For most eligible businesses[1], today is the first day that banks and other qualified lenders are supposed to start accepting applications for forgivable loans under what is commonly known as the Paycheck Protection Program (PPP), a key element of the $2.2 trillion stimulus package known as the CARES Act (the Act). As late as yesterday, there was still a lot of confusion by both would be borrowers and lenders on many aspects of the PPP. However, yesterday evening the U.S. Small Business Administration (SBA) released interim final rules (the Rules) that provide answers to many (but not all of the) questions and issues that borrowers and lenders have been grappling with since the PPP was announced. Many of our clients and friends are advising us that because they have just received the Rules, they will not be accepting applications today, but you should check with your lender.

The Rules are effective without advance notice and public comment to allow for immediate implementation of the PPP. Although effective immediately, the SBA is soliciting comments from interested members of the public on all aspects of the Rules and will consider the need for making any revisions as a result of these comments. The Rules further indicate that the SBA intends to issue additional guidance in the future with respect to certain aspects of the affiliation rules.

This alert outlines the key provisions of the Rules and is recommended reading for both borrowers and lenders.

Guidance for Borrowers

Applicability of Affiliation Rules. Other than for a few limited exceptions, the Act left in place the SBA’s affiliation rules, which exclude from participation in the PPP many otherwise eligible small business, including those owned by private equity firms or which have received venture capital or other institutional investment or have unrelated businesses owned by the same family or other small group. While these types of small businesses and their owners or investors were hoping that the SBA would relax the application of the affiliation rules, the Rules did not do so, instead noting that SBA “intends to promptly issue additional guidance with regard to the applicability of affiliation rules.”

Reading between the lines, it does appear that the SBA may relax the rules in further guidance. As this issue is of critical importance to many of our clients and friends, we will continue to monitor and update you once this additional guidance has been released.

Ineligible Borrowers. Applicants that meet the size requirements for eligibility are advised that they will nevertheless be ineligible for a PPP loan if:

• applicant is engaged in any activity that is illegal under federal, state or local law;
• borrower is a household employer (i.e. individuals who employ household employees such as nannies or housekeepers), because it is not a business;
• an owner of 20% or more of the equity of the Borrower (i) is incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment or other means by which formal criminal charges are brought in any jurisdiction; or (ii) has been convicted of a felony within the last five (5) years; or
• borrower, or any business owned or controlled by Borrower or any of its owners, has ever obtained a direct or guaranteed loan from the SBA or any other federal agency that is currently delinquent or has defaulted within the last seven (7) years and caused a loss to the government.

Payroll Costs. Under the Act, payroll costs are used to (i) calculate a borrower’s maximum loan amount, (ii) as an allowable use of PPP loan funds and (iii) as amounts eligible for loan forgiveness.

The Rules clarify that “payroll costs” consist of:

• compensation to employees (whose principal place of residence is the United States) in the form of salary, wages, commissions or similar compensation;
• cash tips, or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips);
• payment for vacation, parental, family, medical or sick leave;
• allowance for separation or dismissal;
• payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums and retirement; and
• payment of state and local taxes assessed on compensation of employees.

In the case of applicants that are independent contractors or sole proprietors, “payroll costs” include wages, commissions, income or net earnings from self-employment or similar compensation.

Payroll costs specifically exclude:

• any compensation of an employee whose principal place of residence is outside of the United States;
• the compensation of an individual employee in excess of an annual salary of $100,000, prorated as necessary;
• federal employment taxes imposed or withheld between February 15, 2020 and June 30, 2020, including the employee’s and employer’s share of FICA (Federal Insurance Contributions Act) and Railroad Retirement Act taxes and income taxes required to be withheld from employee; and
• qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127);

As noted above, the Rules confirm that compensation in excess of an annual “salary” of $100,000 for an individual employee is excluded from payroll costs. The Rules did not address a lingering question of whether benefits for employees that make over $100,000 can be included in payroll costs, but since there is no separate limit on benefits in the Act or the Rules, a reasonable interpretation would be that the benefits for such employees can be included in the payroll costs. And, while it appears that federal withholding taxes cannot be included in payroll costs (or the amount of the loan), which of those taxes are now less clear given that the Rules now only require exclusion for February 15 to June 30, 2020.

Independent Contractors Not Included in Payroll Costs. The Rules clarify that independent contractors do not count as employees and are not included in the calculation of a business’s “payroll costs” for purposes of the PPP.

