SBA Loans Under the CARES Act - Updated

Foley & Lardner LLP

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), signed into law on Friday March 27, 2020, introduces the Paycheck Protection Program (the “PPP”) with $349 billion in funding and the goal of preventing job loss and small businesses failure due to losses caused by the COVID-19 pandemic. The new PPP loan program is available for eligible small businesses, including sole proprietors, and non-profits, veterans organizations and tribal business concerns, to provide a forgivable loan to cover payroll and other costs. The CARES Act greatly expands the separate Economic Injury Disaster Loan Program (the “EIDL” Program) with $10 billion of additional funding for the SBA.

The PPP provisions of the CARES Act were further interpreted by the U.S. Small Business Administration (“SBA”) in two interim final rules issued on April 2, 2020 (the “Interim Rule”) and April 3, 2020 (the “Affiliation Rule”)”), and Frequently Asked Questions issued on April 6, 2020 (the “FAQs” ). In conjunction with the issuance of the Affiliation Rule, the SBA also issued a two-page explanation of the affiliation principles applicable to the PPP (the “Affiliation Guidance”). This Alert has been updated to reflect this SBA guidance and to add some additional practical insights into the PPP program. The key updates from the Interim Rule and Affiliation Rule, and FAQs are highlighted in red text for ease of reference. The Interim Rule provided important information on the calculation of the loan amount, and added some further requirements. The Affiliation Rule and Affiliation Guidance clarified the affiliation principles that apply to applicants. The FAQs provide some additional clarification regarding the application of the affiliation rules and interpretation of the CARES Act, including guidance on how to calculate “payroll costs” and how a relationship with a third-party payroll provider and/or Professional Employer Organization (“PEO”) should be viewed for purposes of the PPP.

The FAQs make it clear that borrowers and lenders may rely on the SBA’s guidance in the FAQs and the Interim Rule available at the time of application. Specifically, the FAQs provide that the government will not challenge lender PPP actions that conform to such guidance.

Businesses need to understand both programs as well as the additional financial and other relief (including an Emergency Relief loan program for eligible mid-size employers) that may be available under the CARES Act in order to make short- and long-term planning decisions. The CARES Act provides assistance to many businesses that may not meet the customary small business thresholds. Given the various qualification criteria, the programs and incentives enacted under the CARES Act must be evaluated separately for each business, considering industry, legal requirements and financial and other contractual commitments during this challenging time. For more information on the CARES Act, follow this link.

Paycheck Protection Program (“PPP”)

Overview

PPP loans are 100% federally guaranteed loans for small businesses intended for companies to maintain their payroll levels and allow partial loan forgiveness, as described below. Unlike most typical SBA loans, the PPP Loans are unsecured loans requiring no collateral, no personal guarantee, and no showing that credit is unavailable elsewhere.

The Interim Rule clarifies that the PPP loans, to the extent not forgiven, will have:

  • A 2-year term (decreased from the maximum maturity of 10 years under the Act),
  • An interest rate of 1% (increased from prior Treasury guidance that set the interest rate at 0.5%)
  • Principal and interest deferred for 6 months and no interest charged on forgiven amounts

Small businesses and sole proprietorships can begin applying April 3, 2020, and independent contractors and self-employed individuals can begin applying April 10, 2020. The Interim Rule also makes it clear that the loans will be made on a first-come, first-served basis. Given the currently available funds for the program, Treasury and SBA are anticipating an over-subscription, so it is critical to gather required information and, if eligible, submit an application as soon as possible.

The SBA borrower application is available (here). Lenders may require borrowers to complete additional paperwork. The FAQs make it clear that lenders may use their own online systems and a form they establish that asks for the same information (using the same language) as the SBA borrower application. Loans are offered through any existing SBA 7(a) lender or through any eligible and participating federally insured depositary institution, federally insured credit union, Farm Credit System institution and certain other depository or non-depository financing providers.

Eligible Borrowers and Affiliation Principles Applicable to PPP

In general and subject to certain SBA exclusions, to be eligible for a PPP loan, a company must be either (i) a small business concern under the SBA regulations, or (ii) a business concern, nonprofit organization, veterans’ organization, or Tribal business concern that employs not more than 500 employees whose principal place of residence is in the United States (or the number of employees in the size standard applicable to the borrower’s industry, which for some industries is up to 1500 employees), in each case after application of affiliation rules, if applicable. This reference to United States residence is a new detail that was added by the Interim Rule and included in Question 3 of the FAQs, but was not addressed in the CARES Act and possibly subject to further clarification by additional guidance. Businesses in the Accommodation and Food Services Industry that operate at more than one physical location can avail themselves of the PPP loan program as long as they employ 500 or fewer employees per location. The Interim Rule and FAQs do not reference or further interpret the Accommodation and Food Services Industry rules.

