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Client Alert: Paycheck Protection Program Loans – Your Questions Answered

In light of the rapid developments related to the Paycheck Protection Program (the “PPP”), enacted as part of the CARES Act, we have addressed a number of frequent questions for clients and others, which we have identified and responded to here to assist with determining whether a PPP loan is a good fit for your business.
 
For background about the PPP, please refer to our March 27 article, The CARES Act – New Financial Resources for Small Businesses and Nonprofits.
 
Certain Regulatory Developments since CARES Act Passage (new, May 19)
 
On April 2, 2020, the U.S. Small Business Administration (“SBA”) issued an “interim final rule” as regulations for all employers applying for a PPP loan. We refer to these as the “Employer Regulations.”
 
Since April 7, 2020, the U.S. Treasury Department (“Treasury”) has issued a series of answers to PPP Frequently Asked Questions, which it has identified as binding on both Treasury and SBA as they administer the PPP.   We refer to each of these questions and answers as an “FAQ”.
 
The SBA issued, on April 14, 2020, a new interim final rule concerning self-employed individuals, which supplements the Employer Regulations. We refer to this as the “Self-Employment Regulations”.

On May 15, 2020, the SBA released the SBA issued the long-awaited Paycheck Protection Program Loan Forgiveness Application and its instructions, which consists of four components: (1) the PPP Loan Forgiveness Calculation Form; (2) PPP Schedule A; (3) the PPP Schedule A Worksheet; and (4) an (optional) PPP Borrower Demographic Information Form. We refer to this as the “Forgiveness Application.” For a more thorough review of the Forgiveness Application, please refer to our article, More Questions Answered in the PPP Loan Forgiveness Application.

Who can apply? (new, April 16)
 
All small businesses concerns, as defined by the SBA, can apply.  Typically that means having 500 employees (whether full time, part time or otherwise) or less whose primary residence is located in the U.S., although there are other size standards applicable to a for-profit businesses that may permit it to apply even if it has in excess of 500 employees.
 
In addition, permissible applicants are nonprofits exempt from taxation under IRC 501(c)(3), tax-exempt veterans organization described in section 501(c)(19) of the IRC, and Tribal business concerns described in section 31(b)(2)(C) and Native American Tribal Businesses exempt from taxation under IRC 501(c)(19), can apply provided that the business has 500 or fewer employees. These include faith based organizations.
 
Under the Self-Employment Regulations, individuals who have self-employment income are eligible for a PPP loan if (i) their self-employment business was in operation on February 15, 2020, (ii) they have self-employment income, (iii) their principal residence is in the U.S. and (iv) they filed a Form 1040 Schedule C for 2019. According to the April 14 IFR, guidance is forthcoming regarding individuals who do not meet the 2019 Form 1040 Schedule C requirement, but who meet the other requirements and will file a 2020 Form 1040 Schedule C.
 
The Self-Employment Regulation also clarified that partners in a partnership are not eligible to submit a separate PPP loan application for themselves as a self-employed individual. Rather, the self-employment income of partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.
 
Are affiliates included in the size determination? If so, what are “affiliates” for purposes of the PPP? (new, April 16)
 
Except for certain circumstances (identified below), the employees of affiliated entities are aggregated to determine whether an entity is below the 500 employee threshold. The SBA has broad affiliation rules that essentially treat as affiliates any entities where one controls the other, or that are under common control through third parties. So, parent/subsidiary and brother/sister groups are affiliates for purposes of this determination. Overlapping directors or management would also be an indication of common control and, therefore, affiliation.
 
For the PPP, the SBA’s affiliation standards are waived for businesses that either (1) are under NAICS code 72 (hotel and food service industries); (2) are franchises in SBA’s Franchise Directory (click here to check); or (3) receive financial assistance from a small business investment company licensed by SBA.  In its FAQ #24, Treasury has provided the following examples to demonstrate the affiliation waiver:
 

• One company, multiple locations: Company X directly owns multiple restaurants and has no affiliates. Company X may apply for a PPP loan if it employs 500 or fewer employees per location (including at its headquarters), even if the total number of employees employed across all locations is over 500. Company X’s total loan amount is capped at $10 million.

 

• Affiliated NAICS Code 72 companies, multiple locations: Company X wholly owns Company Y and Company Z (as a result, all companies are affiliates). Company Y and Company Z each own a single restaurant with 500 or fewer employees. Company Y and Company Z can each apply for a separate PPP loan for up to $10 million.

