United States: Paycheck Protection Program – Where Are We Now? An Up-To-Date Guide To The Paycheck Protection Program

Originally published on April 14, 2020. Last updated as of the evening of May 1, 2020.

Since the enactment of the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") on March 27, 2020, the U.S. Small Business Administration (the "SBA") and the U.S. Treasury Department ("Treasury") have issued a sizable number of rules and additional guidance to implement the CARES Act's marquee small business loan component – the Paycheck Protection Program (the "PPP").

To date, the SBA and Treasury have issued a number of Interim Final Rules governing the PPP (collectively, the "PPP Rules").¹ In addition, the SBA and Treasury have also published: borrower ( SBA Form 2483) and lender ( SBA Form 2484) application forms; program "fact sheets" for borrowers and lenders; a summary of the applicable affiliation rules; and responses to certain Frequently Asked Questions (which the SBA has updated numerous times).  This rapidly changing regulatory environment is making it difficult for potential borrowers to avail themselves of the program with certainty as to their eligibility and scope of available benefits.  This alert (I) summarizes the key terms of the PPP, (II) addresses certain frequently asked questions that Proskauer attorneys have been assessing, and (III) provides an overview of the Federal Reserve's new Paycheck Protection Program Lending Facility, which is aimed at helping participating lenders originate more loans under the PPP loan for the many businesses, non-profits and other eligible organizations in need of financial relief as a result of COVID-19.

The SBA announced on April 16, 2020 that the $349 billion authorized for the PPP had been exhausted.  On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act (the "PPPHCEA") was signed into law, which increased the funding available for the PPP by $310 billion, bringing the total funding amount to $659 billion.²  Given the "first come, first served" nature of the PPP and the speed with which the additional funding is expected to be exhausted, prospective borrowers should submit applications as soon as possible.  In addition, a borrower applying through a lender with which it does not have an existing relationship will need to supply standard "know your customer" information and should advance that process now to the extent possible.

KEY UPDATES

• Single Corporate Group $20m Cap: On April 30, 2020, the SBA published an Interim Final Rule that implemented a maximum cap of $20 million on the total amount of PPP loans that a "single corporate group" can receive.  Businesses are part of a "single corporate group if they are "majority owned, directly or indirectly, by a common parent."  This rule applies to all loans not fully-disbursed as of April 30, 2020 (and to the undisbursed portion of any partially disbursed loans).  For purposes of this new cap, the SBA affiliation rules are disregarded and "[b]usinesses are subject to this limitation even if the businesses are eligible for the waiver-of-affiliation provision under the CARES Act or are otherwise not considered to be affiliates under SBA's affiliation rules."  This new cap is undoubtedly a response to the highly publicized receipt of total PPP loans ranging from $10 to nearly $70 million by national restaurant and hotel corporations.  The inapplicability of affiliation rule waivers to the single corporate group cap significantly alters the utility of the PPP for businesses that benefit from such waivers, in particularly those in the accommodation and food services sector (NAICS code beginning with 72).  Previously each hotel or restaurant in a single corporate group would individually be eligible for a PPP loan up to the $10 million loan cap, but now such groups are collectively limited to $20 million.  For funds that invest in NAICS 72 companies the lack of clarity around whether "ownership" will be strictly based on equity interest or if a control element is contemplated (or will be later introduced) is concerning, as the latter would result in such companies with a common general partner (that has a minority equity interest) being deemed part of a "single corporate group" and subject to the $20 million cap even when the affiliation waivers would have otherwise made such companies eligible for independent PPP loans (up to the individual per-property $10 million cap with no aggregate cap).
  
  An applicant must (i) notify a lender if it has applied for or received PPP loans in excess of the $20 million cap and (ii) withdraw or request cancellation of any pending PPP loan application or approved PPP loan that would cause the applicant to exceed such cap.  Failure to deliver such notice and to withdraw/request cancellation is deemed use of PPP funds for an unauthorized purpose and the PPP loan would be ineligible for forgiveness.  While not expressly stated in the Interim Final Rule, additional penalties (criminal and civil) may apply to applicants who fail to comply with such requirements and retain or receive PPP loan proceeds in excess of the new cap.

• Treasury Audit: On April 28, 2020, Secretary of the Treasury Steven Mnuchin announced that recipients of PPP loans in excess of $2 million will be audited by the SBA, including with respect to the borrower's analysis and certification of eligibility to participate in the PPP.  The SBA further clarified this review process in Question 39 of its FAQ published on April 29, 2020, which states that the SBA "will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender's submission of the borrower's loan forgiveness application." The SBA has indicated additional guidance implementing such review and audit procedures are forthcoming.  Given the potential risks and heightened scrutiny from Treasury, the SBA, the U.S. Justice Department (nationally and regionally), and the public and press more broadly of the companies receiving PPP loans, it is imperative the applicants carefully read and consider all certifications being made in Form 2483, an application for loan forgiveness, and in any other documentation submitted to the SBA or a PPP lender. 
• Necessity Certification and Liquidity Availability: The SBA clarified (in Questions 31 (published on April 23, 2020) and 37 (published April 28, 2020) that while the CARES Act waives the "credit elsewhere" requirement, borrowers (whether private or publicly-traded) must nonetheless carefully review and make the "necessity" certification ("current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant") in good faith.  In so doing, borrowers must take into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.  In somewhat related guidance, the Interim Final Rules published on April 24, 2020 provide that hedge funds and private equity firms are ineligible to receive PPP loans as they are "engaged in investment or speculation", though portfolio companies of private equity funds may still be eligible if they meet applicable size standards after application of the affiliation rules and can make (after careful consideration) the "necessity" certification.
  
