[co-author: Roke Iko, Law Clerk]
Since the inception of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) nearly eight weeks ago, the Small Business Administration (SBA) has issued loans under the Paycheck Protection Program (PPP) that have helped thousands of businesses remain afloat during the COVID-19 pandemic. One of the most beneficial aspects of these loans for borrowers is that the entire loan amount may be forgiven if the proceeds are spent on payroll costs and other qualifying expenses during the eight-week period after loan disbursement (the “Covered Period”). Last week, SBA released its PPP Loan Forgiveness Application, which provides borrowers with insight into what documentation and information will be necessary to apply and qualify for full loan forgiveness.
Over the weekend, SBA issued additional guidance on this process by issuing two new interim final rules on loan forgiveness and the loan review process, respectively. Below, we have highlighted a few of the most noteworthy aspects of these new rules.
New Rule on Loan Forgiveness
As we described previously, the PPP Loan Forgiveness Application provides detailed guidance for borrowers on how to calculate eligible payroll and non-payroll costs. The new forgiveness rule incorporates this guidance, but also contains some additional clarifications:
- Alternate Time Frames for Eight Weeks of Payroll. Borrowers can select either:
(1) the date the lender disburses the PPP loan to the borrower, (“Covered Period”), or (2) the first day of the first payroll cycle after the date of disbursement (“Alternative Payroll Covered Period”) as the first day for purposes of calculating the eight week time period for forgiveness eligibility. Payroll costs paid and/or incurred during the Covered Payroll Period or Alternative Payroll Covered Period are eligible for forgiveness. The new rule confirms that payroll costs are considered paid on the date of paycheck distribution or ACH credit transaction, and also clarifies that payroll costs are generally incurred on the day the employee’s pay is earned (i.e., on the day that the employee worked). For incurred expenses to be eligible for forgiveness, the borrower must pay those costs on or before the next regular payroll date – even if that payroll date is after the eight-week period. This flexibility means that borrowers need not run a special payroll during the eight weeks following disbursement to ensure eligibility for forgiveness.
- No Alternative Time Frame for Non-Payroll Costs. Non-payroll costs are handled a little differently from payroll costs, however, as there is no Alternative Payroll Covered Period. Non-payroll costs are mortgage interest payments (not including any prepayments or payments of principal), business rent or lease payments, and covered utility payments. Such costs are eligible for forgiveness if they are: (i) paid during the covered period, or (ii) incurred during the Covered Period and paid on or before the next regular billing date, even if the billing date is after the Covered Period.
- 40 Hour FTEs. Unless an exception applies, if the borrower’s average number of full-time equivalents (FTEs) during the Covered Period (or the Alternative Payroll Covered Period) is lower than its average number of FTEs between February 15, 2019 and June 30, 2019 or between January 1, 2020 and February 29, 2020, then the forgiveness amount will be subject to a reduction (unless salary/wage reduction is also a factor, as detailed below). In general, a reduction in average FTEs will reduce the loan forgiveness amount by the same percentage as the percentage reduction in average FTEs.
The new rule defines an FTE as “an employee who works 40 hours or more, on average, each week.” To calculate the total average number of FTEs during the Covered Period (or Alternative Payroll Covered Period), the borrower must assign a value from 0-1.0 to each person employed during the Covered Period (or Alternative Payroll Covered Period), then aggregate those values. In determining which value to assign to each employee, borrowers must divide the average number of hours the employee is paid per week during the Covered Period (or Alternative Payroll Covered Period) by 40. If the result is one or higher, the value 1.0 is to be assigned, while “the hours of employees who work less than 40 hours per week are calculated as proportions of a single full-time equivalent employee.”
For part-time employees, borrowers can use one of two calculations: (1) the average number of hours a part-time employee was paid per week during the covered period to arrive at a proportionate FTE count (e.g., a part-time employee who was paid for 30 hours per week on average would equal 0.75 of an FTE, while an employee paid for 10 hours a week on average would equal 0.25 of an FTE); or (2) considering all part-time employees (i.e., those at any amount less than 40 hours on average per week during the Covered Period or Alternative Payroll Covered Period) as 0.5 FTE employees for convenience. Whichever method a borrower selects, it must apply the method consistently.
After assigning a value to each employee, and aggregating those values to arrive at the total average FTEs for the Covered Period, the borrower must go through the same process of calculating the total average FTEs for the reference period that the borrower chooses. Importantly, however, SBA will not use the reduction in total average FTEs against a borrower in the forgiveness reduction calculation if, by June 30, 2020, the borrower eliminates any reductions in FTEs that occurred between February 15, 2020 and April 26, 2020 (the “FTE Reduction Safe Harbor”). In other words, if the number of FTEs in the borrower’s pay period inclusive of February 15, 2020 (calculated using the above methodology) is the same as or lower than the borrower’s total FTEs as of June 30, 2020, then the FTE Reduction Safe Harbor will apply.