Accordingly, amounts paid to independent contractors:

1. are not included in the calculation of a borrower’s maximum PPP loan amount; and
2. do not count for purposes of a borrower’s loan forgiveness.

The Rules explain that “independent contractors have the ability to apply for a PPP loan of their own so they do not count for purposes of a borrower’s PPP loan calculation.” What is not answered is whether temporary or leased employees that are paid through a staffing company or other contingent workforce provider can be included in payroll costs.

Calculating PPP Loan Amount. The Rules offer the following methodology (contained in the Act) for determining PPP loan amount:

1. Aggregate payroll costs from the last 12 months for employees whose principal place of residence is the United States;
2. Subtract any compensation paid to an employee in excess of an annual salary of $100,000 and/or any amounts paid to an independent contractor or sole proprietor in excess of $100,000 per year;
3. Calculate average monthly payroll costs (divide the amount from Step 2 by 12);
4. Multiply the average monthly payroll costs from Step 3 by 2.5; and
5. Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL COVID-19 loan (because it does not have to be repaid).

The Rules explain that these steps will work for most borrowers, but there are alternatives for seasonal and newly formed companies. Importantly, the Rules do not further clarify the measurement period for determining the average payroll and there is potentially an inconsistency between the form application that was released by the SBA, which provided that the measurement period would be FY2019, whereas the Rules (and the Act) appear to suggest that the measurement period is the last 12 months before the loan application date.

Interest Rate & Term. The interest rate on PPP loans will be 1% and the maturity date is two (2) years. Payment will be deferred for the first six (6) months following the date of disbursement, however, interest will accrue during the deferment period.

Non-Payroll Cost Use & Forgiveness Limitation. The Rules now limit the amount of the PPP loan that can be used for things other than payroll costs. As a result, not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs.

Although the Act provides that borrowers are eligible for forgiveness in an amount equal to the sum of (i) payroll costs, (ii) payments of interest on mortgage obligations incurred before February 15, 2020, (iii) rent payments on leases dated before February 15, 2020 and (iv) utility payment under service agreements date before February 15, 2020, the Rules impose a limit on non-payroll portion of the forgivable loan amount “to effectuate the core purpose of the statute and ensure finite program resources are devoted primarily to payroll.”

Accordingly, at least 75% of the PPP loan proceeds must be used for payroll costs to be eligible for forgiveness and a borrower will have to document the use of proceeds. The Rules state that the SBA will be issuing additional guidance on loan forgiveness.

Refinancing EIDL Loans. Borrowers who received a direct SBA loan under the EIDL program between January 31, 2020 and April 3, 2020 are eligible to apply for a PPP loan.

If the EIDL loan was not used for payroll costs, the borrower’s eligibility for a PPP loan is not affected. However, if the EIDL loan was used for payroll costs, the borrower’s PPP loan must be used to refinance the EIDL loan.

Misuse of PPP Loan Funds. The SBA will direct a borrower to repay PPP loan funds used for an unauthorized purpose. Knowingly using the funds for unauthorized purposes will subject the borrower to liability including fraud. In the event of misuse by the borrower’s shareholders, members, or partners, SBA will have recourse against such shareholders, members, or partners.

One PPP Loan per Borrower. No eligible borrower may apply for, or receive, more than one PPP loan.

Guidance for Lenders

Lender Eligibility Under the PPP. The SBA approved lenders are automatically eligible to provide loans under the PPP. In addition, Congress expressly authorized the SBA and the Department of the Treasury to allow additional lenders to participate in the PPP. The SBA issued such eligibility criteria, under the Rules, making all lenders who meet the following criteria eligible to participate in PPP (each, a “Qualified Lender”):

1. lenders not currently designated as in Troubled Condition by their primary federal regulator or are subject to a formal enforcement action with their primary federal regulator that addresses unsafe or unsound lending practices;
2. any federally insured depository institution or any federally insured credit union; and
3. any Farm Credit System institution (other than the Federal Agricultural Mortgage Corporation) as defined in 12 U.S.C. 2002(a) that applies the requirements under the Bank Secrecy Act and its implementing regulations (collectively, BSA) as a federally regulated financial institution, or functionally equivalent requirements that are not altered by this rule.

All qualified institutions described in subsections (a), (b) and (c) above will be automatically qualified under delegated authority by the SBA once the lender submits the CARES Act Section 1102 Lender Agreement (SBA Form 3506).