 

• Affiliated companies, only one is under NAICS Code 72: Company X wholly owns Company Y and Company Z (as a result, all companies are affiliates). Company Y owns a restaurant with 400 employees. Company Z is a construction company with 400 employees. Company Y can apply for a PPP loan, because its affiliation is disregarded. Company Z does not meet the 500 employee limit, because the affiliation rules apply to it (construction is not a NAICS 72 industry). However, Company Z may be eligible to receive a PPP loan as a small business concern if it, together with Companies X and Y, meets SBA’s other applicable size standards, as explained in Q&A 2.

 
By a series of guidance issued April 3, 2020, including a second interim final rule, the SBA clarified that faith-based organizations are not considered affiliates if the relationship is based on a religious teaching or belief or otherwise constitutes a part of the exercise of religion.  

How are Employees paid by a Third Party Payer (such as a payroll provider or Professional Employer Organization) Treated by an Applicant? (new, April 16)

The ability of an applicant to include such employees and their related Payroll Costs in its application will depend upon the documentation made available by the third party payer. In these cases, payroll documentation provided by the third party payer that indicates the amount of wages and payroll taxes reported to the IRS by the third party payer for the applicant’s employees will be considered acceptable PPP loan payroll documentation. Relevant information from a Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, attached to the third party payer’s Form 941, Employer’s Quarterly Federal Tax Return, should be used if it is available; otherwise, the applicant should obtain a statement from the third party payer documenting the amount of wages and payroll taxes.
 
In addition, employees of the applicant will not be considered employees of the applicant’s third party payer, so coordination may be required to avoid double counting employees. 

When can I apply for a PPP loan? (new, April 16)

On April 3, 2020, the window opened for qualifying businesses and nonprofits that had employees and were operating as of February 15, 2020 were able to apply for PPP loans through federally-insured banks approved as SBA lenders. As of April 6, most such banks were accepting applications.
 
Starting April 10, 2020, independent contractors and self-employed individuals were permitted to apply for PPP loans through existing SBA lenders.  The Self-Employed Regulations provided important clarifications that allow the lenders to process applications.
 
Other lenders will be able to make PPP loans once approved and enrolled by the SBA.
 
Due to the high demand for these loans, most banks only have been accepting applications from customers with whom they have an existing relationship (e.g., a commercial banking relationship, working capital lender, mortgage holder). Among other reasons, this is because banks do not need to complete a Bank Secrecy Act certification of its existing business customers or require beneficial ownership information, which streamlines its processing of the loan application.
 
How much can I obtain? (new, April 16)
 
The maximum loan size is 2.5 times your average monthly Payroll Cost.  
 
Payroll Costs are primarily determined by adding these amounts from calendar year 2019: (a) salary, wages, tips, commissions or other cash compensation to W-2 employees, including leave and severance payments; (b) employer-paid health, dental, vision, and retirement benefits (e.g., 401(k) matching); and (c) amounts paid to state or localities due to employee compensation (e.g., state unemployment insurance taxes). However, the following must be subtracted: (d) amounts for any employee whose principal residence is outside of the USA; and (e) salary or wages for any employee in excess of $100,000, without reference to non-cash benefits such as retirement plan contributions and payment of state and local taxes assessed on compensation of such employees.
 
Under the Employer Regulations, Payroll Costs are calculated on a gross basis without regard to federal taxes imposed or withheld, such as the employee’s and employer’s share of Federal Insurance Contributions Act and income taxes withheld from employees. As a result, Payroll Costs are not reduced by taxes imposed on an employee and required to be withheld by the employer, but payroll costs do not include the employer’s share of federal payroll taxes (e.g., FICA tax of 6.2% of wages). 
 
The Self-Employment Regulations detail how sole proprietors and partners can determine their eligible loan amount. Specifically, if a sole proprietor has no employees, the following methodology is to be used to determine his or her maximum loan amount:
   
Are an employer’s payments to Independent Contractors part of the Payroll Costs? (new, April 16)
 
Under the Employer Regulations, amounts paid by employers to independent contractors are not qualified Payroll Costs for loan size or forgiveness purposes. This is because independent contractors and self-employed persons can apply for their own PPP loans. 
 
What do I need to do to apply? (new, April 16)
 
The SBA’s approved form of application is available here; however, before completing this you should find out from your bank whether it is requiring a different method of applying, because certain banks are requiring that the information and certifications required in that form be inputted into the bank’s online system instead.
 