The response to Question 14 of the FAQs provides additional clarification regarding how businesses should calculate their employee headcount for purposes of eligibility under the employee-based size standards applicable to the PPP. The FAQ response clarifies that borrowers should use a twelve-month period to calculate the number of employees, either by using their average employment over the same twelve-month period used to calculate their average monthly payroll costs, or by using what the FAQs describe as “SBA’s usual calculation” found in its regulations. The SBA’s usual calculation of employee count is based on the average number of employees per pay period in the twelve completed calendar months prior to the date of the loan application (or the average number of employees for each of the pay periods that the business has been operational, if it has not been operational for twelve months).

Notably, the CARES Act waives the SBA’s affiliation rules for determining PPP program eligibility for certain specific categories of businesses, including businesses in the Accommodation and Food Services Industry with 500 or fewer employees, businesses operating as a franchise that are assigned a franchise identifier code in the SBA Franchise Directory (available here), and businesses that receive financial assistance from a licensed Small Business Investment Company. As stated in the Affiliation Rule and FAQs, the remainder of businesses are subject to the SBA’s affiliation rules applicable to its business loan programs, summarized here in the Affiliation Guidance. The affiliation rules used for this purpose are different than the affiliation rules used for purposes of establishing whether a company is subject to the paid sick leave and expanded FMLA requirements under the Families First Coronavirus Response Act (FFCRA), which uses the integrated employer test under the FMLA.

Eligible companies must have been in operation on February 15, 2020 and must have, as of that date, had employees for whom the entity paid salaries and payroll taxes, or paid independent contractors. Question 10 of the FAQs clarifies that (i) eligible borrowers that use PEOs or similar third-party payers to process payroll and report payroll taxes may rely on the payroll documentation provided by the payroll provider/PEO for purposes of a PPP loan, and (ii) employees of an eligible borrower will not be considered employees of the payroll provider or PEO for this purpose.

Additionally, when applying for a PPP loan, a borrower must certify that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient and acknowledge that the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments. The borrower also must certify that it is eligible for a PPP loan under the CARES Act and guidance in place as of the application date. The FAQs further clarify that providing an accurate calculation of payroll costs and applying the affiliation rules is the borrower’s responsibility. Lenders are only expected to perform a good faith review of the payroll cost calculations, the depth of which should be informed by the quality of the documents provided by the borrower. These and other certification requirements are significant, as false or misleading certifications could potentially give rise to civil False Claims Act liability or criminal penalties.

Amount of the Loan

The maximum amount of a PPP loan available to each borrower is equal to the lesser of: (a) $10 million, or (b) 2.5 x its average total monthly payroll costs (as defined below). The CARES Act and Interim Rule provide that average monthly payroll costs should be calculated over the 12-month period preceding the application, but the application form itself states that monthly payroll costs will be calculated using 2019 payroll costs for most applicants. As explained above, Question 14 of the FAQs reconciles these two requirements, providing that borrowers may base aggregate payroll costs and employee counts on either calendar year 2019 or the 12-month period preceding the application.

For purposes of the PPP, “payroll costs” include:

  • For a borrower other than an independent contractor, the sum of payments of any compensation with respect to employees, that is:
    • Salary, wage, commission, or other similar compensation*
    • Cash tips or equivalent*
    • Payment for vacation, parental, family, medical, or sick leave (other than qualified sick leave wages or qualified family leave wages under the FFCRA)* - See Question 8 of the FAQ for further clarification/support.
    • Allowance for dismissal or separation*
    • Payment of group health care benefits and insurance premiums (generally, medical, dental, vision and health flexible spending account benefits)
    • Payment of retirement benefits
    • Payment of State or Local tax assessed on employee compensation. Question 16 of the FAQs clarifies that payroll costs are calculated on a gross basis; provided that payroll costs do not include the employer’s share of payroll costs (e.g., FICA).

      * Important Note: Question 7 of the FAQs clarifies that the CARES Act exclusion of any employee compensation in excess of an annual salary of $100,000 applies only to cash compensation. Therefore, non-cash benefits, including employer contributions to defined benefit and defined contribution retirement plans, payment for the provision of group health care benefits and insurance premiums, and payment of state and local taxes assessed on employee compensation, are not counted in calculating the cap and, therefore, those non-cash benefits may be included as a payroll cost, even for employees who have cash compensation in excess of $100,000 on an annualized basis.
  • For an independent contractor, the sum of payments of any compensation or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment or similar compensation (not in excess of more than $100,000 in 1 year, prorated)

The Interim Rule and FAQs clarify that independent contractors of a borrower do not count for purposes of the borrower’s PPP loan amount or forgiveness calculations. This was not clear from the face of the CARES Act, and should be considered by borrowers pursuing a PPP loan. Since independent contractors can also apply for a PPP loan, this appears to be a change to eliminate potential double counting.

