Earlier today, Congress approved the House Bill 748, the Coronavirus Aid, Relief and Economic Security Act or the CARES Act (the “Act”), which was signed into law by the President moments ago. The Act is the culmination of rapid negotiation by both Republican and Democratic Senators. The most recent available version of the final text of the Act can be found here.
This summary focuses solely on the new SBA loan program – the Paycheck Protection Program (the “Program”) – which the Act created under the existing Section 7(a) of the Small Business Act (“SBA Act”). The Program is intended to help certain small businesses and nonprofits stay afloat during the COVID-19 pandemic.
This Act goes much farther than the “Phase II” legislation related to the economic injury disaster loan (EIDL) program under Section 7(b) of the SBA Act (see our previous client alert here). For example, (1) the pool of funds available under the Act is much larger ($349 billion, as compared to the original $7 billion approved in the Phase II legislation for EIDLs), (2) the funds are designed to be distributed through SBA-approved banks, as opposed to being distributed by the SBA itself (which we hope will increase the speed at which the funds are disbursed to businesses), (3) there are no collateral or personal guaranty requirements, and (4) significant portions of the funds distributed are forgivable if used for eligible expenses.
As an initial matter, you should reach out to your regular banker to begin the loan application process as soon as possible. If you do not have a regular banker, you should reach out to any local bank, as the SBA’s requirements for a bank to become an SBA-approved lender will be streamlined under the Act, so we assume that many more banks will become approved to make loans under the Program. Banks are not accepting applications yet (and we believe the SBA is preparing a new standardized application for this Program), but anything you can do to get on your banker’s radar will be helpful in this respect, as it is expected that there will be very strong demand for these loans.
The SBA also must issue additional guidance and its implementing regulations related to the Act. When the SBA issues these regulations and guidance, or as other updates become available with respect to the Program, we will provide additional updates. In the meantime, please see below for an initial summary of some frequently asked questions and answers on the Act, with relevant links included throughout. We will provide our updates here as additional guidance is released or as specific questions arise.
Frequently Asked Questions and Answers
Q1: What businesses are eligible?
Eligible businesses will include: (a) small business concerns (which typically qualify under the SBA Act – these are typically local bars, restaurants, hair salons, barbershops, etc.), and (b) any other businesses (even if they do not meet the “small business concern” definition under the SBA Act), nonprofits (under 501(c)(3)), veterans’ organizations (under 501(c)(19)) or tribal businesses with not more than: (i) 500 employees, or (ii) if greater than, the maximum size standard in number of employees for a particular industry set forth in the SBA's size standards tool (which may yeild a revenue limit instead of an employee headcount limit). There is also an exception to the 500-employee limit for certain businesses that are NAICS Code 72 (accommodations and food service) that have less than 500 employees at each store/location. The Act also delegates more authority to lenders on borrower eligibility determinations without requiring the lenders to go through all the usual SBA hurdles and steps. The application and loan origination process should be much quicker and streamlined than typical Section 7(a) loans, in order to be consistent with the main goal of the Act – get necessary cash to businesses as quickly as possible.
Q2: Must a business include parent businesses, subsidiaries or related affiliates in measuring its revenue or headcount?
Yes, however the Act waives the SBA Act’s typical affiliation rules for businesses in the hospitality and restaurant industries (NAICS Code 72 – accommodations and food service), franchises that are approved on the SBA’s franchise directory, and small businesses that receive financing through the Small Business Investment Company (SBIC) program. However, the Act does not waive the SBA Act’s typical affiliation rules for other businesses or for nonprofits, so those entities will still need to include affiliates when determining eligibility for a loan under the Program.
Q3: Are independent contractors and self-employed individuals eligible for loans under the Program?
Yes. The Act deems sole proprietors, independent contracts and self-employed individuals to be eligible to receive loans under the Program, assuming they provide the necessary documentation to evidence their eligibility, such as payroll tax filings, Forms 1099-MISC, and income and expense reports. See below for limits on how much they can borrow.
Q4: What due diligence will lenders have to complete prior to making a loan under the Program?
