The Coronavirus Aid, Relief, and Economic Security Act (as amended and modified, the “CARES Act”) was enacted to provide immediate assistance to individuals, families, and businesses affected by the COVID-19 emergency. Among other provisions, the CARES Act allowed Congress to authorize the Small Business Administration (“SBA”) to temporarily guarantee forgivable loans under a new 7(a) loan program titled the Paycheck Protection Program (“PPP”).
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was enacted and authorized additional funds for new First Draw PPP Loans and for Second Draw PPP Loans. On January 6, 2021, the SBA and the Department of Treasury released an Interim Final Rule called “Business Loan Program Temporary Changes; Paycheck Protection Program as Amended by Economic Aid Act.” That rule restates existing regulatory provisions into a single regulation on borrower eligibility, lender eligibility, and loan applications or origination requirements issues for new first time PPP borrowers (the “First Draw PPP Loans”), as well as general rules relating to First Draw PPP Loan increases and loan forgiveness. The SBA also released an Interim Final Rule called “Business Loan Program Temporary Changes; Paycheck Protection Second Draw Loans” (“Second Draw Rules”). For more information about the First Draw PPP Loan changes and Second Draw Rules, see our articles “Economic Aid Act: 10 Things to Know about Second Draw PPP Loans ” and “What to Know about the Paycheck Protection Program, Round Two.” On March 3, 2021, the SBA released an Interim Final Rule on Loan Amount Calculating and Eligibility (“March 2021 IFR”) which modified certain eligibility restrictions, such as elimination of the one-year look back for non-financial fraud felonies and elimination of the exclusion due to defaulted and delinquent federal student loans. On March 11, 2021, the American Rescue Plan Act of 2021 (the “ARP Act”) was enacted, certain eligibility changes were made to the PPP, and an additional $7.25 billion was added for PPP Loans. On March 12, 2021 and April 6, 2021, the Frequently Asked Questions (“FAQs”) were updated. On March 18, 2021, the SBA posted an Interim Final Rule on Paycheck Protection Program as Amended by American Rescue Plan Act (“Eligibility IFR”) and posted updated borrower and lender application forms for First Draw and Second Draw PPP Loans.
This article summarizes which businesses are not eligible for First Draw PPP Loans and Second Draw PPP Loans.
Eligibility in General: A business is eligible for a First Draw PPP loan if it was operating on February 15, 2020, with 500 or fewer employees whose principal place of residence is in the United States, or if it is a business that operates in a certain industry and meets the applicable SBA employee-based size standards for that industry or applicable annual receipts-based size standards. There are other categories, including certain nonprofit organizations, veteran organizations, and tribal organizations, and self-employed workers and independent contractors. Under the Economic Aid Act, 501(c)(6), destination marketing organizations, eligible nonprofit news organizations, and housing cooperatives are also eligible, although some have a 300 employee limitation. Under the ARP, additional entities were made eligible. In addition, the Treasury Department and the SBA have issued interim final rules and FAQs indicating that businesses must also meet the SBA’s definition of a “small business concern,” unless that requirement is specifically waived in the CARES Act and other guidance. For general eligibility requirements for First Draw PPP Loans, see our article “What to Know about the Paycheck Protection Program, Round Two.”
The eligibility requirements for Second Draw PPP Loans are narrower than the eligibility requirements for First Draw PPP Loans. For the general eligibility requirements for Second Draw PPP loans, see our article “Economic Aid Act: 10 Things to Know about Second Draw PPP Loans.”
For PPP purposes and as amended by the Economic Aid Act, the ARP Act and rules, some businesses are ineligible for both First and Second Draw PPP Loans. There are PPP specific exclusions and general SBA categories of ineligible businesses depending on the owners’ or businesses’ status, activities, or industry, and there are other eligible businesses. There have also been challenges to the ineligibility rules for PPP loans.
