the PPP (the SBA or Treasury website is best). We also recommend that you print or take a screenshot of any guidance you rely on, and that you double-check before you apply. Last week, guidance was updated every few days and occasionally changed on the fly.
Summary of the PPP.
The PPP loan application floodgates opened April 3, although many SBA-qualified lenders weren’t ready since rules and the final loan application came out just the day before; independent contractors could apply beginning April 10. Banks were unprepared for the clamor for loans, and were inconsistent in who they served first or why, although almost all favored customers with existing bank loans for obvious reasons (spoiler: solvency of their borrowers). Anecdotal evidence has flooded in from those who applied early with full information and who missed out on the first round of loans. They aren’t happy.
The loan application is two pages and SBA-mandated underwriting requirements are skimpy (aside from checking the math on loan amount, lenders can rely on borrower certifications), the application lenders must file with the SBA also is short, and most lenders are using a six-page SBA form of note (with supplements that cause varying degree of concern) to make the loans. All loans are two years at 1% interest with no payments for six months.
Eligible borrowers are those with fewer than 500 employees (full time, part time, temporary, leased) on average in the pay periods in either 2019 or a trailing 12-month period. Small businesses qualified under preexisting SBA standards, some of which, depending on their industry, may have more than 500 employees or may be eligible based on revenue thresholds (see 13 CFR § 121.201).
A borrower may need to count the employees of “affiliates” under complicated SBA regulations, except that restaurants, hotels, SBA-approved franchises, and some religious nonprofits do not.2 (In addition to the links above, guidance on “affiliation” is here: Guidance on Affiliation from GC for Procurement Law to Associate Administrator for Capital Access; SBA Affiliation Rules Guidance; SBA Affiliation Discussion and further SBA Affiliation Discussion.)
An employer can borrow up to two and a half times the average monthly amount it spent, either in 2019 or in a trailing 12-month period, on “payroll costs” (salaries, wages, tips, medical leave, vacation, etc.; health care costs and retirement contributions; state and local taxes assessed on employee compensation). The maximum loan is $10 million, but consolidated groups that are exempt from affiliation requirements can work around this. (Like Ruth’s Chris Steak House, see here.)
Loan proceeds used in the eight-week period (the “covered period”) after the loan origination date (which should be the date you get the money but most of the promissory notes we’ve seen have been dated at least a day before any funds hit bank accounts) may be forgiven if used for permitted purposes: at least 75% must be used for payroll costs and up to 25% may be used for mortgage interest, rent, or utilities.
Unfortunately, the loan forgiveness provisions in the CARES Act are a mess and impossible to calculate with certainty until the SBA issues additional guidance or the CARES Act is amended to make them clear. (Honestly, the provisions read like they were written with a particular business in mind, but the drafters aren’t willing to tell you which one … maybe Larry Kudlow’s wife’s?3) The SBA promised, here, it “will issue additional guidance on loan forgiveness.” It hasn’t yet. We hope guidance will come before anyone actually applies for forgiveness, but as of April 17, we’ve heard from the SBA only that the “banks are the ones who are going to be in charge of making sure that companies have used the money the way they said they would.” Which tells us basically nothing.
The CARES Act lays out the forgiveness calculation as follows:
Here’s some things about those provisions that seem dumb.
- amount of the loan used for permitted purposes,
- subtract the amount by which compensation to an employee in the covered period is less than 75% of that employee’s compensation in the last full quarter during which the employee was employed, and
- multiply that number by a fraction that equals the average number of full-time employees (FTEs) in the covered period over the number of FTEs in a historical period (January 1, 2020-February 29, 2020 or February 15, 2019-June 30, 2019, or another period for seasonal employers).
- The 75% reduction provision literally says if cash compensation paid to an employee in the eight-week covered period is less than 75% of the cash compensation paid to the employee in the last full quarter (12 weeks), you can’t have that “reduced” amount forgiven. That means if you didn’t reduce the employee’s salary in the last quarter and continue to pay them the same amount in the eight-week covered period, a portion of the loan will not be forgiven. For example, if the employee consistently made $100 per week, or $1,200 in the last quarter and $800 in the eight-week covered period, the portion of the loan that must be repaid is $100. (75% of $1,200 is $900; $900 - $800 = $100.)
- If you had to fire someone, is that a “reduction” of 100% of their salary, or do you only count people you continue to employ? What if you fired them in January? Or in 2019? What if they quit?
- Why do you use an FTE ratio based on the eight-week covered period and a historical period? What do those have to do with one another, and isn’t it true that the people comprising the FTEs in the numerator and denominator are likely not going to be the same?