The Act’s due diligence and qualification requirements are vastly different than any other loan program under Section 7(a) of the SBA Act. Essentially, lenders will only need to confirm the following: (1) that a business was operational on February 15, 2020, (2) that the business had employees for whom it paid salaries and payroll taxes, or paid independent contractors, and (3) that the business has been substantially impacted by COVID-19. This third requirement may be self-certified (i.e., the lender may presume that it is met and need not treat it as an underwriting requirement).
Q5: If I have laid off employees and am now below the maximum employee number, can I obtain a loan?
The 500-employee headcount analysis seems to be made on the date of the loan application (so long as it is during the period February 15, 2020 and June 30, 2020). Under existing SBA guidance, however, the number of employees for applying an employee-size standard is applied by determining the average number of employees based upon numbers of employees for each of the pay periods for the preceding completed 12 calendar months. This would also be consistent with the 1-year lookback period to determine monthly payroll for purposes of calculating the maximum loan amount under the Program. Other principles in existing SBA guidance that may apply to this determination include the following:
- Includes employees obtained from a temporary employee agency, professional employee organization or leasing concern.
- Consider the criteria used by the IRS for Federal income tax purposes in determining whether individuals are employees of a concern.
- Volunteers are not considered employees.
- Part-time and temporary employees are counted the same as full-time employees.
Q6: If a business has more than 500 employees may it simply borrow less (perhaps up to costs associated with 500 of its employees)?
Generally, no; however, businesses in the hospitality and food/restaurant industries (NAICS Code 72) with more than one physical location are also eligible at the store and location level if the store/location employs 500 or fewer employees. This means that each store location could be eligible for loans under the Program. In addition, if a franchisor is listed in the SBA’s National Franchise Directory, assistance will also extend down to the franchisee at the store or location level.
Q7: Does foreign ownership disqualify a business?
Generally, no, but you will likely need to submit additional proof and/or background information about such foreign owner(s) to your lender and there may be additional restrictions on the use of the funds (i.e., used exclusively for domestic purposes, operating company located in the United States, etc.). See below also; compensation to employees whose principle place of residence is outside the United States may not be used as the basis for a loan.
Q8: Do I need to be profitable?
No. The Act removes the requirement for the lender to evaluate the borrowers’ ability to repay the covered loan, only requires lenders to verify that a business was operational on February 15, 2020, and does not require the borrower to show that it is not able to find credit elsewhere, unlike the normal 7(a) requirements. Therefore, this should allow startups to also take advantage of these loans under the Program subject to certain affiliation rules as described below.
Q9: Are there any industries that are not eligible?
Generally, Section 7(a) of the SBA Act deems several types of businesses ineligible for purposes of loan programs thereunder. A list of businesses that are typically deemed ineligible for Section 7(a) loans can be found in the in Part 120 of Title 13 in the Code of Federal Regulations (C.F.R.), and includes businesses such as casinos, political/lobbying organizations, illegal businesses and businesses located in a foreign country. Nonprofits are also typically considered ineligible, but as we’ve mentioned throughout this alert, nonprofits are explicitly eligible under the Act for loans under the Program. However, the language in the Act regarding eligible entities is extremely broad and seems to make all types of businesses eligible, but we will need to wait to review the regulations issued by the SBA with respect to the Program to determine a definitive answer to this question. For now, all businesses (whether for profit or not for profit) should assume that they will probably be eligible and begin preparing to apply.
Q10: How much is my business eligible for?
Under the Act, a business is eligible for the lesser of $10,000,000 or 2.5 times the average monthly payroll costs incurred during the one-year period before the date of the loan. The technical summary of “payroll costs” is below, but, for the most part, whatever you’ve spent on employees – all in, salary, wages and benefits and even including independent contractors – is your loan eligibility number. Thus, the very name of this new program – the Paycheck Protection Program. The government is trying to ensure that these businesses have enough money to keep people on the payroll until businesses can get back to normal.
Seasonal employers should look at their average costs during the 12-week period beginning February 15, 2019 or they may choose to use March 1, 2019 to June 30, 2019. If a covered entity was not in business in 2019, then they may elect to use the average payment for the period January 1, 2020 to February 29, 2020.
Q11: What exactly is included in payroll costs?
