Most Paycheck Protection Program (“PPP”) borrowers are working toward full forgiveness of their PPP loans and are anxious to get this process started. A borrower generally may submit a loan forgiveness application any time on or before the maturity of the loan—including before the end of the covered period—if the borrower has used all of the loan proceeds. But that does not mean a borrower should submit a loan forgiveness application as soon as possible. There are many considerations you should take into account when deciding when to submit forgiveness applications to the lender. Patience and adequate preparation may be more than just virtues in the PPP loan forgiveness context; they may lead to financial benefits for borrowers as well. This article discusses the timing considerations and other items that may impact a borrower’s decision to submit the loan forgiveness application to its lender.
Forms and Readiness of the Small Business Administration (“SBA”) and the Lender
Forms and Process: As of October 2, 2020, there are two types of loan forgiveness application forms: Form 3508 and Form 3508EZ. Neither of these forms has been updated since June 16, 2020 and each has an expiration of October 31, 2020. In addition, there are legislative proposals to reduce this paperwork and streamline the process for loans under $150,000. As such, we expect changes to these loan forgiveness applications. However, as of this date, no changes have been made.
SBA Timing: The SBA opened up its new platform to accept PPP forgiveness submissions from lenders on August 10, 2020, subject to extension if any new legislative amendments to the forgiveness process necessitate changes to the system. We expect further legislative changes.
Lender Timing: Even if a borrower is ready to apply for forgiveness, its lender may not be ready to receive and review loan forgiveness applications. The SBA allows lenders to have their own “lender equivalent form.” Most lenders are not ready to process forgiveness applications and are still in the process of developing tools such as “forgiveness portals.” Some lenders have opened up their portals, but are taking applications in batches or by invitation only, including some based on the date of the loan. Other banks are not allowing forgiveness applications until the covered period ends. Please contact your bank to see what process they are following. In addition, although the SBA and the U.S. Treasury Department have issued some guidance, we expect that more guidance may be needed for lenders to finalize their portals or documents.
Time Is on Your Side
Extended Coverage: The covered period of PPP loans was extended, so there is no need for a borrower to rush the loan forgiveness application process. The Paycheck Protection Program Flexibility Act of 2020 (“PPPFA”) was enacted on June 5, 2020, and it extended the covered period from 8 weeks to the earlier of December 31, 2020, or 24 weeks from the date of the loan. If a borrower received its PPP loan before June 5, 2020, the PPPFA allows the borrower to elect to use an 8 week covered period. The covered period extension was made with retroactive effect as if it were originally enacted in the CARES Act. If the borrower does not apply for loan forgiveness within 10 months after the last day of the covered period, or if the SBA determines that the loan is not eligible for forgiveness (in whole or in part), the payments on the PPP loan are no longer deferred and the borrower must begin paying principal and interest. Taking advantage of the full 24 weeks may give a borrower more time to take steps that will help them qualify for full loan forgiveness. This is especially true for the self-employed and owner-employees whose compensation was capped at 2.5 months’ worth of 2019 net profit. However, it should be noted that waiting may increase the amount of interest a borrower pays with respect to any part of the loan that will not ultimately be forgiven. In addition, there may be other reasons, not to wait—see below.
Guidance May Evolve: Because of the constantly evolving guidance with respect to loan forgiveness, borrowers should consider waiting before they file their loan forgiveness applications. For example, consider the plain language of the PPPFA that the SBA interpreted differently in a later Interim Final Rule. Section 3(b)(8) of the PPPFA expressly provides that unless 60% or more of the loan proceeds are used for payroll, no forgiveness will be allowed. However, the SBA announced later that it would not be interpreting the PPPFA in that manner. Instead, the SBA indicated that the proper interpretation of Section 3(b)(8) of the PPPFA is that it does not make loan forgiveness under the PPP an all-or-nothing proposition for the borrowers. Rather, the 60% number is to be applied on a proportional basis instead of a cliff, thus allowing borrowers to seek forgiveness even though less than 60% of the loan proceeds were used for payroll costs. Although the plain language of the acts related to the PPP may seem clear, the constantly evolving guidance from the SBA and Treasury may change interpretations. Because new interim final rules are coming out and further pandemic aid bills are still being introduced into Congress, hurrying up the process of filing for loan forgiveness may not be warranted if the forgiveness landscape continues to change.
