06.22.2020 | Articles / Publications
“PPP Loans: Where Are We Going, Where Have We Been?” ACC South Carolina Chapter Newsletter
Featured in FOCUS…on the South Carolina Chapter, The ACC South Carolina Chapter Newsletter
Two months have passed since the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law, creating the much-discussed paycheck protection program (“PPP”). The PPP has been subject to criticism over its rollout, with many arguing the funds are not reaching small businesses with the greatest need. In addition to facing practical complications in accessing financial institutions offering these loans, applicants must navigate a stream of guidance from the U.S. Department of Treasury (“Treasury”) and Small Business Administration (“SBA”).
As of [June 8], SBA has released an FAQ that, at 48 questions, strains the traditional notion of “frequently asked questions.” The FAQ has been accompanied by 16 Interim Final Rules, addressing topics ranging from calculating employees, affiliation rules, definitions of full-time equivalent employees, loan forgiveness requirements, and audit mechanisms.
Congress has reacted to certain of the SBA’s administrative guidance by passing the Paycheck Protection Program Flexibility Act (the “PPPFA”), signed into law by President Trump June 5. The PPPFA liberalized a number of the administrative requirements imposed by the SBA, and also added flexibility to certain aspects of the PPP initially included in the CARES Act. While the PPPFA provides much-needed flexibility to borrowers, it imposes yet another layer of rules on top of the administrative rules provided by the SBA and Treasury.
This article examines the current lay of the land of PPP loans. While the loan program has existed for only a couple months, the ever-shifting rules applicable to PPP funds may leave borrowers and lenders alike feeling like they stand on quicksand. This article will guide parties toward those areas in which PPP rules now appear firmly shaped and highlight those areas in which caution should likely be exercised.
Basic PPP Provisions: Eligibility, Use of Loan Proceeds, and Interaction with Economic Disaster Loans
PPP loans are available to (i) borrowers that qualify as “small business concerns” under existing SBA regulations, (ii) any business concern, nonprofit organization, veterans organization, or Tribal business concern with not more than 500 employees or that meet the SBA size standards for their North American Industry Classification System Code, or (iii) borrowers that meet an alternate size standard. Under the PPPFA, potential borrowers may apply for PPP loans through December 31, 2020.
It is important to note that the definition of “nonprofit organization” in the CARES Act is limited, and includes only those organizations exempt from tax under sections 501(c)(3) and (c)(19) of the Internal Revenue Code (the “Code”). This excludes a number of nonprofit organizations, such as homeowners’ associations, chambers of commerce, and social welfare organizations exempt from tax under section 501(c)(4). While existing SBA regulations have extended PPP eligibility to certain nonprofit hospitals exempt from taxation under section 115 of the Code and to electric cooperatives exempt from taxation under section 501(c)(12) of the Code, it remains to be seen how much further the SBA and Treasury will extend PPP eligibility for nonprofit organizations. Any nonprofit organization that is not a 501(c)(3) organization, 501(c)(19) veterans’ organization, 501(c)(12) electric cooperative, or a hospital exempt under section 115 of the Code should thoroughly analyze its eligibility under PPP guidance, as it continues to evolve (or not) in this regard. Nonprofit organizations that do not fit into one of the foregoing categories that are struggling during the COVID-19 pandemic are eligible for economic injury disaster loans (“EIDLs”) and may apply directly to the SBA for this assistance.
An eligible borrower may obtain a PPP loan equal to the lesser of (i) 2.5x the borrower’s average monthly payroll, or (ii) $10,000,000. Independent contractors and sole proprietors can also obtain a PPP, capped at $20,833. The loan is forgivable if used for certain purposes during an 8-week period beginning upon disbursement of the PPP loan (the “Covered Period”) ; namely, the loan must be used for (i) payroll costs , (ii) rent, (iii) covered mortgage obligations, and (iv) utilities. Initial SBA guidance required that at least 75% of the proceeds of a PPP loan must be used for payroll costs.
The PPPFA liberalized several rules imposed by the CARES Act and administrative guidance thereunder. Specifically, the PPPFA has lowered the 75%-used-for-payroll-costs requirement to 60%, thereby permitting up to 40% of PPP loan proceeds to be used for rent, utility bills or mortgage interest. Likewise, the PPPFA has widened the Covered Period window to 24 weeks beginning upon disbursement of the PPP loan. Borrowers who took out their loans prior to the date of the PPPFA’s enactment may still choose the 8-week Covered Period, which may be recommended in certain circumstances.
