Up-to-the-Minute Update

While finalizing this month’s ICYMI for distribution, the SBA published the Paycheck Protection Program (PPP) Loan Forgiveness Application, here. The form, assuming it is not altered, answers or suggests answers to some of the questions we pose in the first item below. Our colleagues will issue a subsequent client alert, but our initial thoughts:

• You may fill FTEEs with new hires and you need not count as an FTEE anyone who, during the eight week covered period of the loan, was fired for cause, resigned or requested and received a reduction in hours.
• “40 hours” paid per week is the basis for FTEEs. A borrower may use a simplified calculation where 40 hours and above is one FTEE, and less than 40 hours is 0.5 FTEEs. (This leaves open the obvious incentive to juice FTEEs in the covered period by hiring, say, a hoard of college kids to work 0.1 hours per week and to count each as 0.5 FTEEs. Based on historical precedent, we expect the SBA to tumble to this after applications are submitted, lash out wildly at companies who do it, and then publish guidance that leaves any who already submitted an application wondering what to do.)
• Borrowers with a bi-weekly (or more frequent) payroll schedule may use an eight week “Alternate Payroll Covered Period” that starts on the first day of the first pay period following the date of the PPP loan disbursement. In addition to administrative ease, that may allow some additional runway to hire back employees to improve your FTEE ratio and increase aggregate payroll costs you spend in the eight week covered period. On the other hand, because the application suggests both amounts paid in the covered period and amounts accrued in the covered period count as forgivable payroll costs, you may be better off with a covered period that straddles pay periods – that might allow up to 10 weeks’ worth of payroll costs to be eligible for forgiveness (e.g., if you get a loan on Day 0 and payroll for the prior two weeks is paid on Day 1, that payment is eligible for forgiveness; all payroll paid or accrued over the next 55 days also is eligible for forgiveness).
• The salary/wage reduction adjustment is based only on individuals employed in the loan forgiveness period – an employee terminated before the covered period affects the FTEE ratio calculation but not the salary adjustment calculation. To determine whether an employee’s salary is reduced, you compare average pay in the covered period to average pay in the first quarter of 2020 and not total pay in the quarter, which is what the CARES Act says. (Oddly, the salary adjustment provision seems to require adjustment for employees making over $100,000 if they were hired in the first quarter of 2020, even though their salary adjustments would be ignored if they were hired in 2019. We assume that is an error.)
• If a borrower qualifies for the “re-hire” exemption, the exemption will apply not only for the period from February 15 through April 26, 2020, but for the entire eight week covered period of the loan. That is, if you fired people before April 26, as long as you bring them back before June 30, you apparently can ignore the FTEE ratio and salary adjustments entirely. That doesn’t match the language of the CARES Act, and we are in awe of the interpretive contortions that might have landed the SBA there, but that is good news, at least for borrowers who terminated people early and who can manage their return to maximize loan forgiveness. Still unclear, at least to us, is how the salary reduction safe harbor and the FTE safe harbor described in the application actually work. Each muddles whether calculations are done at specific points in time or are averages over periods of time. (What does “the average annual salary or hourly wage as of June 30, 2020” mean?)
• The amount of cash compensation for any employee eligible for forgiveness may not exceed $100,000 as prorated for the Covered Period (regardless of whether you’re otherwise using the Alternate Payroll Covered Period), and as such is capped at $15,385 for the 8-week period following the date of disbursement. In other words, if you hire back an employee at the end of the covered period, you could pay them $15,385 even though that would exceed $100,000 on an annualized average pay period basis.

1. Six weeks after enactment of the CARES Act, the Paycheck Protection Program (PPP) remains a mess. On April 24, Congress allocated an additional $310 billion for the program (see here) but made no corrections to the hastily drafted Act. Small Business Administration (SBA) and Treasury Department guidance has lagged and, in some cases, been confusing and even harmful.ⁱ Recall that last month we whinged about the lack of clarity in the PPP and the many basic questions that remained unanswered. For example, how to calculate the loan forgiveness amount which is, to borrowers, kind of a biggie. (Recall, the calculation of the forgivable amount is (a) amount spent for allowable uses in the first eight weeks of the loan, multiplied by (b) the ratio of average FTEEs during those eight weeks over average FTEEs in a historical period, and then minus (c) the amount by which total compensation for an employee during the eight weeks was less than 75% of their compensation last quarter.)