  For a prospective borrower, this guidance creates significant uncertainty as to whether a borrower can make this certification when it may have access to other sources of liquidity (e.g., cash reserves, other investments or assets, access to undrawn lines of credit or other debt).  The SBA has indicated that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification were it to apply for a PPP loan.  Beyond the large, public company context the SBA has not provided direction on what constitutes "liquidity" or when the use of such liquidity would be "significantly detrimental," and a borrower will need to make a good faith assessment based on its individual facts and circumstances. In so doing, a borrower should create a thoughtful record documenting the process and factors involved in its assessment of necessity and eligibility prior to submitting a PPP loan application.
  
  This guidance also presents questions about how a borrower having an owner or owners with significant capital should factor such facts into a borrower's evaluation of other sources of liquidity, and therefore necessity for a PPP loan.  Such lack of clarity around owner capital and liquidity is particularly relevant for private equity portfolio companies, where sponsors may have complicated ownership structures that involve layers of debt and equity financing (each with their own significant and complicated use limitations) and while many such structures are blocked by the affiliation rules, this new interpretation has raised a lot of questions for businesses with NAICS 72 codes, to whom the affiliation rules do not apply.

Going forward, this client alert will be updated to reflect any further changes in the key terms of the PPP resulting from any new legislation, rules, and guidance issued by the Federal government.  While we have addressed below the principal criteria of the program and will endeavor to update this alert regularly, it is not possible to cover all of the (ever-changing) rules and guidance published by the SBA and Treasury.  THIS ALERT IS INTENDED TO BE A HELPFUL RESOURCE, BUT SHOULD NOT BE VIEWED AS LEGAL ADVICE FOR ANY SPECIFIC SITUATION.  THIS ALERT IS UPDATED AS OF THE EVENING OF MAY 1, 2020.

I. Key Terms Of The Paycheck Protection Program

• Maximum Loan Amount: Equal to the lesser of: (i) 2.5x trailing 12 month average monthly payroll costs;³ and (ii) $10 million.  The SBA has published a step-by-step guide for calculating the maximum loan amounts based on the business type of an applicant.
• [KEY UPDATE] Single Corporate Group Cap: The Interim Final Rules published on April 30, 2020 implement a maximum cap of $20 million on the total amount of PPP loans that a "single corporate group" can receive.  Businesses are part of a single corporate group if they are majority owned, directly or indirectly, by a common parent.  This rule applies to all loans not fully-disbursed as of April 30, 2020 (and to the undisbursed portion of any partially disbursed loans).  SBA affiliation rules are disregarded and "[b]usinesses are subject to this limitation even if the businesses are eligible for the waiver-of-affiliation provision under the CARES Act or are otherwise not considered to be affiliates under SBA's affiliation rules." Consequently, this cap applies to businesses that otherwise benefit from the affiliation waivers (including those in the accommodations and food services sector (NAICS 72)).
• Interest Rate: 1.00%.
• Payment Deferral: Interest and principal payments are deferred for 6 months (during which time interest accrues).
• Loan Maturity: 2 years.
• Collateral/Personal Guarantee: No collateral or personal guarantee is required.
• Eligibility:
  • Generally: Eligible applicants (assuming they meet applicable size and other eligibility requirements listed below) include business concerns, 501(c)(3) non-profit organizations, tax-exempt veterans organizations (501(c)(19)), tribal business concerns (described in §31(b)(2)(C) of the Small Business Act), sole proprietors, independent contractors and other self-employed individuals.
    
    An applicant must have been in operation on 2/15/20 and either (A) had employees for whom salaries and payroll taxes were paid, or (B) paid independent contractors.  An individual applicant with self-employment income (such as an independent contractor or sole proprietor) is also eligible if such applicant was in operation on 2/15/20 and filed or will file a Form 1040 Schedule C for 2019.  A seasonal business will be considered to have been in operation as of 2/15/20, if the business was in operation for any 8-week period between 5/1/19 and 9/15/19.
    
    Further, if a business was in operation on 2/15/20, but has since changed ownership, it may apply for a PPP loan (assuming it is otherwise eligible).  Similarly, if a change in ownership is effectuated through a sale of substantially all assets of a business that was in operation on 2/15/20, the business acquiring the assets may apply for a PPP loan, even if the change in ownership results in a new TIN and even if the acquiring business was not in operation on 2/15/20.

• Ineligible Industries: An applicant is not eligible if its business is in an ineligible industry or otherwise described as ineligible under 13 C.F.R. § 120.110, except where there is an express exception under the CARES Act (such as for certain non-profits) or the PPP Rules.  Key ineligible industries include businesses primarily engaged in lending or investment and passive investment in real estate.  An applicant that is a debtor in a bankruptcy proceeding (either at the time of application or at any time before a PPP loan is disbursed) is ineligible to receive a PPP loan and must cancel any pending application.
  
  In the Interim Final Rules published on April 24, 2020, the SBA made notable changes and provided significant clarifications as to the scope of ineligible industries:

• Hedge Funds and Private Equity Firms are Not Eligible – Hedge funds and private equity firms are ineligible to receive PPP loans as they are "engaged in investment or speculation." Portfolio companies of private equity funds may still be eligible if they meet applicable size standards after application of the affiliation rules and can make (after careful consideration) the "necessity" certification (each discussed below).
• Legal Gambling Businesses are Eligible – Businesses that derive revenue from legal gambling activities are now eligible for PPP loans regardless of the amount of the business's revenue that is derived from gambling activities (as 13 C.F.R. § 120.110(g) no longer applies to the PPP).
• Certain Government-Owned Hospitals are Eligible – A state or local government-owned hospital that would otherwise be ineligible (under 13 C.F.R. § 120.110(j)) as a government-owned entity, is now eligible for a PPP loan if the hospital receives less than 50% of its funding from state or local government sources, exclusive of Medicaid.