Borrowers with an EIDL may apply for a PPP loan, but if the EIDL is used for the same purposes as the PPP, it must be refinanced into the PPP. The corollary to this, of course, is that EIDL and PPP funds cannot be used for the same purposes. If a borrower obtains both a PPP loan and an EIDL, it is generally most beneficial for that borrower to use its PPP loan for payroll costs to maximize forgiveness on the PPP loan, and to put its EIDL to use in paying other operating costs. The full extent of this non-duplication rule remains unclear. For example, it isn’t clear whether a borrower that used PPP funds to pay rent or utilities prior to receipt of an EIDL couldn’t use the EIDL for such expenses going forward, especially where necessary to maintain the proper payroll costs spending threshold.
The CARES Act prohibited borrowers from receiving the employee retention credit thereunder and a PPP loan, and prohibited borrowers from seeking forgiveness of a PPP loan and the benefit of the deferral of payment for employer payroll taxes through December 31, 2020. The PPPFA has removed the proscription on deferral of payment of employer payroll taxes.
Pursuant to the current forgiveness application, an authorized representative of the borrower must certify that the forgiveness amount was (i) used to pay costs that are eligible for forgiveness; (ii) includes any applicable reduction to the forgiveness amount; (iii) does not include forgiveness for nonpayroll costs in excess of 25% of the forgiveness amount requested; and (iv) does not exceed 8-weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner (subject to a cap). The application, of course, will necessarily be subject to adjustment going forward in order to comply with the PPPFA.
The CARES Act provides for a reduction in the amount of forgiveness allowed where a borrower has reduced its workforce during the covered period (based on a calculation relative to full-time equivalent employees) or reduced salaries by more than 25%. This forgiveness reduction could be cured if salaries and workforce were restored to their prior levels by June 30. The PPPFA extends this restoration period to December 31, 2020, and also provides for further relief from forgiveness reduction where (1) a borrower was unable to re-hire individuals who were employees as of February 15, 2020 and was also unable to hire similarly qualified employees for unfilled positions as of December 31, 2020; or (2) is able to document that it was unable to return to the same level of business activity that it was operating at prior to February 15, 2020 due to compliance with sanitation, social distancing, or other worker or customer safety standards related to COVID-19, as such standards are established or set forth in guidance issued from March 1, 2020 until December 31, 2020 by the U.S. Department of Health and Human Services, the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration.
The extended covered period provided by the PPPFA does not come without consequences. In the absence of further regulatory guidance, borrowers will have to wait a full 24 weeks before submitting their forgiveness applications, even if their loan funds have been fully expended. This could create non-PPP related headaches, especially for businesses involved in an ongoing time-sensitive merger or acquisition, where an acquirer may want some comfort that its target’s loan will be fully forgiven.
The Treasury Department has announced that all PPP loans in excess of $2,000,000 will be audited, with smaller loans still subject to audit. The audits will likely focus on (i) borrowers’ threshold eligibility for a PPP loan, and (ii) use of proceeds.
An initial point of concern for businesses receiving PPP loans was the “need certification” contained therein. While the CARES Act and the form PPP loan application require only that a borrower certify “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient,” subsequent pressure and outcry led Treasury to indicate that it would likely review such certifications critically. In guidance released May 13, 2020, Treasury backed down somewhat and created a safe harbor, pursuant to which for any PPP loan of less than $2,000,000, this certification will be deemed to have been made in good faith. While this safe harbor should offer some comfort to borrowers with PPP loans under $2,000,000, such PPP loans could still be subject to audits. Ultimately, each business must analyze the economic impact of the COVID-19 pandemic upon it, taking into account its cash reserves, pre-existing means of accessing additional capital, whether by credit or additional investment, that will not be “significantly detrimental” to the business, foreseeable capital and operating expenses, and any other relevant conditions and circumstances in considering how the economic downturn has affected a business.
The PPP forgiveness application requires that each borrower seeking forgiveness must retain all records relating to the PPP loan, including documentation submitted with its PPP loan application, documentation supporting the certifications as to the necessity of the loan request and its eligibility for a PPP loan, documentation necessary to support the loan forgiveness application, and documentation demonstrating the material compliance with PPP requirements. Further, the borrower must maintain this documentation in its files for six years after the date the loan is forgiven or repaid in full, and permit authorized representatives of SBA, including representatives of its Office of Inspector General, to access such files upon request. Maintaining a proper and comprehensive set of such records will be crucial not only to support a forgiveness application, but in any ensuing audit.
All applicants should keep in mind that PPP loans are subject to ongoing rulemaking and guidance by Treasury and the SBA and therefore should pay close attention as further guidance is issued by these agencies. It is possible that new guidance will have been released between the date of this article’s completion and its publication.
With audits, investigations, and potential criminal investigations looking on the horizon, it is likely that the impact of the PPP will be felt for years to come.