Application Process for Non-Qualified Lenders. All other lenders must contact their local SBA District office in order to begin the application process. The SBA provides, that all “[b]anks, savings and loans, credit unions, and other specialized lenders [may] participate with the SBA on a deferred basis to provide small business loans” if a lender meets the following requirements:

1. have a continuing ability to evaluate, process, close, disburse, service and liquidate small business loans;
2. be open to the public to issue loans (and not be a financing subsidiary, engaged primarily in financing the operations of an affiliate);
3. have continuing good character and reputation, and otherwise meet and maintain the ethical requirements as identified in 13 CFR Part 120.140; and
4. be supervised and examined by a state or federal regulatory authority, satisfactory to the SBA.

Key Underwriting Considerations for PPP Loans. The PPP authorizes all SBA-approved lenders and Qualified Lenders (collectively, the PPP Lenders) to originate PPP loans without complying with the SBA’s general eligibility process, in order to facilitate the efficient origination of PPP loans. The Act effectively allows all PPP Lenders to use the SBA’s Preferred Lenders Program process, which currently allows certain SBA lenders to approve SBA loans unilaterally.

Despite having the SBA’s delegated authority to originate PPP loans, all PPP Lenders must still consider the following criteria:

1. Has the borrower provided eligibility certifications required under the PPP Application form issued by the SBA?
2. Does the borrower’s business qualify as a small business (generally having less than 500 employees)?
3. Does the borrower have affiliate entities, which should be included in the lender’s small business size determination, or does the borrower’s business fall into the SBA’s NAICS CODE 72 exception (including travel accommodations, food services, bar and restaurants), which makes the business eligible if it has less than 500 employees per business location?
4. Whether the borrower’s business was in operation and paid salaries on or about February 15, 2020?
5. Can the borrower’s average monthly payroll costs for the preceding calendar year be confirmed?
6. Whether the borrower had employees for whom it paid salaries and payroll taxes or paid independent contractors as reported on Form 1099-MISC?
7. Have the anti-money laundering, know your customer, fraud and other standard BSA risk-based protocols been followed?

It is important to note that each lender’s underwriting obligation under the PPP is limited to the items listed above and the information found in the borrower’s Paycheck Protection Application Form. The Rules also provide that lenders must also identify and report certain suspicious activity to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). If lenders have questions with regarding such requirements, they should contact the FinCEN Regulatory Support Section at FRC@fincen.gov.  

Key PPP Loans Lender-Specific Restrictions. The key lender-specific restrictions on PPP loans include the following:

1. no collateral is required;
2. no personal guarantees are required; and
3. the SBA will pay lenders fees for processing PPP loans equal to the following amounts:
   1. 5% for loans of $350,000 or less;
   2. 3% for loans of more than $350,000 but less than $2,000,000; and
   3. 1% for loans of $2,000,000 or more.

Loan Documentation Requirements for PPP Loans. The Act does not require lenders to use specific forms to document PPP loans, however, lenders should be sure to modify their existing form documents in order to comply with the PPP’s requirements. It is also expected that the SBA will release form PPP loan documents, but no official guidance has been provided as of yet.

Additional Updates to Existing SBA Programs. The Act increased the maximum loan amount under the SBA’s 7(a) Express Loan program, from $350,000 to $1,000,000. The 7(a) Express Loan program is much more streamlined than the traditional 7(a) loan program and has an origination process of a couple days instead of the traditional 7(a) loan program that can take a couple weeks to a couple months to complete. It is important to note that 7(a) Express loans are backed by an SBA guarantee of 50% of the loan amount.

Intercreditor Considerations Under PPP. Lenders should discuss a borrower’s existing financing prior to entering into a PPP loan in order to determine whether an intercreditor agreement is necessary. In the event a borrower has existing financing, it is likely the existing lender’s financing documents prohibit additional liens on existing collateral or additional financing in general, which will likely require either an intercreditor agreement or amendment to the borrower’s existing financing documents.

Concerns for Lenders Under the PPP. Although there are a number of concerns under the PPP, an initial concern for lenders relates to the SBA’s and Treasury Department’s guidance under the Act, which provides that lenders are expected to verify borrower eligibility and comply with all standard BSA risk-based protocols, as detailed in the Rules. Accordingly, it is important for lenders to adhere to prudent underwriting practices when originating PPP loans, despite the unprecedented demand from borrowers.

[1]  Starting April 3, 2020 eligible business concerns and sole proprietorships can apply for PPP loans. Independent contractors and self-employed individuals will be able to apply beginning on April 10, 2020. 

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