• Size Standard: An applicant (taking into account its affiliates) must either:
  • Existing Size Standards – qualify as a "small business concern" by meeting the SBA's existing SBA size standards for the applicable North American Industry Classification System (NAICS) code, which are based on either employee headcount (full-time, part-time or other basis) or 3-year average annual gross receipts;
  • Alternative Size Standard – qualify as a "small business concern" by meeting the SBA's "alternative size standard," which requires that the applicant (together with its affiliates) have not more than $15m in tangible net worth and not more than $5m in average net income after Federal income taxes (excluding any carry-over losses) for the 2 full fiscal years before the date of the application ( 13 C.F.R. § 121.301(b)(2) is instructive as to how to calculate net income after Federal income taxes for pass-through entities);
  • Employee Headcount Standard – have (together with its affiliates) not more than 500 employees (on a full-time, part-time or other basis); or
  • Accommodations and Food Services – be a business assigned to the "accommodation and food services" sector (NAICS code beginning with 72) having not more than 500 employees per physical location.
• Affiliation: When determining whether any of the above size standards are met, the SBA's existing affiliation rules require a business to aggregate the number of its employees, receipts, or other applicable metric with that of its foreign and domestic affiliates (see FAQ 4 below).  Applicants and entities are affiliates when one controls or has the power to control the other or such entities are under common control.  Control is broadly defined in the SBA's regulations, and encompasses affirmative and negative control rights, as well as equity-based and contractual control rights (including affiliation based on a management agreement).   The SBA has confirmed that the pre-2020 version of 13 C.F.R. § 121.301(f), the affiliation rule for 7(a) loans, applies to the PPP.  Relatedly, the SBA and Treasury have issued Affiliation Guidance with respect to the affiliation rules that apply to the PPP.  There are some exceptions to the application of the SBA's existing affiliation rules that are specific to the Paycheck Protection Program:
  • CARES Act Exceptions – Under the CARES Act, the SBA's affiliation rules are waived for businesses in the accommodation and food service sector with a NAICS code beginning with 72, franchises assigned a franchise identifier code by the SBA, and businesses that receive assistance from an approved small business investment company under § 301 of the Small Business Investment Act of 1958 (e., SBIC portfolio companies).⁴ As a result, each hotel or restaurant location owned by a parent business (held within a separate legal entity) that employs not more than 500 employees can apply for a separate PPP loan, provided it uses a unique EIN.  However, this waiver applies only when determining eligibility for an applicant business with an NAICS code beginning with 72.  The affiliation exemption does not apply when determining eligibility of an applicant that is not in such sector.  Such applicant would be required to take into account the employees, receipts, or other applicable metric of all of its affiliates, including those operating in the accommodations or food service sector.
  • PPP Rules Exceptions – Under the PPP Rules, affiliation rules are waived for faith-based organizations where the application of such rules would "substantially burden [such an] organization's religious exercise."
  • Statutory Exceptions – Under the SBA's existing regulations, the exceptions to the affiliation rules in 13 C.F.R. § 121.103(b) (but not the exception in 121.103(b)(5), which does not apply to 7(a) loans) continue to apply in the context of the PPP. While these exceptions should be reviewed in connection with any affiliation analysis, they are narrow and will not benefit most businesses (unless owned or controlled by certain tribal organizations or small business investment companies).
  • Calculating Employee Headcount – The SBA confirmed that borrowers should use either of the following methods for purposes of determining employee headcount: (i)  average employment over the same time periods as used for payroll costs (previous 12 months, calendar year 2019 or applicable period for seasonal businesses) to determine number of employees, for the purposes of applying an employee-based size standard; or (ii) average number of employees per pay period in the 12 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 less than 12 months).
• [KEY UPDATE]> Necessity: Applicants are required to certify that the "current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant."  All applicants (but especially larger companies, public companies and portfolio companies of private equity sponsors) should carefully review and be thoughtful about the implications of making this certification (including how it speaks to the applicant's economic viability and the message it communicates to investors and the market).  When making a "necessity" assessment, applicants should create a thoughtful and detailed record supporting its determination and the process employed in that assessment.
  • Other Sources of Liquidity –The SBA has clarified (in Questions 31 and 37 of the SBA FAQs) that while the CARES Act waives the "credit elsewhere" requirement, borrowers must nonetheless carefully review and make the "necessity" certification in good faith. In so doing, borrowers must take into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.  This applies to both publicly traded and private companies.
  • Large/Public Companies – As a response to the much-reported receipt of PPP loans by certain publicly traded companies, the SBA further clarified that it is unlikely that a company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to the SBA, upon request, the basis for its certification.
  • Retraction and Safe Harbor – Any borrower (whether publicly-traded or privately-owned) that applied for a PPP loan prior to the April 23^rd guidance and repays the loan in full by May 7, 2020 is deemed to have made the required certification in good faith.

For a prospective borrower, the SBA's guidance on the "necessity" certification has resulted in significant uncertainty as to whether a borrower can make the certification of need when it may have access to other sources of liquidity (e.g., must cash reserves be depleted and other investments or assets liquidated before a borrower can certify? Does access to other (non-forgivable) debt (e.g., undrawn lines of credit), which likely comes at a higher cost of capital, dictate that the borrower cannot make the certification of need?  If such other sources of capital are available but can only carry the business for a limited period of time, what financial cushion makes it impossible to make the certification?).  Beyond the large, public company context (noted above) the SBA has not provided direction on what constitutes "liquidity" or when the use of such liquidity would be "significantly detrimental," and a borrower will need to make a good faith assessment based on its individual facts and circumstances (with the factors and processes involved contemporaneously documented).