Payroll costs include:
- The sum of any compensation with respect to an employee that is
- salary, wages, commission, or similar compensation,
- payments of cash tips or the equivalent;
- payment for vacation, parental, family, medical or sick leave;
- allowance for dismissal or separation;
- payments required for the provision of group health care benefits, including insurance premiums;
- payment of any retirement benefit;
- payment of state or local tax assessed on the employee;
- The sum of any compensation with respect to a sole proprietor or independent contractor that is a wage, commission or similar compensation and that is not more than $100,000 in one year, as prorated during the covered period (February 15 through June 30; $37,260)
Payroll costs may not include:
- compensation of an individual employee in excess of an annual salary of $100,000 in one year, pro-rated during the covered period;
- taxes imposed or withheld under chapters 21, 22, or 24 of the Internal Revenue Code during the covered period (these are withholdings for FICA, railroad wages and federal income taxes);
- Any compensation of an employee whose principal place of residence is outside the United States; or
- Qualified sick leave wages or family leave wages for which a credit is allowed under Section 7001 or 7003 of the Families First Coronavirus Response Act.
Q12: What are the terms of the loan?
As of this writing, it looks like each lender will set their terms but they must comply with the following:
Payments: Payments (of principal and interest) must be completely deferred for a period of not less than six months. There may be no prepayment penalties.
Interest rate: No more than four percent during the covered period. It is not clear if the SBA will approve loans which have a rate higher than four percent after the covered period.
Unsecured: The loan will be nonrecourse (against shareholders, officers, directors etc.) so long as the proceeds are properly used. An applicant need not assert that it cannot obtain credit elsewhere nor is a personal guarantee required.
The Borrower must make a good faith certification that 1) the uncertainty of current economic conditions makes necessary the loan request to support ongoing operations; 2) the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments; 3) there is no application pending for the SBA’s Export Express Program, and 4) during the period February 15, 2020 through December 31, 2020 there has been no receipt of amounts under the Export Express Program for the same purposes of the Paycheck Protection Program.
Q13: Are portions of the loans actually forgivable? Yes. Perhaps the most important part of the Paycheck Protection Program is the loan forgiveness provisions, Section 1105 of the Act, whereby the federal government will outright forgive portions of the loan balance if the borrower keeps employees on the payroll as measured on June 30, 2020. The terms for that forgiveness are as follows:
A borrower is eligible for forgiveness on an amount equal to certain expenses incurred during the eight-week period beginning on the date of the loan for payroll costs, mortgage interest, rent and utilities (electricity, gas, water, transportation, telephone or internet). The Act requires these expenses to have been in place on or prior to February 15, 2020 and the amount forgiven may not exceed the principal balance owed. So, while the amount of these loans is premised on an employer’s payroll headcount history, the forgiveness provisions permit expenditures on more than just payroll – for those employers that maintain employee headcount and compensation.
Loan forgiveness is reduced by a percentage equal to the average number of full time employees per month employed during the eight week covered period divided by the average number of full-time equivalent employees per month employed by the eligible recipient during either (at the election of the borrower) the period beginning on February 15, 2019 and ending on June 30, 2019, or the period January 1, 2020 through February 29, 2020. Naturally rapidly growing companies should choose the 2019 period as a baseline.
Seasonal employers can use different periods as described above. The Act looks to headcount on each pay period that falls within that month.
In addition to the headcount reduction provision, loan forgiveness is reduced for any reduction in total salary or wages of any employee used in the covered period that is in excess of 25 percent of what that employee earned during the most recent full calendar quarter. This limitation only applies to employees earning wages or salary below $100,000.
The Act excludes from calculations headcounts and salary reductions that occurred between February 15, 2020 and ending on the date 30 days after enactment of the Act. In short, for layoffs or salary reductions that occur during that window, employers can re-hire or restore pay before June 30, 2020 and still qualify for otherwise applicable loan forgiveness. It does not appear that a layoff, for example, enacted on the 31st day would qualify for this savings clause regardless of whether the employer meets the standard on June 30, 2020.
Once forgiven the SBA will remit funds to the lender within 90 days. Look for our upcoming client alert here specifically for bankers and members of the financial services community.