More Guidance Is Expected: We are expecting more guidance in a number of areas. Some guidance was posted in August 2020 (see links below) and related to owner-employee compensation, the eligibility of nonpayroll costs, and certain calculations for reductions in employee salary or hourly wages. But gray areas remain. If any of these gray areas are critical for a borrower’s loan forgiveness, the borrower may want to consider waiting for additional guidance. On August 4 and 11, 2020, the SBA posted 11 pages of guidance—the Frequently Asked Questions (FAQs) on PPP Loan Forgiveness—and updated the Interim Final Rule on Appeals of SBA Loan Review Decisions under the PPP, and on August 24, 2020, it posted the Interim Final Rule on Treatment of Owners and Forgiveness of Certain Nonpayroll Costs. We expect more guidance.
Deductibility of Certain Expenses: On April 30, 2020, the IRS issued Notice 2020-32 clarifying that no deduction is allowed under the IRS Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan and the income associated with the forgiveness is excluded from gross income. With that in mind, borrowers who are considering having all or a portion of those loans forgiven must consider the collateral tax consequence of that forgiveness. To the extent a borrower would have deducted from the taxpayer’s income amounts spent on eligible expenses, the borrower should evaluate whether or not it might pay more in taxes than to pay back some or all of the original loan or how the taxpayer will pay the taxes due on those expenditures. Taxpayers will also want to separately account for those expenditures so they are easy to pull out and identify in preparing their 2020 (or fiscal year) tax returns affected by the Notice. It was the expectation that Congress would overrule this position, but that has not happened to date. In the meantime, taxpayers would be best served analyzing the potential tax consequences of the Notice and preparing for those tax consequences now. See IRS Issues Guidance Regarding PPP Loan Forgiveness and Deductibility of Expenses (May 1, 2020).
Documents Are Critical: The forgiveness applications issued by the SBA require that they be accompanied by detailed documentation and that additional documents be retained by the borrower. If the lender identifies errors in the borrower’s calculations or a material lack of substantiation in the borrower’s supporting documents, the lender is to work with the borrower to remedy the issue. A borrower should take the time to make sure they have both the accompanying documentation and the documents to be retained available at the time of the submission. Don’t put off getting the “retained” documents together. The SBA has a right to request that retained information as part of its review. If the borrower does not promptly provide documents, this may cause delay and possibly denial of forgiveness. Furthermore, as the rules for PPP loan forgiveness contain so many gray areas, borrowers should also document how a conclusion was reached and what guidance they used to reach the conclusion. See “Key Consideration for PPP Documentation” and “A Guide to the SBA PPP Loan Forgiveness Review Process.”
Calculations: The borrower is responsible for accurately calculating the loan forgiveness amount, even though most lenders will have their own calculators. The American Institute of CPAs (AICPA) and Biz2Credit, Inc. have put together a PPP Forgiveness Tool, which some borrowers may find helpful to double check their bank’s calculator. We were not involved with the preparation of this tool. We do not make any warranties regarding the accuracy or propriety of the information that is provided by the tool. Each borrower should seek its own accounting and legal advice regarding its calculations.
Loans Over $2 Million: The SBA has indicated that it will review loans in excess of $2 million, and the SBA loan forgiveness applications have a box relating to PPP loans in excess of $2 million (including affiliates). However, at this time, we do not know the timing and extent of this SBA review. We do know that the SBA will be reviewing these loans to make sure the borrower’s self-certification for the loans was appropriate. In particular, it has highlighted that borrowers must have “an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance.” In addition, the SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to SBA review for compliance with program requirements set forth in the PPP interim rules and in the borrower’s PPP loan application. Borrowers should take the time to prepare, gather, and organize these documents in contemplation of this review.
Does the Borrower Want to Be the First One through the System: The PPP process has been uneven and frustrating for many borrowers. The loan forgiveness process will be a new system for the lenders and for the SBA. Borrowers should consider whether they want to be the first ones through the system or whether they want to wait for the process to get established before submitting an application.