Even in the case where a borrower's business has no cash or other readily available sources of liquidity, but where borrower's owners, such as private equity or other funds, may have or be able to access such liquidity, the guidance raises questions as to the ability to make the "necessity" certification.  This ambiguity is particularly problematic for hotels, restaurants and other 72-code businesses that have faced severe reduction or even elimination of all revenues and that are owned by private equity sponsors, but are exempted from the affiliation rules, and are thus eligible to receive PPP loans if they are able to make the "necessity" certification. 

In the teeth of a crisis unlike any other and lacking clear guidance or precedent, this is a significant issue, all the more so given the focus that the PPP has recently received (and is expected to continue to receive) in the press and by government officials who have committed to pursue abuse of the program.  The fact that funds are likely to run out without funding all eligible applicants guaranties that there will be parties that will challenge loans received by others.  Both the legal and the public relations "judgments" will be made in hindsight, which leaves borrowers and their sponsors facing difficult choices in a crisis without any clear end.  Combined with the warning that borrowers who return funds by May 7^th will be deemed to have been in good faith, but that all others could be subject to prosecution and other remedies, this choice affects not only new borrowers but also existing ones.   Lobbying continues to have Treasury clarify this, and the regulations continue to be updated with new FAQs almost daily, so this bears continued focus.

• Eligible Uses: PPP loan proceeds may be used for: (i) payroll costs (as further described below), (ii) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums; (iii) employee salaries, commissions, or similar compensations; (iv) payments of interest on any mortgage (but not prepayment of or payment of principal); (v) rent (including under a lease agreement); (vi) utilities; and (vii) interest on any other debt obligations incurred before 2/15/20.  Borrowers are required to use at least 75% of PPP loan proceeds for payroll costs.  The CARES Act provides that loan proceeds can also be used for any allowable use for which a 7(a) loan can be applied under the Small Business Act, which uses are set forth in 13 C.F.R. § 120.120 and include, g., inventory, supplies, working capital.  However, the PPP Rules list as permitted only those uses detailed in (i) through (vii) (and refinancing of certain EIDLs), and only generally reference that the CARES Act permits PPP loans to be applied toward other allowable uses for a 7(a) loan under the Small Business Act in a paragraph explaining the SBA's decision to require 75% of loan proceeds to be applied to payroll costs.  Consequently, it remains unclear whether the SBA is restricting permitted uses to only those that are expressly listed in items (i) through (vii).  Note further that some of the items listed in (i) through (vii) are not forgiveness-eligible, and any additional allowable uses not specifically listed in the CARES Act or the PPP Rules are not forgiveness-eligible.
  • Independent Contractors: A business cannot include independent contractors as "employees" either for purposes of calculating the loan amount (i.e., with payroll cost calculations) or amount of loan forgiveness. Independent contractors can themselves apply for a PPP loan.
  • Required EIDL Refinancing: A borrower who has received an economic injury disaster loan between 1/31/20 and 4/3/20 and who used such EIDL funds for payroll costs is required to refinance any outstanding amounts under such EIDL with the proceeds of a PPP loan and such amounts count towards the $10m maximum that a borrower is allowed to borrow under the PPP.
  • Self Employed Applicants: Self-employed applicants who filed (or are eligible to file) a Form 1040 Schedule C for 2019 may use loan proceeds for: (i) owner compensation equal to 8 weeks of 2019 net profit up to a maximum annualized amount of $100,000; (ii) payroll costs to employees with a principal place of residence in the US (if any); (iii) mortgage interest, rent or utility payments that can be claimed as a business expense deduction on Form 1040 Schedule C; (iv) interest payments on any loan incurred prior to 2/15/20; and (v) refinancing of any EIDL obtained between 1/3/20 and 4/3/20.  Further, the PPP Rules indicate that an applicant that did not claim (or was not entitled to claim) such mortgage interest, rent or utility payments on its 2019 Form 1040 Schedule C cannot use the loan proceeds for such expenses during the initial 8-week period following the first disbursement of the loan.  The 25% limitation on non-payroll cost uses applies to self-employed applicants as well.
• Payroll Costs: 
  • Included: "Payroll Costs" generally include:
    • For Applicants (other than Self-Employed Applicants) – Includes the following compensation for employees (and not any independent contractors) whose principal place of residence is in the US: (i) salary, wage, commission, or similar compensation; (ii) cash tips or equivalents; (iii) payment for vacation, parental, family, medical, or sick leave; (iv) allowance for dismissal or separation; (v) payment required for the provision of group health care benefits, including insurance premiums; (vi) payment of any retirement benefit; and (vii) payment of state or local taxes assessed on employee compensation. The SBA has indicated that payroll costs are calculated on a gross basis without regard to federal taxes imposed or withheld.
    • For Self-Employed Applicants⁵ – Includes the sum of payments of any compensation that is a wage, commission, income, net earnings from self-employment, or similar compensation up to a maximum annualized amount of $100,000. When calculating payroll costs, such compensation for self-employed applicants that filed (or will file) a Form 1040 Schedule C for 2019 will be equal to the net profit amount computed therein (subject to a $100,000 annualized cap).  For self-employed applicants that also have employees, payroll costs for such employees are calculated using:
      • 2019 gross wages and tips paid to such employees with a principal place of residence in the US (using 2019 IRS Form 941 Taxable Medicare wages & tips from each quarter) plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips (net of any amounts paid to any individual employee in excess of $100,000 annualized); and
      • 2019 employer health insurance contributions and retirement contributions listed on the 2019 Form 1040 Schedule C and state and local taxes assessed on employee compensation.
    • For Partnerships with General Operating Partners – Partners in a partnership may not submit a separate PPP loan application as a self-employed individual. Self-employment income of general active partners may be reported as a payroll cost on a PPP loan application filed by or on behalf of the partnership.  The SBA's step-by-step maximum loan amount calculation guide confirms that payroll costs for self-employment income for individual U.S.-based general partners is calculated using 2019 Schedule K-1 (IRS Form 1065) net earnings from self-employment (reduced by any section 179 expense deduction claimed, unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties) multiplied by 0.9235^[6, subject to a $100,000 annualized cap.
  • Excluded: Payroll costs do not include: (i) cash compensation (e., exclusive of non-cash benefits) of any individual employee in excess of an annual salary of $100,000, as prorated for the covered period; (ii) federal income taxes imposed or withheld under chapters 21, 22, or 24 of the Internal Revenue Code of 1986 during the covered period (includes Federal Insurance Contributions Act and Railroad Retirement Act taxes and income taxes required to be withheld from employees); and (iii) qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act.