PPP Specific Industries, Activities, and Other Factors: The following activities and industries make a business ineligible:
- illegal activity under federal, state, or local law;
- household employer (individuals who employ household employees such as nannies or housekeepers);
- an owner of 20% or more of the equity of the borrower is presently incarcerated or, for any felony, presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of, pleaded guilty or nolo contendere to, or commenced any form of parole or probation (including probation before judgment) for a felony involving fraud, bribery, embezzlement, or a false statement in a loan application or an application for federal financial assistance within the last five years;
- an owner, or any business owned or controlled by the owner or any of its owners, has ever obtained a direct or guaranteed loan from SBA or any other Federal agency made or guaranteed through a program administered by the Department of Education that is currently delinquent or has defaulted within the last seven years and caused a loss to the government;
- the President, the Vice President, the head of an Executive Department, or a Member of Congress, or the spouse of such person as determined under applicable common law, directly or indirectly holds a controlling interest in the business;
- an issuer, the securities of which are listed on an exchange registered as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) (certain conditions for news organizations);
- the business has permanently closed;
- the business or any owner (20% or more) is “presently involved in any bankruptcy proceeding” (see Forms 2483 and 2483-SD). On April 6, 2021, FAQ 67 detailed that an applicant or owner of 20% or more of the applicant are not “presently involved in any bankruptcy” for PPP loan eligibility purposes: (a) for Chapter 7 bankruptcy petitions, until the Bankruptcy Court has entered a discharge order in the case; (b) for Chapter 11, 12 or 13 bankruptcy petitions, until the Bankruptcy Court has entered an order confirming the plan in the case; or (c) if the Bankruptcy Court has entered an order dismissing the case, regardless of the Chapter, the applicant or owner is no longer “presently involved in any bankruptcy.” FAQ 67 further states: (i) that the discharge order, the order confirming the plan or the order of dismissal, whichever is applicable, must be entered before the date of the PPP loan application; and (ii) notwithstanding the foregoing, if an applicant has permanently closed as a result of a bankruptcy filing, the applicant is ineligible for a PPP loan because the applicant is required to certify on the PPP borrower application that the applicant “has not permanently closed.” Also, FAQs 59 and 60 clarified that (a) if a borrower that was eligible for a First Draw PPP Loan files for bankruptcy protection after disbursement of the First Draw PPP Loan, that borrower is eligible for loan forgiveness, provided it meets all requirements for loan forgiveness set forth in the PPP interim final rules, including but not limited to, loan proceeds are used only for eligible expenses and at least 60% of the loan proceeds are used for eligible payroll costs; and (b) a borrower that received a First Draw PPP Loan and files for bankruptcy protection after disbursement of the First Draw PPP Loan is not eligible to apply for a Second Draw PPP Loan. In general, if the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. Note: if the borrower or owner becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant’s obligation to notify the lender and request cancellation of the application. Failure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes; or
- a hedge fund or private equity firm because they are primarily engaged in investment or speculation.
General SBA Ineligible Businesses as Modified by the PPP Rules: In general, the ineligibility restrictions in 13 CFR 120.110 apply to all PPP loans, but certain sections do not apply or are suspended for PPP loans—such as nonprofits, legal gambling, certain religious organizations, certain lobbying activities, and the rules relating to incarceration, probation, parole, or indictment for a felony or a crime of moral turpitude. For a general list of ineligible businesses, see 13 CFR 120.110 (“What businesses are ineligible for SBA business loans?”) and the SBA’s Standard Operating Procedure (SOP) 50 10 6 Part 2, Section A. Chapter 3 (effective October 1, 2020).
In summary, ineligible businesses include:
- businesses that have defaulted on federal loans, if there is a “prior loss” to the federal government, or if the borrower is in delinquent status for nontax debt to the federal government (excluding federal student loans);
- businesses located in a foreign country or owned by undocumented (illegal) aliens;
- businesses utilizing a pyramid sale distribution plan;
- private clubs and businesses that limit the number of memberships for reasons other than capacity, with some exceptions;
- companies that have discriminatory hiring practices (such as a restaurant that employs only servers of one gender);
- government-owned entities, excluding Native American tribes; and
- passive businesses:
- owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds;
- primarily engaged in subdividing real property into lots and developing it for resale or its own account;
- primarily engaged in owning or purchasing real estate or leasing it for any purpose—such as shopping centers, and similar business models that generate income by renting space to accommodate independent businesses that provide services to the public;
- that lease land for the installation of cell phone towers, solar panels, billboards, or wind turbines, except that businesses operating the cell phone tower, solar panel, billboard, or wind turbine are eligible;
- businesses that have entered into a management agreement with a third party that gives the management company sole discretion to manage the operations of the business, including control over the employees, the finances, and the bank accounts of the business, with no involvement by the owner;
- apartment building and mobile home parks; and
- residential facilities that are not licensed as nursing homes or assisted living facilities and do not provide healthcare and/or medical services;
- businesses engaged in lending, like banks, life insurance companies, finance companies, factoring companies, investment companies, bail bond companies, and other businesses whose stock-in-trade is money; however, there are limited exceptions;
- businesses engaged in any illegal activity, such as marijuana or cannabis-related businesses (both direct and indirect marijuana businesses); however, the SBA clarified that some cannabidiol (“CBD”) companies may be eligible depending on, in part, where its CBD is derived from and whether the products being sold comply with the rules issued by the Food and Drug Administration;
- businesses principally engaged in promoting religion;
- businesses deriving more than a certain amount of gross annual revenue from products or live performances of a prurient sexual nature;
- businesses with an associate of poor character;
- businesses primarily engaged in political or lobbying activities; and
- speculative businesses such as those dealing in stocks or bonds, mining gold or silver in other than established fields, wildcatting in oil, engaging in research and development, and building homes for future sale.