Loan Documents May Need to Be Amended: Some lenders’ PPP loan documents require a borrower to apply for forgiveness within a certain time period or have set maturity dates or interest payment dates. Some lenders specified explicit terms, such as how much of nonpayroll expenses are forgivable, covenants regarding eight-week covered periods, or a requirement to not take out additional PPP loans. The recent legislative changes and expected additional legislation will likely alter these previously established loan terms. It would be well worth reviewing those documents to determine if they contain such provisions, what the consequences might be for failing to meet the deadlines or covenants, or if the provisions may be extended or corrected with an amendment to the loan document. This may be very important if the borrower has cross default provisions in other loan documents or leases or important contracts, like major supplier/vendor contracts, as these other parties may take advantage of these “technical breaches.” In addition, the lender’s forgiveness applications may require the borrower to certify that the borrower has met all the terms of the loan documents, resulting in a potential false certification if the terms are not changed or updated. In the past, the SBA has been very strict and unforgiving of “technical false certifications.”
Changes to Business Structure: Many borrowers have had to revise their business structure in the face of the pandemic. Changes to a business’s legal structure, a decrease in employee count, or eliminating a division or subsidiary after a borrower takes out a PPP loan may affect the borrower’s ability to receive full or partial loan forgiveness. Depending on the timeline of these changes, it may be beneficial to apply for forgiveness before the changes take place, especially if the borrower is relying on FTE Reduction Safe Harbor 2, which is tied to the date of the forgiveness application. In addition, if a borrower applies for forgiveness before the end of the covered period and has reduced any employee’s salary or wages in excess of 25%, the borrower must account for the excess salary reduction for the full covered period. See also below, on the need for prior lender consent for “changes in business structure.”
M&A Transactions and Changes in the Ownership: The PPP may have a variety of implications on pending and potential M&A transactions and changes in the ownership.
- Changes in the Ownership: The SBA form of promissory note contains certain restrictions and a specific default provision concerning transactions where a borrower “reorganizes, merges, consolidates, or other changes ownership or business structure without Lender’s prior written consent.” Although a lender could use its own form of note, most loan documents preclude a change in ownership or change in business structure during the term of the PPP loan. In addition, SBA guidance relating to “7(a) loans,” which is applicable to PPP loans, requires a lender to obtain SBA consent before a borrower is permitted to perform or allow certain activities, including a change in percentage of ownership but it does not specify any minimum threshold. This may impact some borrowers who have planned estate planning and gifting programs which may change ownership of a company before year-end. If the PPP loan is in place and consents are required, then the parties need to consider whether the change in ownership transaction could trigger a default under the PPP loan documents and a loss of forgiveness. For PPP borrowers contemplating any changes in ownership, please contact your lender to discuss how the lender is handling this guidance and whether SBA regional approval should be sought prior to a change in ownership.
- M&A Transactions: With respect to M&A transactions, the SBA guidance on “change in the ownership” would specifically pick up a merger or an equity transaction. Recently, it has been reported that the SBA informed PPP lenders that the SBA does not distinguish between an asset acquisition and a “change in the ownership” situation and expects lenders to obtain SBA consent prior to approving those transactions. As such, the prior SBA consent requirement will likely apply to any “business combination”—whether an asset sale, merger, or equity acquisition. Prior consents take time—typically two to six weeks. Failure to obtain consents could result in the denial of PPP loan forgiveness and may result in a demand for immediate repayment of the PPP loan. If obtaining consent is impractical, it may be preferable to delay the transaction timeline in order to obtain forgiveness prior to closing, or to analyze the importance of forgiveness in light of the transaction. There may also be issues in an asset transaction relating to staffing changes and the timing of the forgiveness application. Furthermore, in an M&A transaction, if the parties want to keep the PPP loan in place post-closing, then prior lender and SBA consent will likely be required. In addition, if the loan remains in place post-closing, there are a number of negotiating points that need to be covered regarding the borrower’s compliance with the PPP loan terms, the representations and warranties and indemnifications regarding the loan, and control of the forgiveness application process and submission. These considerations are in addition to the items set forth in the “Changes to Business Structure” section.
Because of the many variables that affect each borrower differently, a borrower should consider discussing the loan forgiveness process with legal counsel before submitting the application.