  • Please note that the language in the PPP Rules for self-employed applicants largely tracks the employee payroll cost categories and exclusions for applicants generally. While the PPP Rules direct self-employed applicants as to the sources of information to be used to calculate payroll costs, it is somewhat unclear whether such direction is also intended to narrow the scope of included payroll costs for such applicants.
  • Period for Calculating Payroll Costs: SBA guidance indicates that borrowers (other than self-employed applicants) can calculate their aggregate payroll costs using data either from the trailing 12 months or calendar year 2019.  Seasonal businesses may use average monthly payroll for the period between 2/16-6/30/19 or 3/1-6/30/19.  Note that language in the PPP Rules and CARES Act, which reference a TTM calculation, and in the PPP application, which references a calendar year 2019 calculation, is somewhat inconsistent and consequently some lenders have not accepted both calculation methods.
• Loan Forgiveness:
  • Forgiveness Eligible Uses: Up to the entire principal amount and any accrued interest on a PPP loan is eligible for forgiveness.  The loan forgiveness amount will be equal to the total amount of payroll costs, interest payments on mortgages existing before 2/15/20, rent under leases in place before 2/15/20, and payments for utilities for which service began before 2/15/20, in each case incurred and made during the initial 8 weeks after the date the lender makes the first disbursement of the PPP loan.  However, not more than 25% of the forgiven amount can be attributable to non-payroll costs. 
    • Limitations for Self-Employed Applicants – Self-employed applicants who file a Form 1040 Schedule C in 2019 are only eligible for forgiveness in respect of loan proceeds used for: (i) owner compensation equal to 8 weeks of 2019 net profit up to a maximum annualized amount of $100,000; (ii) payroll costs to employees with a principal place of residence in the US (if any); and (iii) mortgage interest, rent or utility payments that applicant claimed or was entitled to claim as a business expense deduction on its 2019 Form 1040 Schedule C. The 25% limitation on forgiveness of non-payroll costs applies to self-employed borrowers as well. 
  • Reductions in Forgiveness Amount: The loan amount eligible for forgiveness will be reduced (i) proportionally for reductions in the average number of full-time equivalent (FTE) employees during the 8-week period compared to the average number of FTE employees per month during either, at the borrower's election, 2/15/19 – 6/30/19 or 1/1/20 – 2/29/20, or, in the case of seasonal employers, average number of FTE employees per month between 2/15/19 – 6/30/19, and (ii) dollar-for-dollar by the amount of any salary cut in excess of 25% of an employee's total salary or wages during their most recent full quarter of employment for any employee who did not receive annualized compensation of $100,000 or more in any pay period in 2019.  Such reductions that occur between 2/15/20 and 4/26/20 will not reduce the forgiveness amount if restored by 6/30/20 (e., via rehiring or increasing compensation).  At present, reductions occurring after 4/26/20 cannot be cured.
  • Amounts forgiven are not taxable income to the borrower.
  • Notably, the SBA has said it will issue additional guidance on loan forgiveness.
• Credit Elsewhere: The SBA has waived the requirement that borrower not be able to obtain financing elsewhere (but see discussion of the "necessity" certification above).
• Disbursements: Lenders must make a one-time, full disbursement of a PPP loan within 10 calendar days of approval (the date on which the SBA assigns a loan number).  Loans that have not been disbursed because a borrower fails to submit required loan documentation within 20 days of loan approval are cancelled.
• Other Economic Considerations: PPP loans are non-recourse obligations provided that the loan proceeds are used for permitted purposes. No yearly or guarantee SBA fees will be charged.
• Employee Retention Tax Credit: Borrowers under the PPP are ineligible for the Employee Retention Tax Credit made available under the CARES Act.
• Social Security Tax Deferral: The CARES Act permits employers to delay payment of the 6.2% employer share of the Social Security tax (but not the 1.45% employer share of the Medicare tax) from the date of enactment through 12/31/20.  The tax is payable over the following 2 years with half paid by 12/31/21 and the other half by 12/31/22.  However, such deferral is not available for an employer who has a PPP loan forgiven.
• First Come, First Served: The PPP Rules expressly state that the PPP is "first-come, first-served".  As noted above, should additional funding become available, potential borrowers should be prepared to apply quickly.
• Lender Fee Limits: Processing fees paid to lenders will be based on the balance of the loan outstanding at the time of final disbursement.  A lender will receive a fee equal to a percentage of such final disbursement as follows: (i) 5.00% for loans $350,000 and under; (ii) 3.00% for loans of more than $350,000 and less than $2 million; and (iii) 1.00% for loans of at least $2 million. Lenders may not collect any fees from the applicant.
• Agent Fee Limits: The CARES Act authorizes the SBA to establish limits on fees that can be collected by agents that assist applicants in applying for the PPP.  The PPP Rules provide that the fees of such agents will be paid by the lender out of the fees the lender receives from the SBA (e., the agent may not collect fees from the borrower or be paid out of PPP loan proceeds).  The total amount an agent can collect from a lender for providing such assistance is capped at: (i) 1.00% for loans of not more than $350,000 (≤$3,500); (ii) 0.50% for loans of more than $350,000 and less than $2 million ($1,750 - ~$9,999); and (iii) 0.25% for loans of at least $2 million ($5,000 +).
• Application: Each applicant seeking a 7(a) loan under the PPP is required to submit a Paycheck Protection Program Borrower Application Form (SBA Form 2483) to a participating lender (together with any other documentation required by the lender as part of the application process (see FAQ 5 below)).
• Burden of Assessing Eligibility/Certifications: PPP Rules and related SBA guidance place the burden on borrowers to confirm their own eligibility (including calculating payroll costs, assessing affiliation and determining employee headcount) and the accuracy of the information it supplies to the lender, and permit lenders to rely on borrower certifications in determining loan eligibility and provide that the SBA will hold lenders harmless for a borrower's failures to comply with the PPP's criteria.
• Consequences of a False Filing: An applicant is required as part of Form 2483 to certify that it understands that knowingly making a false statement in order to obtain a SBA-guaranteed loan is punishable by law (including by imprisonment and significant monetary fines).  Penalties include:
  • Criminal Penalties – Potential criminal penalties for false statements or fraud in connection with a PPP loan include (i) imprisonment of not more than 5 years and/or a fine of up to $250,000 ( 18 USC §§ 1001 & 3571); (ii) imprisonment of not more than 2 years and/or a fine of not more than $5,000 ( 15 USC § 645(a)); and (iii) imprisonment of not more than 30 years and/or a fine of not $1 million ( 18 USC § 1014). ⁷ Beyond the penalties expressly referenced in the PPP loan application, criminal penalties under other federal fraud statutes or SBA-specific criminal statutes (g., regarding embezzlement or concealment) may apply.
  • Civil Penalties – In addition to criminal penalties, the government can pursue civil fraud remedies under the civil False Claims Act ( 31 U.S.C. 3729-3733) or the Program Fraud Civil Remedies Act ( 31 U.S.C. 3801-3812).