Use of Loan Proceeds

The loans may be used for the following expenses/costs from February 15, 2020 through June 30, 2020:

  • Payroll costs (as defined above)
  • Costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave, and insurance premiums
  • Employee compensation
  • Mortgage interest obligations (but not principal)
  • Rent and utilities
  • Interest on debt incurred prior to the loan
  • Refinancing of SBA EIDLs that are made between January 31, 2020 and April 3, 2020

Note, however, that (i) the Interim Rule clarifies that at least 75% of the loan amount must be used for payroll costs and (ii) only a subset of these uses may be forgiven, as explained in more detail below. This is different from prior Treasury guidance, which did not require that 75% of the loan be used for payroll costs if the borrower was not seeking forgiveness. Certifications, including those carrying the penalties described above, must be made about the uses of the loan proceeds.

Forgiveness

A borrower of a PPP loan is eligible for loan forgiveness up to the full amount of the loan and any accrued interest for costs incurred and payments made during the 8-week period after the origination date, subject to proper documentation, on:

  • payroll costs (as defined above),
  • mortgage interest on mortgages that had been in place prior to February 15, 2020,
  • rent with respect to leasing agreements that had been in place before February 15, 2020, and
  • payment of service for the distribution of electricity, gas, water, transportation, telephone, or internet access for such services that began before February 15, 2020.

Note, however, that (i) at least 75% of the forgiven amount must be used for payroll costs and (ii) the amount of the PPP loan forgiveness may be reduced if the borrower reduces the number of employees or salaries and wages (for employees with annual salaries of $100,000 or less by more than 25%).

The reduction penalty will not apply to the extent the borrower restores their workforce count and salaries/wages by June 30, 2020.

Economic Injury Disaster Loan (“EIDL”) Program:

Another option for small businesses is the SBA’s existing EIDL Program, which was expanded by the CARES Act and provides for longer-term loans with favorable borrowing terms. Companies in all 50 states, District of Columbia, and some U.S. territories are eligible for EDILs relating to economic injury caused by the COVID-19 pandemic. While there are no loan forgiveness provisions applicable to EIDLs, companies that have already applied for or received EIDLs due to economic injury attributable to the COVID-19 pandemic can seek to refinance their EIDLs under the PPP to take advantage of the PPP’s loan forgiveness provisions. Additionally, while companies may be eligible for loans under both programs, they are unable to seek recovery under the EIDL for the same costs that are covered by a PPP loan.

The CARES Act expanded EIDL eligibility for the period between January 31, 2020 and December 31, 2020, to include any business with not more than 500 employees, any individual operating under a sole proprietorship or as an independent contractor, and any cooperative, ESOP or tribal small business concern with not more than 500 employees. Subject to guidance from the SBA, these applicants would also appear to still be subject to the SBA’s affiliation rules governing financial assistance programs. Entities previously eligible to receive SBA EIDLs, including small business concerns, private nonprofit organizations and small agricultural cooperatives, remain eligible for such loans under the more favorable terms authorized by the CARES Act.

To qualify for an EIDL under the CARES Act, the applicant must have suffered “substantial economic injury” from COVID-19. EIDLs under the CARES Act are based on a company’s actual economic injury determined by the SBA (less any recoveries such as insurance proceeds) up to $2 million. EIDLs may be used for payroll and other costs as well as to cover increased costs due to supply chain interruption, to pay obligations that cannot be met due to revenue loss and for other uses. The interest rate on EIDLs is 3.75% fixed for small businesses and 2.75% for nonprofits. The EIDLs have up to a 30-year term and amortization (determined on a case-by-case basis).

The CARES Act also permits applicants to request an advance of up to $10,000 to pay allowable working capital needs; the Act stated the advance is expected to be paid by the SBA within 3 days of submission of an EIDL application to SBA, provided the application contains a self-certification under penalty of perjury of the applicant’s eligibility for an EIDL. However, the SBA’s website now indicates that the funds will only be made available “within days following a successful application.” This advance is still essentially a grant and is not required to be repaid, even if an eligible borrower is ultimately denied an EIDL, but the amount of the advance must be deducted from any loan forgiveness amounts under a PPP loan, described above.

EIDLs under the CARES Act do not require personal guarantees for loans up to $200,000, but do require personal guarantees by owners of more the 20% of the borrower for loans in excess of that amount. The CARES Act waives the requirement for the borrower to demonstrate that it is unable to obtain credit elsewhere. However, unless changed by the SBA, it appears that the requirement for collateral on EIDLs over $25,000 would still apply, and, in processing a borrower’s application, the SBA must make a determination that the applicant has the ability to repay the loan. Further, the SBA can approve a loan based solely on the credit score of the applicant or other means of determining the applicant’s ability to repay the loan, without requiring the submission of tax returns, which should expedite approval of EIDLs during the covered period.

Given the very favorable terms of these two SBA loan programs and the potential for loan forgiveness under PPP loans, eligible small businesses who have been economically impacted by the COVID-19 pandemic should strongly consider taking advantage of these loan programs. Applications for EIDLs should be submitted directly to the SBA, while PPP loans will be available from SBA-approved lenders and the other lenders described above.

For more information about recommended steps, please contact your Foley relationship partner. For additional web-based resources available to assist you in monitoring the spread of the coronavirus on a global basis, you may wish to visit the CDC and the World Health Organization.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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