   We’d still love for the SBA to let us know:

   • What are full-time employee equivalents (FTEEs)? 30 hours? 40 hours?
   • Can you hire new FTEEs to juice the ratio, and does it matter that they aren’t paid as much as old FTEEs?
   • How does the “75% of total compensation” provision work? Is the full salary of employees you didn’t offer to hire back counted as a reduction of 100% of the salary? Can we use a prorated salary in the previous full quarter or is it really “total salary”?
   • What does “costs incurred and payments made” in Section 1106(b) of the CARES Act mean? Can payroll costs for work done before, but paid during, the eight-week initial loan period be forgiven? Can payroll costs for work done during, but paid after, the eight-week period be forgiven?
   • How on earth does the SBA think the “re-hire” provisions in Section 1106(d)(5) of the CARES Act work?
   • Can you spend loan proceeds after June 30, 2020 on allowable uses?ⁱⁱ If not, isn’t that silly?
   • Is Congress or the SBA going to scrap the unworkable loan forgiveness provisions created for a theoretical company that doesn’t exist, and adopt provisions that work? (Please call. We have ideas.)

   Instead of addressing those and other questions, the SBA and the Treasury Department seem to have spent most of their time in the last six weeks reacting to, and echoing, public ire toward companies like Ruth’s Chris and Shake Shack (here and here) and taking jabs at the L.A. Lakers (here) and more generally at “large” and “public” companies (see here and here).

   On April 23, 2020, despite that PPP loan applicants are by design exempt from the traditional SBA loan criteria that no other sources of credit be available, the SBA “clarified” that a borrower must consider other potential sources of liquidity before determining in good faith that a PPP loan is necessary. (See FAQ 31, here.) Parroting popular opinion, the SBA continued that “it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith” and threatened to audit every loan over $2 million. (See FAQs 31 and 39, here.)

   Hating “corporations”ⁱⁱⁱ is a proud American tradition, to be sure, but a few counterpoints:

   • The CARES Act specifically exempted restaurants like Ruth’s Chris and Shake Shack from affiliation rules and specifically stated that restaurants qualified for loans if they had fewer than 500 employees per location. (“Loophole” does not mean “specifically provided for by law,” so people should stop using that word when referring to loans to restaurant and hospitality groups. See here.)
   • Ruth’s Chris and Shake Shack were eligible for large loans because their payroll costs are large – recall, the maximum loan amount is 2.5x historical monthly payroll costs. Restaurants employ thousands of relatively low-paid workers (the kind who might, say, work in restaurants). 75% of loans must be used for payroll, and loan proceeds must not fund annualized compensation in excess of $100,000.
   • If the point of the PPP is to get money to employees, and because loan proceeds not used in the first eight weeks of the loan must be repaid, the anger is confusing. Forgoing the loans may only mean that Ruth’s Chris and Shake Shack didn’t re-hire largely low-wage workers, which it could have done at scale and presumably more efficiently than “mom & pop” restaurants. Why does the SBA hate dishwashers at Ruth’s Chris? (Similarly, the L.A. Lakers loan wasn’t going to pay basketball players. Admittedly, though, hatred of anyone associated with the Lakers is easier to understand.)
   • Large and public companies are not immune to the COVID-19 downturn. Large restaurant companies were hammered, and shed thousands of employees.
   • Being public doesn’t mean a company necessarily has access to public markets and can easily raise money in a way that is not detrimental to its business. If a company’s public float (shares not owned by affiliates multiplied by market price) is less than $75 million, it is limited in the amount it can raise from equity sales in a 12-month period (see General Instruction I.B.6. to Form S-3, here). More significantly, some public company share prices are in the tank, and if a company taps out its credit and goes to capital markets too early, that may leave no dry powder when additional funds are needed in a few months. (Just a shade naïve to think COVID-19 will have only an eight-week effect on businesses, no?)
   • Arguably, PPP loans were not “necessary” for Ruth’s Chris and Shake Shack since each found alternate financing (although time will tell whether the alternate financing is adequate or whether the sources they tapped will significantly harm their business), but there’s no question the SBA jerked the rug out from under them, and joining the chorus that they “cheated” small businesses seems helpful to exactly no one. (Our view: Each qualified for the loans and would have used the money for intended purposes; nonetheless, they probably concluded that the loans weren’t sufficient in any case, that a big chunk likely would need to be repaid since they were limited in using funds on payroll while their restaurants remained closed, and that the negative publicity just wasn’t worth it.)

