The Rule becomes effective upon the date of publication in the Federal Register (although ambiguity in the Rule release suggests it is effective immediately) and comments may be submitted until 30 days after publication in the Federal Register. While the Rule does provide guidance on key aspects of the Act – lowering the interest rate from 4 percent to 1 percent and the maturity of the loans from 10 years to two years – critical details with respect to implementation remain unaddressed. The SBA acknowledged that further guidance on key issues is needed, specifically with respect to the applicability of its affiliation rules (sections 121.103 and 121.301) to borrowers seeking PPP loans, loan forgiveness, and advance purchase of loans sold in the secondary market. We note that the CARES Act only identified the affiliation rules under 121.103, but the Rule is now signaling that the affiliation rules under 121.301 - which are different in some respects from 121.103 - may apply.
Below is a summary of key issues that both borrowers and lenders seeking to participate in PPP should consider. Small businesses will be eligible to receive one PPP loan and applications must be received by June 30, 2020. PPP is a temporary effort under the SBA Section 7(a) loan program. We recommend that all potential borrowers apply as soon as possible as funds are distributed on a first come, first served basis. Payment of the principal and interest will begin six months from the date of disbursement.
Borrower requirements
Eligibility. The eligibility standards articulated in the CARES Act and subsequent guidance from the SBA generally remain the same. However, one notable change is the Rule’s apparent expansion of eligibility for nonprofit organizations to include “other businesses” beyond 501(c)(3) nonprofit organizations, 501(c)(19) veterans organizations, and Tribal business concerns expressly referenced in the Act. The Rule (and the April 3 issued updated application form) suggest that other forms of nonprofits, such as 501(c)(6) trade organizations and 501(c)(7) social clubs may be considered eligible.
To recap, U.S. businesses – including sole proprietorships, independent contractors, and nonprofit organizations (see discussion above) – that were operational as of February 15, 2020 and meet the SBA’s size requirements, can apply for a PPP loan. Those requirements encompass companies with 500 or fewer employees or companies that meet the SBA's table of size standards based on their NAICS code. Companies that have fewer than 500 employees per each physical location and a NAICS code that begins with 72 are also eligible.
There are several factors that may disqualify a potential applicant, including a recent bankruptcy, involvement in debarment, suspension or criminal proceedings, and prior delinquency on an SBA loan. Notably, PPP loans are only available to U.S. citizens or lawful permanent residents.
Affiliation regulations. Since the CARES Act was released, businesses have struggled to makes sense of how the SBA’s existing affiliation regulations, found at 13 CFR sections 121.103 (cited within the CARES Act) and 121.301 (cited within 121.103 as the applicable rule to SBA’s loan and disaster programs), apply to PPP loans. Under those regulations, the SBA would normally include all the employees of a business’s affiliates to determine whether the business meets the SBA’s size requirement. The CARES Act specifically waived only 121.103’s affiliation requirements in some circumstances and, in doing so, has caused confusion.
Several industries expected the SBA to clarify the scope and application of its affiliation regulations in the Rule. Instead, the SBA has simply stated that additional guidance would be forthcoming to clarify the ambiguity. Until such additional guidance is provided, affiliation should be determined in consultation with counsel and upon a review of the relevant factors and precedent to assess the control rights, if any, of an applicant’s minority investors.
Loan application. The SBA released a sample loan application (SBA Form 2483, “PPP Application Form”) and related materials on March 30, 2020. As promised – and consistent with Congress’s desire to deploy these funds as quickly as possible – the application is short and easy to complete and can be signed electronically.
After this Rule was released, the SBA provided an updated version of the application. While similar, there are material differences in the updated application. For example, it places less emphasis on the citizenship of significant owners, and the applicant must certify that all its employees are US citizens. The updated application also includes a list of required documentation in the certification section. We recommend that companies redo their application on the new form prior to submission.
The Rule clarifies how applicants must calculate the average monthly payroll and loan amount for inclusion on the application:
- Aggregate payroll costs from the last 12 months (i.e., looking back from the date in which the loan is made).
- Subtract any compensation paid to an employee in excess of an annual salary of $100,000 and/or any amounts paid to an independent contractor or sole proprietor in excess of $100,000 per year.
- Calculate average monthly payroll costs (divide the amount from step 2 by 12).
- Multiply the average monthly payroll costs from step 3 by 2.5 to calculate the loan amount.
- Add the outstanding amount of any Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL loan (because it does not have to be repaid).
