What You Need to Know to Understand About the Payment Protection Program

The purpose of this article is to answer certain frequently asked questions regarding the Paycheck Protection Program—the federal program that makes available $349 billion of forgivable loans to certain small businesses and entrepreneurs—and the corresponding loan forgiveness program enacted as part of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) as further clarified by the Small Business Administration’s recent guidance.

From February 15th to June 30th, 2020, qualified applicants are eligible to receive a loan for up to $10 million (a “covered loan”) and to refinance any existing small business loan that was obtained through the Small Business Administration 7(a) loan program (an “SBA 7(a) loan”) if such SBA 7(a) loan was obtained between January 31, 2020 and the date that covered loans are available.

Frequently Asked Questions: 

  • Who can qualify for a covered loan? 
  • How can a borrower spend the proceeds from a covered loan? 
  • What are the material terms that apply to a covered loan? 
  • How does a borrower qualify to have a covered loan forgiven? 

A.  Who Can Qualify for a Covered Loan?

The following is the list of organizations and individuals that can qualify for a covered loan:

  • Any small business concern, business organization, nonprofit organization, veterans organization and certain tribal business organizations if such organization was operating on February 15, 2020 and employs not more than the greater of:
    • 500 employees (including employees that are employed on a full-time, part-time or other basis); or
    • if applicable, the size standard in number of employees established by the Small Business Administration for the industry in which the organization operates.
  • Individuals that operate as:
    • a sole proprietorship;
    • an independent contractor; or an individual that regularly carries on any trade or business and would be entitled to paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act if the individual were an employee of an employer (other than himself or herself).
  • Any organization that employs no more than 500 employees at any single physical location and possesses an NAICS Code Number beginning with “72”, which is the designation for Accommodation and Food Services (e.g., traveler accommodations, food service contractors, caterers, mobile food services, drinking places, and full-service restaurants).

In order to determine whether an organization meets the size requirements, the organization must count its own employees and the employees of all other affiliated organizations. Organizations are deemed to be affiliated when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. It does not matter whether the control is exercised, so long as the power to control exists. The Small Business Administration considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationship in determining whether affiliation exists. For example, private equity and venture capital backed companies are generally considered to be affiliates of one another.

The CARES Act allows the following organizations to qualify even though they would have previously been disqualified under the affiliation rules:

  • Any organization that employs no more than 500 employees at any single physical location and possesses an NAICS Code Number beginning with “72”, which is the designation for Accommodation and Food Services (e.g., traveler accommodations, food service contractors, caterers, mobile food services, drinking places, and full-service restaurants);
  • Franchisees that have been given an identification code by the Small Business Administration; and
  • Any business organization that receives financial assistance from a Small Business Administration licensed Small Business Investment Company.

An organization or entrepreneur that meets the above-referenced criteria is considered ineligible to receive a covered loan if:

  • it is engaged in illegal activity under federal, state or local law;
  • it is applying as a household employer;
  • 20% or more of the equity in the proposed borrower is owned by an individual that is incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years; the proposed borrower, its affiliated entities or its owners has ever obtained a direct or guaranteed loan from the Small Business Administration or other federal agency that is currently delinquent or has defaulted within the last seven years and caused a loss to the government.

B.  How Can a Borrower Spend the Proceeds From a Covered Loan?

The Small Business Administration has clarified that 75% of the loan proceeds must be used to cover payroll costs. The term “payroll costs” is defined in the CARES Act to expressly include certain items, such as most forms of employee compensation and paid time off, and to expressly exclude certain items, most notably compensation of an individual employee in excess of an annual salary of $100,000.

The remainder of the loan proceeds can be used for all the same purposes that an SBA 7(a) loan can be used, including, but not limited to, for plant acquisition, construction, conversion, or expansion, including the acquisition of land, material, supplies, equipment, and working capital, and to make loans to any qualified small business concern, including those owned by qualified Indian tribes, for purposes of the Small Business Investment Act.

In additional to payroll costs and the SBA 7(a) loan uses described above, from February 15th to June 30th, 2020, loan proceeds from covered loans may also be used for:

  • costs related to the continuation of group health care benefits during period of paid sick, medical, or family leave, and insurance premiums;
  • employee salaries, commissions, or similar compensations;
  • payments of interest on any mortgage obligation (which shall not include any prepayment of or payment of principal on a mortgage obligation);
  • rent;
  • utilities; and
  • interest on any other debt obligations that were incurred before February 15, 2020.

C.  What Are the Material Terms That Apply to a Covered Loan?

Potential Loan Amount:

A qualified applicant can obtain a loan in an amount that is the lesser of (a) $10 million, and (b) payroll costs multiplied by 2.5, plus amounts owed under certain outstanding disaster relief small business loans made under the Small Business Administration’s 7(b)(2) loan program (an “SBA 7(b)(2) loan”).

Interest Rate:

The Small Business Administration has set the current interest rate on a covered loan at 100 basis points or 1%. The CARES Act sets the maximum interest rate on a covered loan at 4%.

Term:

Although the CARES Act sets the maximum maturity for a covered loan at 10 years from the date that the borrower applies for loan forgiveness, the Small Business Administration has capped the maturity date at 2 years.

Deferment of Initial Payments:

From February 15th to June 30th, 2020, lenders are required to provide impacted borrowers with complete payment deferment for six (6) months. Interest will continue to accrue during the deferment period.

No Prepayment Penalty:

Notwithstanding any other provision of law, there shall be no prepayment penalty for any payment made on a covered loan.