The key substantive information you must provide is your monthly average Payroll Cost during 2019, and the maximum loan requested (2.5 x monthly Payroll Cost), and the number of employees.
 
Banks are required to obtain proof of the Payroll Costs incurred during 2019 and the number of employees during February 2020, before the pandemic began in the USA. Though your lender will ultimately tell you what it needs to process your application:
 

• 2019 IRS Quarterly 940, 941 or 944 payroll tax reports.

• Reports of each employee’s compensation during 2019, due to the $100,000 cap on counting each employee’s cash compensation.

• Documentation of employee benefits that the business paid in 2019.

• Documentation of the sum of all retirement plan funding that was paid by the company.

• Documentation of the payroll and to whom it was paid in February 2020.

The Self-Employment Regulation details what a sole proprietor must provide with a PPP application:
 

• Regardless of whether you have filed a 2019 tax return with the IRS, you must provide the 2019 Form 1040 Schedule C with your PPP loan application to establish the loan amount.

• A 2019 IRS Form 1099-MISC detailing non-employee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed.

• A 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.

How can a Borrower use PPP Loan Proceeds? (April 16)
 
PPP loan proceeds can be used as follows:
 

• Employee Payroll Costs, including those of borrower’s owners who receive W-2 income.

• For a sole proprietorship or partnership, owner compensation replacement limited to 8 weeks of replacement based on the owner’s 2019 average monthly net profit amount (See the answer to “How much can I obtain?” for details about this calculation).

• Mortgage interest, business rent and business utility payments that gave rise to a valid tax deduction for the borrower’s corporate, partnership or Schedule C return.

• Interest payments on other debt obligations incurred before February 15, 2020.

• Refinancing an EIDL loan made from January 31 to April 3, 2020

What amount of PPP loans will be forgiven? (new, April 16)
 
The maximum amount of loan forgiveness is equal to the amount of loan proceeds, used over the 8 week period after the loan is disbursed to borrower, for Payroll Costs, owner compensation replacement (as described above), deductible utility costs, and either deductible rent or mortgage interest. According to the Employer Regulations, only 25% of the total forgiveness may be for utilities and rent or mortgage interest expenditures; the remainder must be for Payroll Costs and/or owner compensation replacement, as applicable.
 
The Self-Employment Regulations require that at least 75% of PPP loan proceeds be used for Payroll Costs and/or owner compensation replacement, which is a different standard than limiting total forgiveness as provided in the Employer Regulations. It is unclear whether the 75% floor applies only to self-employed PPP applicants, or is a new standard for all PPP loan borrowers.

What are qualified Payroll Costs for Forgiveness? (new, April 16)
 
Payroll Costs for both forgiveness and determining loan amount are gross wages, without any deductions for federal taxes withheld. Payroll Costs do not include, however, the employer’s share of payroll tax. See the answer to “How much can I obtain?” for more information.
 
How are the Number of Employees for Loan Forgiveness Purposes Determined? (new, April 16)
 
The number of employees on or around February 15, 2020 is an important figure due to certain limitations on forgiveness as described below. The CARES Act says that the figure is the number of full-time equivalent employees (“FTEs”) during January and February 2020. To-date, the SBA has not issued definitive guidance regarding the determination of FTEs for purposes of a PPP loan.

What other limitations are there on Forgiveness?
 
The employer will have the period between now and June 30, 2020 to bring the number of FTE employees back to the same level as it employed on February 15, 2020. If the borrower does not bring the number of employees back to that level by June 30, then the otherwise permissible forgiveness amount will be reduced proportionally. For example, if the borrower employed 50 FTEs as of February 15, but only 30 FTEs as of June 30, then we expect that its forgiveness from eligible expenditures will reduce by 40%. The regulations do not address the consequence of employees who may leave for reasons other than a reduction in employment by the employer (such as retirement, death or disability).
 
In addition, forgiveness will be reduced for each employee whose rate of compensation is reduced by 25% or more. The Regulations do not detail how such wage cuts will impact forgiveness amounts.
 
How can I request loan forgiveness? (new, April 16)
 
After June 30, 2020, you can submit a request to the lender that is servicing the loan. The request will include documents that verify the number of full-time equivalent employees and pay rates as of June 30, 2020, as well as the expenditures during the 8 week measuring period on eligible Payroll Costs, owner compensation replacement, rent or qualified mortgage interest, and utility obligations. You must certify that the documents are true and that you used the forgiveness amount to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 day.
 