The total loan amount is calculated as described in step 4, capped at $10 million for any individual applicant. The following chart includes guideposts for what can be included as a payroll cost for purposes of determining the average monthly payroll:
Application Certification. The Rule allows a representative of the applicant to certify for the business as a whole if the representative is legally authorized to do so. The business representative must certify to the following:
- The company was operating on February 15, 2020 and paying employees or paid independent contractors;
- The loan need is based on economic uncertainty;
- Funds will be used for the permitted purpose--to retain workers and maintain payroll or make mortgage interest payments, lease payments and utility payments;
- No more than 25% of the amount will be used for non-payroll costs;
- Payroll documentation is accurate;
- No other PPP loans will or have been received between February 15 – December 31, 2020;
- The applicant understands that making a false statement to obtain a guaranteed loan from the SBA is punishable under the law by imprisonment and/or fine; and
- The applicant acknowledges that the lender will confirm the eligible loan amount using the documents submitted, and the lender can share any tax information provided with the SBA for compliance purposes.
Individual applicants and any individual that owns 20% or greater of the applicant, must make the following certifications regarding his or her criminal background
- Whether the individual is subject to any formal criminal charges; and
- Whether the individual has been convicted of or involved in felony charges in the last 5 years.
Application process. The application period for businesses is slated to open on Friday, April 3, 2020; it opens for independent contractors and self-employed individuals the following week, on Friday, April 10, 2020. While the CARES Act sets forth broad guidance on the overall application process, it includes no direct instruction on the details and mechanics of the application process. We anticipated such guidance in the Rule, but it was not included. This leaves the industry with very little meaningful information on how to apply for a PPP loan.
That said, we can glean some information from developments in the past week since the CARES Act was enacted. Many companies appear ready to apply with their existing bank or lender, provided that institution is permitted to make SBA 7(a) loans. While the mechanics of submission remain uncertain, the Rule stresses that loan funds will be doled out on a first come, first served basis. As a result, companies have spent the past few days preparing their applications, including any supporting documentation that may be required or requested. When the mechanics of application submission are released, we expect a flood of applications to hit the lenders authorized to extend PPP loans.
Loan forgiveness
Small businesses are entitled to loan forgiveness up to the full principal amount provided that the funds, which are incurred and paid during the eight-week period beginning on the date of loan origination, are used to cover the following: (i) payroll costs, (ii) interest payments on real or personal property mortgage obligations incurred before February 15, 2020, (iii) rent payments under leases in force before February 15, 2020, (iv) utility payments, or (v) additional wages paid to tipped employees.
To incentivize small businesses to retain employees and maintain employee compensation, the Rule sets forth a detailed forgiveness calculation tied to reductions in payroll and in employee compensation. This calculation compares the monthly average number of full-time employees (FTEs) during the period covered by the loan to the monthly average number of FTEs during a separate reference time period. Under the Rule, borrowers may select the reference period for the purposes of the calculation.1 Both the Act and the Rule make clear that if the borrower re-hires the same number of FTEs it employed during the reference period by June 30, 2020, then the borrower will be eligible for full loan forgiveness. For example, if a borrower has an average of 75 FTEs during the covered period, and an average of 100 FTEs during the reference period, unless the borrower rehires FTEs prior to June 30, 2020, the borrower would only be entitled to 75% of the total eligible forgiveness amount. That said, eligibility for forgiveness is also dependent upon employee compensation. Reductions in employee salary and wages is also subject to a forgiveness reduction. Therefore, if the borrower restores employees’ full compensation by June 30, 2020, there will be no reduction in the amount of loan forgiveness.2
Applying for PPP forgiveness. Borrowers must apply and be approved for the PPP loan forgiveness through their lender. The application for forgiveness must include (i) documentation, including payroll filings, verifying the number of FTEs employed during the relevant reference and covered periods along with their compensation, (ii) documentation, including cancelled checks, payment receipts, and transcripts of accounts, verifying payments of mortgage obligations, rent costs, and utilities, and (iii) a certification representing that the documentation is true and correct and that the amount of forgiveness requested was used for retaining employees and paying mortgage interest, rent costs, and utilities during the covered period. The SBA administrator may require more information; the lender is expected to issue a decision on loan forgiveness within 60 days of receiving a complete application.
Limits on PPP loan forgiveness. Borrowers will owe money when their loan is due if they use the loan amount for anything other than payroll costs, mortgage interest, rent costs, and utilities payments over the eight weeks after receiving the loan. No more than 25 percent of the PPP loan may be used for non-payroll costs.
Recipients of PPP loans are ineligible for the employee retention credit in section 2301 under the CARES Act. In addition, if a PPP loan is forgiven, the recipient is not eligible for deferral of payroll taxes as provided under section 2302 of the CARES Act. Finally, the amount of loan forgiveness is not included in gross income for federal tax purposes.