[KEY UPDATE]  The threat of enforcement of such penalties was bolstered on April 28, 2020, as the Treasury Secretary announced that recipients of PPP loans in excess of $2 million will be audited by the SBA, including with respect to the borrower's analysis and certification of eligibility to participate in the PPP.  The SBA further clarified this review process in Question 39 of its FAQ published on April 29, 2020, which states that the SBA "will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender's submission of the borrower's loan forgiveness application." (emphasis added).  The SBA has indicated additional guidance implementing such review and audit procedures are forthcoming.  Given the potential risks and heightened scrutiny from Treasury, the SBA, the U.S. Justice Department (nationally and regionally), and the public and press more broadly of the companies receiving PPP loans, it is imperative the applicants carefully read and consider all certifications being made in Form 2483, an application for loan forgiveness, and in any other documentation submitted to the SBA or an PPP lender.

II. Frequently Asked Questions

• Q1: What affiliation rules apply (for purposes of determining the number of employees of an applicant together with its affiliates)? ⁸
  • A: According to the S. Treasury Department's affiliation guidance, the four affiliation tests below are applicable to an affiliation assessment for purposes of determining eligibility under the PPP.  The Treasury Department's guidance (combined with language in the CARES Act rescinding the SBA's February 2020 interim final rule on affiliation standards) confirms that the pre-2020 SBA rules on affiliation (13 C.F.R. § 121.301(f)(1) – (4)) are the relevant affiliation rules for purposes of the PPP:
    • Affiliation based on ownership;
    • Affiliation arising under stock options, convertible securities, and agreements to merge;
    • Affiliation based on management; and
    • Affiliation based on identity of interest between "close relatives."
• Q2: When is a minority shareholder deemed to have control (and therefore affiliation)?
  • A: The SBA distinguishes between rights in respect of ordinary business actions and "extraordinary" business actions necessary to protect the minority investor's investment.  In instances where supermajority consent is required for ordinary business actions, the minority investor's ability to block such actions gives rise to negative control and the investor will be deemed an affiliate.  In contrast, a minority investor's ability to block "extraordinary" business actions should not give rise to affiliation between a minority investor and the applicant.  Please note that this distinction is derived from SBA case law, not all of which is specific to the affiliation rules for 7(a) loan programs (like the PPP).  Applicants are strongly encouraged to carefully assess any minority protections before determining that such protections do not give rise to affiliation.

• The SBA has confirmed that a minority shareholder can eliminate such affiliation if such shareholder "irrevocably waives or relinquishes" such rights.