- 25 Percent Wage Reductions. SBA may also reduce loan forgiveness if there is a reduction in an employee’s salary or wages in excess of 25 percent during the Covered Period or Alternative Payroll Covered Period as compared to the wages paid during the selected reference period. The forgiveness amount will be reduced by the weekly reduction in salary or wages that exceed 25 percent. The new rule illustrates this by explaining that if a full-time employee’s weekly salary was $1,000 per week during the reference period, but only $700 per week during the Covered Period (or Alternative Payroll Covered Period), and that employee continued to work 40 hours or more a week, then the forgiveness amount would be reduced by $400. This is because the first $250 reduction per week (i.e., 25 percent of $1,000) is exempt from reduction, but the remaining $50 of reduction per week must then be multiplied by 8 (i.e., the number of weeks in the Covered Period).
The new rule makes clear, however, that borrowers will not be penalized twice if they have both an FTE employee reduction and salary/wage reductions. In this situation, SBA will only apply the salary/wage reduction to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction. Further, these reductions do not apply to compensation above $100,000. Additionally, if the borrower eliminates any reduction in an employee’s salary or wages by restoring the average annual salary or wage to the pre-February 15 level by June 30, then the salary or wage reduction will not be used to reduce the forgiveness amount.
New Rule on SBA Loan Review Procedures and Related Borrower and Lender Responsibilities
This new rule provides further guidance to both lenders and borrowers regarding lender and SBA reviews of loan and forgiveness applications. The following are some of the notable points:
- 60 Days for the Bank, 90 Days for SBA. Borrowers must complete and submit the Loan Forgiveness Application (SBA Form 3508 or the lender equivalent) to their lenders. Lenders are responsible for conducting a good faith review of the forgiveness application and confirming that the borrower made all required certifications, submitted all required documentation, and correctly calculated the forgiveness amounts on the application. The lender will then: (a) approve the forgiveness application in whole or in part, (b) deny the application, or (c) (if directed by SBA) issue a denial without prejudice due to a pending SBA review of the loan. The lender must inform SBA of its decision within 60 days from the date the lender received the borrower’s complete application. SBA will perform its review and, after that review, send the forgiveness amount plus any accrued interest to the lender within no more than 90 days. To the extent the lender’s determination is negative, borrowers will have the ability to request that SBA review the lender’s denial within 30 days of receiving notice from the lender.
- SBA’s Audits. SBA has the right to review any loan application or loan forgiveness application at any time, regardless of the value of the loan. In its review, SBA may review borrower documents to determine (a) if the borrower was eligible for the loan,
(b) whether the borrower calculated the loan amount correctly, or (c) whether the borrower is entitled to loan forgiveness amounts claimed in the forgiveness application. This is important for borrower who, together with its affiliates, received PPP loans in an amount less than $2 million who may not have realized its loan application could still be subject to SBA review for calculations and eligibility. Specifically, SBA previously indicated that it would not audit those loans to determine whether the borrower correctly certified “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” However, this new rule makes clear that simply because SBA will not audit loan applications of loans under $2 million for the specific purpose of reviewing the borrower’s loan necessity certification does not mean such loans are free from SBA review entirely.
- Although the new rule does not specify how SBA will choose when and which applications to review, it does state that SBA can review such applications at any time, therefore making it important for borrowers to retain all PPP-related documentation for the required six years after the date the loan is forgiven or repaid in full.
- Borrower Ineligibility and Forgiveness. If SBA determines that a borrower was ineligible for a PPP loan (for example, because the borrower did not qualify as an eligible small business), then the borrower is not eligible for forgiveness. Borrowers will apparently be given an opportunity to appeal this decision based on a to-be-determined appeal process. Although the rule does not address other remedies, SBA could pursue other actions against businesses that are ineligible.
- Lenders and Ineligible Borrowers. Importantly, and somewhat surprisingly, SBA states that if it determines a borrower was ineligible for a PPP loan, SBA will not pay the lender’s loan processing fee for that loan. This seems contrary to SBA’s earlier guidance to lenders that they could rely on a borrowers’ representations of eligibility in their loan applications. It is possible that some lenders would not have participated in the PPP program or would have more closely scrutinized loan applications had they been aware SBA would not reimburse processing fees in instances where it determines that a borrower was not eligible for the loan in the first instance.
 The borrower has the option to choose one of these two time periods. Seasonal employers will also be able to compare their Covered Period to either of these periods or to any consecutive twelve-week period between May 1, 2019 and September 15, 2019.
 SBA provided this guidance, together with the Treasury Department, when it added FAQ #46 to the FAQ Document on May 13, 2020.