   Secretary Mnuchin seems to have since calmed down. On May 13, the SBA published FAQ 46 (here) which states:

   • If a borrower’s PPP loan is less than $2 million, it is deemed to have made the necessity certification in good faith.
   • If its loan is more than $2 million, it need not worry about penalties or enforcement actions and can argue the necessity certification was made in good faith when it requests loan forgiveness.^iv

   Oddly, given the de facto extension of the repayment safe harbor until the borrower applies for loan forgiveness, the SBA also published FAQ 47 (here) to extend the loan repayment safe harbor deadline to May 18, 2020. That would have made sense if the SBA had actually provided additional guidance about what constitutes an adequate basis for the necessity certification. But it didn’t, and we don’t understand why anyone needs four extra days to consider giving back a loan in light of SBA guidance telling them that they either comply or, if not, that they won’t be punished. That’s certainly not the only thing we don’t understand about the PPP or about the SBA’s approach to guidance. Much more to come, we’re certain, on the PPP in the coming weeks.

2. Not to further frighten those who have fretted about potential liability associated with their PPP loans, but the first PPP fraud cases have already been brought against borrowers – see here and here. Arguably, the lesson from these cases is “don’t commit obvious fraud,” which hardly seems a lesson most need. Nonetheless, additional information about the first prosecution of PPP fraud is here, and we remind you:
   • Federal agencies, including the Office of the Inspector General for the SBA, give special scrutiny to “disaster loans” and other transactions intended to provide quick relief, and most investigations are initiated in response to complaints submitted by employees of participants in SBA programs.
   • Whistleblowers can also file complaints on behalf of the government through a qui tam lawsuit under the False Claims Act, and receive a bounty between 15 and 25 percent of the amount recovered.
3. While searching for information about stay-at-home orders, we discovered a few useful resources for state-by-state COVID-19 reopening plans here, here, here, here and here.
4. Nasdaq adopted rules, here, that temporarily modify Nasdaq’s “20% rule” to allow, until June 30, 2020, an issuer to sell up to 25% of its outstanding stock as long as the discount to the higher of book or market price does not exceed 15%. Nasdaq’s summary of the exception is here and another summary is here. Recall that the NYSE temporarily modified its shareholder approval rules in early April to facilitate private equity sales, see here, but those changes brought NYSE in line with then existing Nasdaq rules and did not go as far as Nasdaq’s new temporary rule. Nasdaq (here) and the NYSE (here) each provided listed companies relief from minimum bid price and market capitalization requirements.
5. The SEC issued several COVID-19 FAQs (here) regarding its earlier order (here) that extended filing deadlines.
6. As of April 20, Audit Analytics notes (here) that 16 public companies have listed COVID-19 as the reason for garnering a “going concern” qualification in their audit opinions. We expect that number to rise.
7. In the past, Elon Musk has been a useful foil to caution public companies about what not to do (e.g., tweet that you’re taking your public company private, tweet incorrect production data, tweet about your disdain for the SEC, or, generally, tweet). The lingering effects of earlier ill-advised tweets (see here) have not dissuaded Musk from recently tweeting that “Tesla stock price too high imo,”^v which is credited here with wiping out $14 billion in Tesla shareholder value. We do not recommend that public company executives send similar tweets. Musk also made news for his expletive-laden earnings call responses, during which he referred to measures to fight COVID-19 as “fascist” (see here), his lawsuit against Alameda County, CA, and his threat to move Tesla’s facility to Nevada (see here).^vi Given Musk’s prior and current antics, it may not be surprising that Tesla is apparently unable to buy affordable D&O insurance (see here), and one wonders at what point a director’s casual cocktail-party mention that he serves on the Tesla board will be met with shock and pity rather than admiration and envy.

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ⁱ Faithful readers of ICYMI may have noticed a recent fondness for endnotes. Generally, these allow our staff writers to rant while offering some limited protection from such rants to our readers. For example: An example of “harmful” guidance is FAQ 44. It took the SBA more than a month to answer the question “Do foreign employees count toward the 500 limit?” – a question employers only had because the SBA issued FAQ 3, which on its face suggests you only must count U.S. employees. After everyone who was going to apply for a PPP loan already did, and undoubtedly after some loan recipients with foreign employees spent PPP money on employees they would not have re-hired but for receiving the PPP loan, the SBA issued guidance saying, essentially, “you shouldn’t have done that.” Its guidance doesn’t say “and if you did that, you must repay the money,” which would have at least offered rare clarity. Instead, the SBA leaves those loan recipients wondering what on earth to do. (See here.) Another example is FAQ 40, which puts employers in the position of coercing employees to return to work and putting in jeopardy their unemployment benefits. (See here.) Since most employers care about their current and former employees, this isn’t a great place to be.
ⁱⁱ See Section 1102 of the CARES Act, which adds to Section 7(a) of the Small Business Act:

• subparagraph (36)(A)(iii), which defines “covered period” under paragraph (36) as “the period beginning on February 15, 2020 and ending on June 30, 2020,” and
• subparagraph (36)(F), which provides that “[d]uring the covered period, an eligible recipient may, in addition to the allowable uses of a loan made under this subsection, use the proceeds of the covered loan for [permitted uses].”

In isolation, the language suggests that loan proceeds must be used before June 30, 2020. This reading makes sense on its face if loans were intended as a stop-gap measure and if Congress assumed that (a) if the loan was necessary, all the funds would be used before June 30, and (b) the two-year repayment term allowed slow repayment as the borrower recovered. There are several conceptual problems with this reading: (i) it is naïve about how businesses work or how long they would be effected by COVID-19 (including being wholly or partially shuttered, by government order, for at least part of the loan period and almost certainly through June 30); (ii) it gives an advantage to early recipients of PPP loans, who had more time to spend the money; and (iii) it seems pointless because it would allow unspent loan proceeds to be held, but not used, for nearly two years. Because the text is permissive (“may” rather than “must only”), a possible reading is that spending loan proceeds after June 30 is not prohibited. Although not a recognized canon of statutory interpretation, that the language in (36)(F) is so poorly phrased may allow a freer hand in interpreting its meaning (for example, because the “covered period” begins on February 15, 2020, it literally says loan proceeds may be used for specified purposes before the CARES Act was adopted, which is impossible; it also says the proceeds may be used for other uses specified in Section 7(a) of the Small Business Act, which was not ever intended and which the SBA quickly put the kibosh on in its initial interim rules on the PPP, here).
ⁱⁱⁱ Don’t get us started. Corporations are a legal construct that grew from mercantilism and took firm root in the English Joint Stock Companies Act of 1856, which both channeled the rights of participants in a single entity and limited their liability. Generally, the advent of corporations has been astoundingly useful to facilitate commerce, foster development and build economies. Much like the advent of hammers has been astoundingly useful to facilitate building houses. So, there it is: Hating corporations is like hating hammers.
^iv A few additional thoughts based on the sentence in FAQ 46: “If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness.”

• It’s up to the borrower to affirmatively prove its case. That flips the standard from an enforcement action, where the SBA would have to prove the borrower didn’t qualify, which we think would be challenging for the SBA in most cases. We hope companies are now documenting things well for inevitable presentation to the SBA, and we are curious to see whether any will challenge the SBA if it determines a loan must be repaid.
• Repayment when? Immediately upon the SBA determination? On the regular payment schedule (in other words, is the SBA really just talking about denying loan forgiveness)? Will this be negotiable with the SBA (will the SBA really want to cast a borrower into bankruptcy by declaring a default)? The timing of repayment might depend on the note terms and what the bank does – we expect that if the SBA threatens that its guarantee isn’t valid, a lender will declare a default and accelerate the loan (if it can).
• The SBA stated in FAQ 39, here, that “it will review all loans in excess of $2 million … following the lender’s submission of the borrower’s loan forgiveness application.” If it sticks to that, and if the SBA requires accelerated repayment, there may be some strategies regarding when to request forgiveness. For example, maybe wait until you’re down to the actual principal you think will be forgiven, and request loan forgiveness then (that is, if you think only 25% of the loan is forgivable, maybe wait 18 months until requesting forgiveness). The SBA has not specified a process for requesting loan forgiveness, nor imposed a requirement that forgiveness be requested by a specific date.

^v “imo” = “in my opinion.” We had to look it up, because we still laboriously speak and write in complete sentences and aren’t hip to the cool kids’ lingo. (See?) We also occasionally yell at the neighborhood kids to stay off our lawn, predict weather through joint pain, and complain (obviously) incessantly about The Government. But those are separate issues.
^vi Musk has been exalted as a defender of civil liberties by some conservatives, e.g., here. Many thoughtfully balancing the concerns of public health and economic realities, might query why Musk is the standard-bearer and not the gentlemen pictured here. (Because, let’s face it, at this point isn’t Musk just the “guy with comically large pistols and a rocket launcher at Subway” of the billionaire automaker set?)