• Q3: When does a management agreement create "control"?
  • A: Management agreements that give the management company sole discretion over the business operations with minimal oversight of the decision-making by the applicant, while not passive, create affiliation between the management company and applicant.  However, affiliation is not created between the applicant and the management company if the management agreement includes "meaningful oversight" by the applicant over the management company's activities.  A management agreement that provides for the applicant business to do all of the following inherently provides for "meaningful oversight": (i) approval of the annual operating budget; (ii) approval of any capital expenditures or operating expenses over a significant dollar threshold; (iii) control over bank accounts; and (iv) oversight over the employees operating the business.
• Q4: Do I include non-U.S. employee in an employee headcount-based size determination?
  • A: It is currently an open question whether an applicant should include non-U.S. employees of its affiliates when determining headcount for an employee-based size test.  Taken together, the language of the CARES Act and the existing SBA regulations in 13 C.F.R. § 121.106(b) indicate that the average number of employees of the concern includes employees of the applicant's domestic and foreign affiliates.  However, the PPP Rules and recent FAQs published by the SBA provide that applicants with "500 or fewer employees whose principal place of residence is in the United States" are eligible for PPP loans. 
• Q5: In addition to the Form 2483, what other documentation are lenders asking for?
  • A: Lenders have been generally requesting the following, though they may request additional or alternative materials:
    • IRS 940, 941, or 944 payroll tax forms for 2019, and if available, Q1 2020;
    • Payroll processor records and other payroll reports/ledger for 2019 and YTD 2020 with corresponding bank statements (which should capture the following information: salary, wages, commission, or similar compensation; tips; vacation; parental, family, medical or sick leave; group healthcare benefits; retirement benefits; and state or local taxes on employee compensation);
    • 1099s for independent contractors for 2019;
    • Documentation evidencing health insurance premiums under a group health plan;
    • Documentation evidencing the sum of all retirement plan funding paid for by the applicant; and
    • Organizational documents (articles of incorporation/organization, bylaws, operating agreement, partnership agreement, owners' driver's licenses, etc.) and tax identification numbers (EINs or SSNs, as appropriate).
• Q6: What non-profits are eligible for the PPP?
  • A: The SBA's Interim Final Rule on the PPP states that tax-exempt nonprofit organizations described in section 501(c)(3) of the Internal Revenue Code (IRC) and tax-exempt veterans organizations described in section 501(c)(19) of the IRC are eligible for the PPP.  The fact that the SBA specifically called out these two types of non-profits suggests that these are the only types of non-profits eligible for the PPP.

III. Overview of the Paycheck Protection Program Lending Facility

On April 9, 2020 the Board of Governors of the Federal Reserve System introduced the Paycheck Protection Program Lending Facility (the "PPPLF") pursuant to section 13(3) of the Federal Reserve Act.  The PPPLF came as part of a broader announcement by the Federal Reserve and Treasury regarding the implementation of new and expansion of existing Federal lending programs, including the Main Street Lending Program aimed at making new loans available to businesses with up 10,000 employees.  Notably, the guidance provides that a borrower under the PPP can also borrow under the Main Street Lending Program.  (For more on the Main Street Lending Program, see our client alert.)

The terms of the PPPLF are summarized in a term sheet released by the Federal Reserve in conjunction with its announcement, and further detailed in frequently asked questions published by the Federal Reserve.  The purpose of the PPPLF is to increase liquidity for lenders participating in the PPP (a "PPP Lender")⁹ so that they can engage in more expansive origination of PPP loans.  Under the PPPLF, Federal Reserve Banks will extend credit to PPP Lenders in the form of non-recourse¹⁰ term loans ("PPPLF Loans") at an interest rate of 0.35%. PPP loans will serve as collateral for a corresponding PPPLF Loan (with such collateral valued at the principal amount of the PPP loan).  PPP Lenders can borrow from the PPPLF an amount up to the principal amount of PPP loan collateral that it can pledge to the Federal Reserve.

PPP Lenders seeking PPPLF Loans are required to pool all PPP Loans that have the same maturity date, and will receive a single extension of credit secured by such pooled PPP loans.  PPP Lenders will need to ensure that they simultaneously pledge all PPP loans with the same maturity date.  There will be a separate extension of PPPLF credit for each maturity date of PPP loans that are pledged as collateral.  PPP loans cannot be pledged as collateral until the PPP loan has been originated, and cannot be pledged in advance for an extension of credit at a later date.

The terms of a PPPLF Loan will be closely aligned with the underlying PPP loans serving as collateral.  The principal amount and maturity period of a PPPLF Loan will be the same as that of the underlying pool of PPP loans (generally 2 years).  A PPP Lender is required to repay an extension of credit under the PPPLF whenever (i) the PPP Lender has been reimbursed by the SBA for a loan forgiveness (to the extent of the forgiveness), (ii) the PPP Lender has received payment from the SBA representing exercise of a loan guarantee, or (iii) the PPP Lender has received payment from the PPP borrower of an underlying PPP loan.  In each such instance, the PPP Lender must promptly report to the lending Federal Reserve Bank any payments on pledged PPP loans so that the corresponding PPPLF Loan can be adjusted accordingly.  The maturity of a PPPLF Loan will accelerate (i) in conjunction with the acceleration of an underlying PPP loan upon a default and resulting sale to the SBA by the PPP Lender of such PPP loan to realize on the 100% guarantee, and (ii) to the extent of any loan forgiveness reimbursement received by a PPP Lender from the SBA in respect of the underlying PPP loan.¹¹  PPP Lenders are not required to pay any fees to participate in the PPPLF and there are no prepayment penalties.

PPP Lenders seeking a PPPLF Loan must execute a PPPLF Letter of Agreement and make a certification that (i) it is not insolvent and (ii)¹² is unable to secure adequate credit accommodations from other banking institutions.¹³

The Federal Reserve has indicated that it will publicly disclose certain information regarding the PPPLF.  The Federal Reserve will report weekly (on an aggregate nationwide basis) balance sheet items related to the PPPLF.  Further, the Federal Reserve has indicated that it will also produce a monthly report regarding the new CARES Act-related lending facilities, which would include PPPLF, detailing (i) names and details of participants in each facility, (ii) amounts borrowed and interest rate charged, and (iii) overall costs, revenues and fees for each facility.  Similar information will also be publicized by the Federal Reserve one year after the termination of the PPPLF.

At present, all depository institutions that originate PPP loans are eligible to borrow under the PPPLF.  On April 23, 2020, the Federal Reserve announced that it is working to expand access to the PPPLF for additional SBA-qualified lenders, including depository institutions (i.e., banks and credit unions) and non-depository institutions, such as some community development financial institutions (notably, such institutions are eligible to receive part of the $60 billion in loan guarantee set-asides under the PPPHCEA).  As with the other Federal programs implemented in connection with the CARES Act, it is reasonable to expect that the contours of the PPPLF will continue to evolve.  The PPPLF is scheduled to remain in effect until September 30, 2020.

