Late last month, the federal government committed $349 billion dollars in forgivable loans to small businesses under the Paycheck Protection Program (“PPP”), which was part of the Coronavirus Aid, Relief, and Economic Stability Act (the “CARES Act”). Under the PPP, eligible small businesses have been able to borrow two and one-half months of payroll costs, up to $10 million, from banks and other financial institutions approved by the U.S. Small Business Administration (“SBA”) in order to fund payroll costs, rent, utilities, and certain other operating-related expenses (“Qualified Expenses”) incurred eight weeks after the loan is disbursed (“Covered Period”).
Many small businesses quickly saw the advantage of the generous terms of PPP capital not requiring collateral, personal guarantees, or SBA fees and providing a six-month deferment period at a fixed interest rate of 1%. On Thursday, April 16, 2020, the SBA announced it is no longer accepting applications because it had already approved the $349 billion allotted for the program (although it seems that Congress may add another $300 billion to the PPP in coming weeks). Approved borrowers have started to receive the proceeds of the loans, beginning the eight week Covered Period within which to spend the proceeds in order to qualify for loan forgiveness. As we enter the disbursement phase, borrowers need to focus on how to properly spend the money to maximize forgiveness and avoid potential problems in the future, when the government reviews the disbursements under the program. The SBA is required by the CARES Act to provide guidance on the implementation of the loan forgiveness feature by April 26, 2020.
The PPP is a massive program that was very quickly rolled out with minimal supervision and review of the loan applications – a primary objective of the program was to inject a large amount of money into the economy quickly. There are undoubtedly some businesses that will take improper advantage of this loan program, and 2021 will likely see enforcement actions aimed at those engaged in fraud under the PPP. Given how quickly this was rolled out, there will also inevitably be those who inadvertently don’t follow the rules and will find themselves trying not to be lumped in with those who committed actual fraud. Borrowers should protect themselves from liability by ensuring PPP funds are used only for authorized purposes.
The basic idea behind the use of the PPP proceeds is simple: Borrowers should use the money quickly, mostly to pay employees, and should bring their workforce levels back to pre-pandemic levels, if possible. That may be a challenge for many recipients given the rapidly changing COVID-19 environment, and the law anticipates that borrowers may not be able to spend all the money in the time frame indicated for the purposes indicated. As borrowers analyze the various options available, they should keep in mind that in applying for the PPP loan, the borrower needed to certify in good faith that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” and loan proceeds “will be used to retain workers and maintain payroll” (emphases added). Those responsible for enforcement and oversight will likely give a good deal of leeway to borrowers trying to navigate these very uncertain times, but will not look kindly on those who they determine did not obtain this money in good faith.
Under the CARES Act, PPP loan proceeds can lawfully be used for the various purposes of a normal SBA 7(a) loan, such as to provide working capital as well as to cover (1) payroll costs (as defined by the Act); (2) costs related to continuation of group health care benefits during periods of paid sick, medical, or family leave, as well as insurance premiums; (3) mortgage interest payments; (4) rent payments; (5) utility payments; (6) interest payments on other debt obligations incurred before February 15, 2020; and (7) refinancing an SBA Economic Injury Disaster Loan made between January 31, 2020, and April 3, 2020. CARES Act § 1102(f). The SBA has declared in its Interim Final Rule that 75% of the PPP loan proceeds must be spent on payroll costs.
If a borrower uses PPP funds for unauthorized purposes, the SBA will direct the borrower to repay those amounts. If a borrower knowingly uses the funds for unauthorized purposes, the borrower will be subject to additional liability charges for fraud. If a borrower uses funds for unauthorized purposes, the SBA will have recourse against the borrower’s shareholders, members, or partner(s) for the unauthorized use.
Because the purpose of the program is to inject money quickly into the economy primarily by paying employees of small businesses, the PPP provides the opportunity for complete forgiveness of the PPP loan. Those portions of the loan that are not spent quickly enough or for the right purposes must be repaid over two years, but the idea is that these amounts should be small. Qualifying businesses will be eligible for loan forgiveness when PPP loan proceeds are spent on Qualified Expenses within the eight week Covered Period and at least 75% (the “75/25 Rule”) of Qualified Expenses were payroll costs. The forgiven amount cannot exceed the principal amount of the PPP loan. CARES Act § 1106(d)(1).
Payroll Costs. The CARES Act defines payroll costs as Qualified Expenses. CARES Act § 1106(b)(1). For a business (as opposed to an independent contractor or sole proprietor), payroll costs are payments to employees that are (i) salary, wages, commissions, or similar compensation (up to an annualized $100,000); (ii) cash tips or equivalent; (iii) vacation, parental, family medical, or sick leave (excluding payments for emergency paid sick leave or expanded family and medical leaves); (iv) separation or dismissal pay; (v) for group health insurance; (vi) retirement benefits; or (vii) state or local payroll tax (but not federal payroll tax). This definition raises some issues for borrowers.
Each borrower needs to weigh carefully its ongoing liquidity needs beyond the eight week Covered Period against the benefit of maximizing the loan forgiveness feature. It may often be prudent for a borrower to forgo loan forgiveness and preserve cash to fund its operations into the late summer and fall.
Mechanics. As soon as practical after the Covered Period, a borrower must submit to the lender that is servicing the PPP loan an application for loan forgiveness, which will include (a) documentation verifying the number of FTEEs on payroll and pay rates for the Covered Period and the applicable reference period, including (i) payroll tax filings reported to the IRS and (ii) state income, payroll, and unemployment insurance filings; (b) documentation, including canceled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments; (c) a certification from the borrower that (i) the documentation presented is true and correct; and (ii) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments; and (d) any other documentation the SBA determines necessary. The lender will have up to 60 days to issue a decision on the loan forgiveness application. We expect further guidance from the SBA on this process. CARES Act § 1106(e) and (g).