Recourse:

Neither the Small Business Administration nor any lender making a covered loan will have recourse against any individual shareholder, member or partner of an eligible recipient of a covered loan for nonpayment of any covered loan, except to the extent that such shareholder, member or partner uses the covered loan proceeds for a purpose other than an authorized purpose.

Personal Guarantee; Collateral:

From February 15th to June 30th, 2020, an applicant is not required to provide a personal guarantee or any collateral as security for a covered loan. This is an exception to the typical SBA 7(a) loan rules.

D.  How Does a Borrower Qualify to Have a Covered Loan Forgiven?  

Forgiveness, Generally:

The recipient of a covered loan can apply to have up to the full amount of the loan forgiven to the extent that the loan proceeds are used to pay for any of the below listed expenses incurred and paid during the 8-week period following the origination date of the covered loan:

  • payroll costs
  • interest payments due on the borrower’s mortgage if such mortgage was obtained prior to February 15, 2020
  • rent payments due on any leasing agreement in force before February 15, 2020
  • utility payments due on any electricity, gas, water, transportation, telephone or internet service if such service began before February 15, 2020

The Small Business Administration is planning to issue further guidance on the loan forgiveness component of the program.

Modifications to Loan Amount Subject to Forgiveness:

Once the borrower has determined the maximum amount of the loan that is subject to forgiveness as described above, the borrower must then determine whether any of the following rules applies to the borrower:

1.  Capped at Principal:

  • The forgiveness amount of a loan is not allowed to be greater than the original principal amount of the loan.

2.  Reduction Based on Reduction of Employees:

  • The forgiveness amount of a loan is reduced by multiplying the original forgiveness amount by the quotient (division) of:
    • Numerator:
      • the average number of full-time employees per month employed by the borrower during the 8-week period following the origination date of the covered loan.
    • Denominator: 
      • for seasonal employers, the average number of full-time employees per month employed by the recipient of the loan during the period beginning on Feb. 15, 2019 and ending June 30, 2019; and
      • for non-seasonal employers, borrowers can choose from either of the following:
        • the average number of full-time employees per month during the period beginning Feb. 15, 2019 and ending June 30, 2019; and
        • the average number of full-time employees per month during the period beginning Jan. 1, 2020 and ending Feb. 29, 2020.
    • EXAMPLE: A borrower has an initial loan forgiveness amount of $10,000 and has 50 employees during the 8-week period following the origination date of the covered loan, and had an average of 100 employees during the period beginning Jan. 1, 2020 to Feb. 29, 2020. Thus, the calculation is as follows:
      • original forgiveness amount x (average employees during 8-week period / average employees between Jan. 1 to Feb. 29) (i.e., 10,000 x (50 / 100) = 10,000 x .5 = 5,000 of loan forgiveness)

3.  Reduction Relating to Salary and Wages:

  • The original forgiveness amount is reduced by the amount of any reduction in the total salary or wages of any employee (only applies to employees that made under $100,000 during 2019) during the 8-week period following the origination date of the covered loan that is in excess of 25% of the total salary or wages during the most recent quarter during which the employee was employed before the 8-week period.

4.  Increase for Additional Wages Paid to Tipped Workers:

  • If a borrower has employees that are normally paid partially in tips, and the borrower decides to pay its employees additional amounts to cover the lost tips, the borrower’s forgiveness amount will be increased by the amount of wages paid over and above the employee’s normal wages.

5.   Exemptions for Re-hires:

  • The amount of loan forgiveness will be reduced because of a reduction of full time employees or a reduction in the salary of 1 or more employees during the period beginning on Feb. 15, 2020 and ending April 26, 2020 if:
    • There is a reduction in full-time employees between Feb. 15, 2020 and April 26, 2020 from those employed on Feb. 15, 2020; and, no later than June 30, 2020, the employer has eliminated that reduction through re-hiring, OR
    • There is a reduction in the salary or wages of an employee between Feb. 15, 2020 and April 26, 2020 to that employee’s salary or wages on Feb. 15, 2020; and, no later than June 30, 2020, the employer has eliminated that reduction of salary or wages.
    • EXAMPLE: Say a Company had 100 employees on Feb. 15, 2020, and throughout March and early April reduced its staff by 15 employees. Then, throughout May and June, the Company re-hires 15 employees. As a result, the reduction of the 15 employees throughout March and early April will not affect the loan forgiveness amount since the Company had re-hired 15 employees before June 30, 2020.

As previously noted, the Small Business Administration is planning to issue further guidance on the loan forgiveness component of the program.

Tax Implications of Loan Forgiveness:

For tax purposes, the amount of the loan that is forgiven does not need to be included in the borrower’s gross taxable income as would normally be the case for forgiven debts.

For further information related to the Paycheck Protection Program, or to further explore the impact of the coronavirus on your business, please contact your main Glaser Weil partner, or contact Glaser Weil’s COVID-19 Taskforce at covid19taskforce@glaserweil.com.

This article has been prepared by Glaser Weil LLP and is intended for informational purposes only. It is not legal advice and its transmission is not intended to create, and receipt by you shall not constitute, the creation of an attorney-client relationship. While we have attempted to provide information as accurately and timely as possible, it is not intended to be a full discussion of all aspects of the subject matter and applicable in all jurisdictions. It is not a substitute for legal advice from a qualified attorney licensed in the appropriate jurisdiction and with knowledge of your particular facts and objectives. Glaser Weil LLP expressly disclaims all liability with respect to actions taken or not taken based on the contents of this article and urges you to contact us or any other qualified attorney to discuss in greater detail your legal situation.