For further information on the CARES Act Title I SBA loan programs, see our prior client alerts:  Small Business Administration Gets (Very) Big — SBA Loan Programs Under Title I of the CARES Act and  "First Come, First Serve", Paycheck Protection Program Launched Today.

Proskauer's cross-disciplinary, cross-jurisdictional Coronavirus Response Team is focused on supporting and addressing client concerns.  We will continue to evaluate the CARES Act, related rules and regulations and any subsequent legislation to provide our clients guidance in real time.  Please visit our  Coronavirus Resource Center for guidance on risk management measures, practical steps businesses can take and resources to help manage ongoing operations.

Footnotes

1 The "PPP Rules" include: (i) an Interim Final Rule governing the PPP generally (published April 2, 2020); (ii)  an Interim Final Rule regarding the application of the SBA's affiliation rules to the PPP (published April 2, 2020); (iii) an Interim Final Rule regarding additional eligibility criteria and requirements for certain pledges of loans (with a principal focus on certain self-employed applicants) (published April 14, 2020), (iv) an Interim Final Rule regarding certain requirements for promissory notes, authorizations, affiliation, and eligibility (published April 24, 2020); (v) an Interim Final Rule on additional criterion for seasonal employers; (vi) an Interim Final Rule on disbursements (published April 28, 2020); and (vii) an Interim Final Rule on corporate groups and non-bank and non-insured depository institution lenders (published April 30, 2020).

2 Of the newly appropriated $310 billion, $60 billion is expressly allocated for guarantees of loans made by smaller banks, smaller credit unions, and community financial institutions (which encompasses certain community development financial institutions, minority depository institutions and other institutions that provide financing to underserved and economically disadvantaged communities).  The PPPHCEA also increased the funding available for the SBA's economic injury disaster loan ("EIDL") program ($50 billion in new funding) and for the EIDL grant program introduced in the CARES Act ($10 billion in new funding).  Additionally, the PPPHCEA appropriated a total of $100 billion to the Public Health and Social Services Emergency Fund, including $75 billion to be distributed by the U.S. Department of Health and Human Services to certain eligible healthcare providers (e.g., hospitals) to reimburse expenses and lost profits attributable to coronavirus.  Read more in our client alert on the  health care funding under the PPPHCEA and the CARES Act (including grants from the Provider Relief Fund). 

3 Plus any outstanding amount under a pre-existing EIDL made on or after January 31, 2020 and before April 3, 2020 net of any EIDL advance (as EIDL advances do not require repayment).

4 The CARES Act waives the affiliation rules if the borrower receives financial assistance from an SBA-licensed Small Business Investment Company (SBIC) in any amount (including, per the PPP Rules, any type of financing listed in 13 CFR 107.50, such as loans, debt with equity features, equity, and guarantees).  The PPP Rules further clarify that affiliation rules are waived even if the borrower received investment from other non-SBIC investors.

5 The Interim Final Rules on Additional Eligibility Criteria and Requirements for Certain Pledges of Loans address in detail the process and requirements for PPP loan applications by self-employed applicants who filed or will file a Form 1040 Schedule C for 2019, including step-by-step instructions for calculating payroll costs depending on whether such applicant has or does not have employees.

6 SBA guidance clarifies that this treatment follows the computation of self-employment tax from IRS Form 1040 Schedule SE Section A line 4 and removes the "employer" share of self-employment tax, consistent with how payroll costs for employees in the partnership are determined.

7  EIDL borrowers may also be subject to fraud charges (and resulting fines and imprisonment) under 18 USC § 1040, which addresses fraud in connection with major disaster or emergency benefits.

8 The SBA has confirmed that, for purposes of the PPP, an applicant's participation in an employee stock ownership plan (ESOP) does not trigger application of the affiliation rules.

9 While referred to here as PPP Lenders (as these are the institutions that ultimately lend to the end-recipients of PPP loans), the term sheet and FAQ refer to such institutions in the context of the PPPLF as PPPLF borrower.

10 Non‑recourse status of the PPPLF Loan may change if the PPP Lender breaches any of the representations, warranties, or covenants in the PPPLF documentation, or engages in fraud/misrepresentation in connection with participation in the PPPLF.

11 As described in Interim Final Rules published collectively by the Federal bank regulatory agencies (Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC)), for participating eligible financial institutions: (i) the PPPLF is considered to be zero percent risk for purposes of risk-based and leverage-based capital requirements because PPP loans are 100% guaranteed by the SBA; and (ii) loans extended by the PPPLF to participating eligible financial institutions will not increase the regulatory capital requirements for those institutions.  The Interim Final Rules take effect immediately, but are subject to a 30-day public comment period.

12 However, the Federal Reserve has clarified that this certification may be based on economic conditions in the market or markets intended to be addressed by the PPPLF facility.  The certifying PPP Lender may consider current economic or market conditions as compared to usual economic or market conditions, including the availability and price of credit for small businesses with diminished revenue streams.  For purposes of certifying that it is unable to secure adequate credit accommodations elsewhere, such PPP Lender does not need to establish that credit is unavailable, rather that credit accommodations may be available, but at prices or on conditions that are inconsistent with a normal, well-functioning market.

13 Certain additional documentation requirements apply for depository institutions that have not already established access to the Federal Reserve's lending programs for depository institutions ("discount window" programs).

Paycheck Protection Program – Where Are We Now? An Up-To-Date Guide To The Paycheck Protection Program

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