Other Eligible Businesses: Historically, nonprofits and certain businesses engaged in legal gambling activities were not eligible, but the program and guidance allow these types of businesses to participate.
Additionally, there are limited circumstances under which certain businesses engaged in renting or leasing may be eligible. For example, eligible businesses include:
- businesses licensed as nursing homes or assisted living facilities and providing healthcare or medical services;
- businesses that lease equipment, household goods, or other items;
- businesses such as barber shops, hair salons, nail salons, and similar types of personal services businesses; and
- hotels, recreational vehicle parks, marinas, or similar types of businesses if more than 50% of the business’s revenue for the prior year is derived from transients who stay for 30 days or less at a time. If the applicant is a start-up, the applicant’s projections must show that more than 50% of the business’s revenue will be derived from transients who stay for 30 days or less at a time.
There are also limited circumstances under which certain non-speculative businesses may be eligible. For example, eligible businesses include:
- A business, such as a grain elevator, that uses a commodity contract to lock in a price;
- A farmer who uses a commodity contract to lock in the sale price of his or her harvest;
- A business engaged in drilling for oil in established fields; and
- A business engaged in building a home under contract with an identified purchaser.
Furthermore, limited circumstances under which certain businesses engaged in lending may be eligible are as follows:
- A pawn shop that provides financing is eligible if more than 50% of its revenue for the previous year was from the sale of merchandise rather than from interest on loans;
- A business that provides financing in the regular course of its business (such as a business that finances credit sales) is eligible, provided less than 50% of its revenue is from financing its sales;
- A mortgage servicing company that disburses loans and sells them within 14 calendar days of loan closing is eligible. Mortgage companies primarily engaged in the business of servicing loans are eligible. Mortgage companies that make loans and hold them in their portfolio are not eligible;
- A check cashing business is eligible if it receives more than 50% of its revenue from the service of cashing checks; and
- A business engaged in providing the services of a financial advisor on a fee basis is eligible provided they do not use loan proceeds to invest in their own portfolio of investments.
Challenges to Ineligibility Rules: There have been challenges to the SBA’s authority to deny loans to certain businesses based on the historical SBA rules. Those challenges have been in the areas of bankruptcy and applicants engaged in “prurient” businesses. The main challenges have been that the CARES Act broadened eligibility for PPP loans and its purpose is different from traditional SBA lending programs.
The cases have been mixed. Businesses in Wisconsin and Michigan in the legal adult entertainment industry successfully obtained preliminary injunctions in federal court requiring that their PPP loans be approved and funded by SBA lenders (provided that the applicants met the other applicable requirements for PPP loans). The reasoning was that the CARES Act broadened eligibility for PPP loans, and one court found that administrative rules and guidance promulgated by the SBA, like the SOP and ineligibility rules, are not applicable or controlling with respect to the clear intent of Congress to broaden eligibility requirements for PPP loans. However, a federal court in New York subsequently denied a preliminary injunction and came to the opposite result. The area remains unsettled.
The SBA’s position has been that businesses in bankruptcy were disqualified from receiving PPP loans. In Alaska, a federal court granted a summary judgment for a debtor that challenged its ineligibility for a PPP loan because it was in “bankruptcy.” However, there is a split among courts that have considered the question. The Economic Aid Act has addressed some of this issue for debtors that are proceeding under Subchapter V of Chapter 11, as well as Chapter 12 and Chapter 13 debtors, by providing that the bankruptcy court, after notice and a hearing, may authorize such a debtor in possession or a trustee to obtain a First Draw PPP Loan or Second Draw PPP Loan. In addition, the SBA has addressed some issues in their guidance. However, these items do not resolve pending litigation over the SBA’s prohibition against extending PPP loans to Chapter 11 debtors that are not proceeding under Subchapter V.
In summary, PPP borrowers must carefully review business ineligibility. The Treasury and the SBA have released extensive guidance on the eligibility of businesses. This resource is not a comprehensive summary of the relevant agency guidance. This article summarizes aspects of the law relevant to the PPP program, it does not constitute legal advice. For legal advice for your situation, you should contact an attorney.
 For PPP loans approved before December 27, 2020, see SOP 50 10 5(K), Subpart B, Chapter 2 for ineligible types of businesses.