- What does “full-time employee” even mean? 30 hours per week? 40 hours per week?
And that’s even before we analyze the “re-hire” provisions, which purport to let you fix your FTE ratio by re-hiring FTEs before June 30, 2020. The “re-hire” provision says that if, before April 27, 2020, you reduced FTEs compared to your FTEs at February 15, 2020, you can re-hire them before June 30, 2020 and your loan forgiveness will not be affected by the reduction.
We have questions.
- Do you have to “re-hire” employees you terminated after February 15, 2020, or employees who make up the FTEs in the ratio denominator (from the period January 1, 2020-February 29, 2020, or February 15, 2019-June 30, 2019), or can you hire new FTEs? What if an employee tells you they’re better off with unemployment insurance and doesn't want the job?
- We do not believe, as some have reported, that re-hiring FTEs before June 30, 2020 is a get out of jail free card for loan forgiveness. Rather, we think a reasonable interpretation is this: if you get a loan before April 27, 2020, you can cure an FTE deficit in that pre-April 27 period, but you can’t cure a deficit in the post-April 27, 2020 period. Below is an example of how we think this works.
Admittedly, this interpretation leaves some holes – the eight-week covered period talks in terms of average FTEs over the period, for example, and the re-hire provision talks about FTEs at fixed points in time. Is it really the case that you can “cure” an FTE deficit by hiring an FTE on June 29 and firing them June 30? Also, this re-hire “cure” is tilted for the privileged few who got PPP loans, and got them early. If an employer gets a PPP loan in round two on May 1, it has no grace period to re-hire employees? And if it can’t snap its fingers and bring all FTEs back on day one of the eight-week covered period, a portion of its loan won’t be forgiven?
- Example: Employer had 10 FTEs at February 15, 2020. For purposes of the denominator in the FTE ratio, the same 10 FTEs apply (i.e., by coincidence, average FTEs in the base period January 1, 2020 through February 29, 2020 also equals 10). Employer reduced FTEs to five as of April 27, 2020. It received a loan of $100 on April 15, all of which it used for permitted purposes. The eight-week covered period of the loan is April 15-June 10 (i.e., 8 weeks x 7 days/week = 56 days). Seventeen of the 56 days are subject to the re-hire provisions.
- Employer keeps five FTEs over the eight-week covered period. On June 29, 2020, it hires five FTEs so that it has 10 total FTEs. Loan forgiveness is calculated as follows: [100 x (17/56)] + [$100 x 5/10 x (56-17)/56] = $30.36 + $34.82 = $65.18
- Employer hires 10 FTEs on April 27. It keeps them until June 10, then it terminates them. Loan forgiveness is $100.
Perhaps Congress or the SBA will clear this all up, but in the meantime there are plenty of traps. For example:
- An employer with high payroll costs whose loan is capped at $10 million may find an unexpected portion of the loan is not forgivable, because they won’t be able to afford to pay 75% of employee salaries and keep average FTEs in the eight-week covered period high enough.
- The employer portion of federal taxes paid to employees is not forgivable, so it’s going to cost the employer something to continue to employ people no matter what.
- An employer who stretched to keep employees employed at their historical salaries while waiting for federal aid may have shot itself in the foot, because (a) it burned cash, (b) it can’t pay everyone 75% of what they got last quarter without handing out bonuses, which it doesn't have the money to do, and (c) it can’t take advantage of the “re-hire” provisions because it didn't fire anyone early enough.
We hope, in the aftermath of this, that federal regulators are forgiving to those who tried in good faith to comply with the CARES Act and hastily crafted regulations, and we expect that they will be. But, as our litigation colleagues are always reminding us, there is risk, including: (a) whistleblowers can report you, and can collect a 15-25% bounty on any federal recovery against you under the False Claims Act, and (b) a lie on an application, or an overly aggressive position that later looks like a lie, carries a potential penalty of $1 million and 30 years in prison.
One way to look at the PPP is that it’s simply a substitute for unemployment insurance. If that’s the case, an employer might at least run the calculations to see if its (particularly low-wage) employees are better off receiving unemployment benefits, which includes the additional $600 per week under the CARES Act.
Another way to look at the PPP is that it’s a cheap short-term loan that doesn’t require guarantees or collateral, and if the portion forgiven is more than the interest payments (and probably even if not), the loan is a win. We think many are reconciling to looking at it this way, rather than as a free cash giveaway. (See, e.g., here.)
(If you’ve made it all the way through this first item, congratulations. We promise to be more brief, if not more interesting, from here on.)