At this time, further guidance is expected with regard to the forgiveness application process.
 
What are the terms of the PPP loan amount that is not forgiven?
 
Each PPP loan will accrue interest at one percent (1%) per annum, and the principal amount will be due 2 years from issuance. No payments are required for 6 months from issuance and there is no prepayment penalty. The PPP loan is unsecured, which means no collateral is required. No personal guarantee from the applicant or anyone else associated with the entity is required for a PPP loan. Loan funds used for allowable expenses are non-recourse against the borrower’s owners.
 
If I have applied for, or received, an Economic Injury Disaster Loan (EIDL) related to COVID19 before the PPP loan became available, will I be able to refinance into a PPP loan?
 
If you received an EIDL related to COVID-19 between January 31, 2020 and April 3, 2020, you may refinance the EIDL into the PPP and add that to the amount eligible for loan forgiveness. If you took advantage of an emergency EIDL grant award of up to $10,000, that amount would be subtracted from the amount forgiven under PPP. You should also note that EIDLs and PPP loans can both be applied for, so long as the use of the proceeds from each loan is different.

If I have already applied for a PPP loan, how do new developments affect me?

Borrowers and lenders may rely on the laws, rules, and guidance available at the time of the relevant application. However, borrowers whose previously submitted loan applications have not yet been processed may revise their applications based on the latest clarifications from Treasury and the SBA.

If I have already applied for a PPP loan, how do new developments affect me? (new, April 23)
 
Borrowers and lenders may rely on the laws, rules, and guidance available at the time of the relevant application. However, borrowers whose previously submitted loan applications have not yet been processed may revise their applications based on the latest clarifications from Treasury and the SBA.
 
What should I consider when making the certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant”? (new, May 11)
 
In FAQ #31, published on April 23, 2020, Treasury emphasized that this “economic uncertainty” certification must be made in good faith, taking into account the applicant’s current business activity and its ability to access other sources of liquidity sufficient to support ongoing operations in a manner not significantly detrimental to the business.
 
By way of example, according to Treasury, it is unlikely that a publically traded company with substantial market value and access to capital markets would be able to make the economic uncertainty certification in good faith. Further, Treasury indicated that the SBA can request that a borrower demonstrate its good faith basis for making the economic certainty certification.
 
Finally, Treasury provided an opportunity for borrowers that applied for a PPP loan prior to April 23, 2020, to return the PPP loan proceeds in full by May 7, 2020, and be deemed by the SBA to have made the economic uncertainty certification in good faith. As of May 5, 2020, through FAQ #43, Treasury extended the date to return the PPP loan proceeds to May 14, 2020, and has indicated that more definitive guidance will be forthcoming from the SBA before then.

Borrowers should remember that a central purpose of the Paycheck Protection Program is to facilitate a willingness by companies to maintain their employee headcount through June 30, rather than laying off employees as a hedge against the current and prospective economic conditions.  We believe that those companies that mostly maintained their employee headcount, and had suffered some downturn in business during the pandemic by the date of the loan agreement, will be well positioned to provide a satisfactory demonstration of their good faith in making the economic uncertainty certification.

How will the SBA review whether I made the necessity certification in good faith? (new May 13)

On May 13, 2020, the SBA provided, via FAQ, the guidance it had promised regarding how it would review whether PPP applicants had a good faith basis for making the necessity certification.

According to FAQ #46, any borrower that, together with its affiliates (applying the same rules used to determine PPP loan eligibility, explained above), received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith. In other words, if a borrower receives a PPP loan of less than $2 million, the borrower is automatically considered to have certified to its need for the loan in good faith.

For borrowers that received a loan of $2 million or more, FAQ #46 acknowledges that they may still have an adequate basis for making the required good-faith certification, based on their individual circumstances. If, upon its review of the PPP loan, the SBA determines that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. So long as the borrower repays the loan, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request.  But if the borrower does not return the funds when required, then the government could bring civil or criminal enforcement actions against the borrower's principal owners or officers.

So, borrowers of $2,000,000 or more in the aggregate (including PPP loans made to affiliates) should document their business need in preparation for the SBA’s review of the PPP loan.  Borrowers who have a questionable necessity argument for should either return the PPP funds unspent or make contingency plans to be able to repay the loan if SBA determines that the borrower did not have an adequate basis for the necessity certification.

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The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.