Lender requirements
Lenders are tasked with determining whether or not a borrower is eligible to receive a PPP loan.3 Given the uncertainty around certain borrower criteria – especially the applicability of the SBA affiliation rules – some lenders are currently exercising caution with respect to borrower eligibility determinations. It is also unclear under the Rule how the SBA will delegate PPP loan funds among participating lenders. Despite the uncertainty, it is expected that some lenders will begin accepting PPP loan applications today (April 3). Below is a breakdown of the key issues that lenders who want to participate in the PPP should consider.
Eligibility. All SBA 7(a) lenders are automatically approved to make PPP loans on a delegated basis. The SBA administrator and the Treasury Secretary may also approve additional lenders to make PPP loans. Currently, the following types of additional lenders have been approved: (i) federally insured depository institutions or any federally insured credit unions, (ii) Farm Credit System institutions as defined in 12 U.S.C. 2002(a), and (iii) any other depository or non-depository financing provider that, among other criteria, has been operating since at least February 15, 2019, and has originated, maintained, and serviced more than $50 million in business loans or other commercial financial receivables during a consecutive 12-month period in the past 36 months.4 Lenders seeking to participate in the PPP can submit their application to DelegatedAuthority@sba.gov in order to enroll with the SBA.5
Required documents. The applicant must provide the lender (i) documentation verifying the number of FTEs on payroll, (ii) the dollar amounts of payroll costs, (iii) covered mortgage interest payments, (iv) covered rent payments, and (v) covered utilities for the eight-week period following the loan.
Loan underwriting standards. Lenders must review the PPP loan application submitted by the borrower and confirm receipt of the required borrower certifications and of information demonstrating that the borrower had employees for whom the borrower paid salaries and payroll taxes on or around February 15, 2020, as well as confirming the dollar amount of average monthly payroll costs for the preceding calendar year by reviewing the payroll documentation submitted with the borrower’s application. In addition, lenders must follow applicable BSA requirements.
Loan terms. The PPP loans, which have an interest rate of 1 percent, will be fully guaranteed. In addition, borrowers will not be required to post collateral or make personal guarantees.6 Importantly, lenders will be permitted to rely on certifications made by the borrower in the PPP application in order to determine the eligibility of the borrower, amount of the loan, and use of loan proceeds. While lenders must comply with the applicable lender obligations set forth in the Rule, they will be held harmless for borrowers’ failure to comply with the PPP criteria.7 Only borrowers will be held liable for violations or fraud.
After loan origination. Under the final interim rules, a PPP loan may be sold on the secondary market after the loan is fully disbursed at a premium or at a discount to par value. The SBA will issue guidance regarding any advance purchase for loans sold in the secondary market. In addition, a lender may request that the SBA purchase the expected forgiveness amount of a PPP loan or pool of PPP loans at the end of week seven of the covered period (i.e., the eight-week period beginning on the date the loan is originated). Importantly, no more than 25 percent of the loan forgiveness may be attributable to non-payroll costs.
Fees. The SBA will pay lenders for processing PPP loans in the following amounts: (i) 5 percent for loans not exceeding $350,000, (ii) 3 percent for loans more than $350,000 and less than $2 million, and (iii) 1 percent for loans of at least $2 million. In turn, lenders will be responsible for paying agent fees out of the fees they receive from the SBA in the following amounts: (i) 1 percent for not exceeding $350,000, (ii) 0.5 percent for loans more than $350,000 and less than $2 million, and (iii) 0.25 percent for loans of at least $2 million.
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Our team continues to monitor developments in the PPP and related SBA Programs. We will provide updates as additional information becomes available. Please feel free to contact us if you have any questions.
- The borrower may choose a reference period of February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020.
- If a borrower employs tipped employees, the borrower may receive forgiveness for additional wages paid to the tipped employees.
- Under the Rule, PPP loans will be designated on a first come, first served basis. Borrowers may only receive one loan.
- Entities that are currently considered to be in a “troubled condition” by their primary federal regulator or are subject to a formal enforcement action with their primary federal regulator that addresses unsafe or unsound lending practices are not eligible to participate in the PPP.
- Prior to engaging in PPP lending, entities that are not presently subject to the requirements of the Bank Secrecy Act (BSA) should establish an anti-money laundering compliance program equivalent to that of a comparable federally regulated institution.
- The borrower must submit SBA Form 2483 (PPP Application Form) and payroll documentation. The lender must submit SBA Form 2484 (PPP Lender’s Application for 7(a) Loan Guaranty) electronically in accordance with PPP requirements and maintain the forms and supporting documentation in its files.
- Lenders will not be required to apply the “credit elsewhere test” (as set forth in section 7(a)(1)(A) of the Small Business Act (15 U.S.C. 636) and SBA regulations at 13 § CFR 120.101)).
Client Alert 2020-200