A borrower may apply for forgiveness by submitting documentation verifying 1) the number of employees and their rates of pay (payroll tax filings to the IRS or state unemployment reporting), 2) evidence (cancelled checks, account transcripts, receipts etc.) for mortgage, rent and utilities payments. The borrower will also be required to submit a certification that the information submitted is true and that the amount forgiven was used for the proper purposes described in the Act. We expect more information will be forthcoming on the forgiveness process as June 30, 2020 nears and that lenders will be active in helping to process these requests. However, lenders must communicate the determination to a borrower within 60 days.
Q14: What can the proceeds be used for?
During the covered period the proceeds may be used for:
- payroll costs;
- costs related to continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
- employee salaries, commissions, or similar compensations;
- payments of interest on any mortgage obligation;
- rent (including rent under a lease agreement);
- utilities; and
- interest on any other debt obligations that were incurred before the covered period.
A recipient of a Payroll Protection Program loan is also eligible for an Economic Injury Disaster Loan (see previous client alert here) but may not receive the PPP loan for the same purpose.
Q15: Who does my business apply with?
Unlike the disaster loan program where applications are made directly to the SBA, under the Paycheck Protection Program, approved SBA lenders will facilitate loans. More specifically, each lender will have independent authority to make the loans based solely on whether the applicant was 1) in operation on February 15, 2020; and 2) had employees for whom the borrower paid salaries and payroll or paid independent contractors as reported on a Form 1099-MISC.
There are many SBA approved lenders already in existence, some of which have experience processing large numbers of SBA loans. We recommend that you contact your existing banker to inquire about their involvement in the program.
Q16: What is included in the application?
Under current 7(a) programs each lender uses its own forms subject to the requirement to include certain standard information which typically include the 7(a) Loan Guaranty Processing Center Submission Cover Sheet, SBA Forms 1919, and SBA Form 1920. Borrowers only complete Form 1919 with the lender completing the remainder. However, given the large volume of loans expected and the minimal underwriting criteria, we expect some standards will develop and that the SBA may issue a standardized and simplified application. Speak with your banking representative about the process before completing these forms.
A borrower will, however, want to begin documenting its payroll costs – as described above.
Q17: Does taking out this loan disqualify my business for other assistance?
It should not but see below regarding the Employee Retention Tax Credit. Also, as noted above a borrower may not apply for both an EIDL loan and a Paycheck Protection Loan for the same purpose.
Q18: If we receive loans under the Paycheck Protection Program will we also be able to participate in the Employee Retention Tax Credit or the Social Security Tax Deferral Program?
No. The Act employers provides for a refundable payroll tax credit of 50 percent of qualifying wages paid by eligible employers during the COVID-19 crisis, capped at $10,000 per employee (the “Retention Tax Credit”). The credit is subject to detailed eligibility requirements and other limitations that are outside of the scope of this discussion. Similarly, the Act allows employers to defer the employer portion of social security taxes, fifty percent to December 31, 2021 and fifty percent to December 31, 2022 (the “Social Security Tax Deferral”). Both the Retention Tax Credit and the Social Security Tax Deferral are NOT available to the employers who receive loans under the Paycheck Protection Program.
Q19: If we participate in the Employee Retention Tax Credit or the Social Security Tax Deferral Program, can we subsequently receive loans under the Paycheck Protection Program?
The answer is unclear. At best, we expect that e an employer who participates in the Employee Retention Tax Credit or the Social Security Tax Deferral Program would be required to disgorge the credit and cease the deferral. At worst, participation in the Employee Retention Tax Credit or the Social Security Tax Deferral Program could potentially disqualify the employer from participation in the Paycheck Protection Program. Based on how the law is written, we do not think the “worst” interpretation is correct, but we cannot guarantee that lenders or the SBA will not interpret the law that way. Given the significance of these programs to many small businesses, we hope that the SBA issues clarifications on this issue.
Q20: Will there be information reporting or government controls over my business after I take this loan?
No. Your loan is with a private lender which receives a guaranty from the government. Other government programs to large businesses will require special agreements or restrictions on certain activities such as share buy backs. Those rules do not apply to the programs available to small businesses. Businesses will need to apply for loan forgiveness as described above.
Q21: Are there any tax implications to my business for taking the loan or if part of the loan is forgiven?
No. A loan in and of itself has not tax consequences to your business. And the Act expressly includes a provision that the forgiveness of any debt (as described above) will not create income tax for your business.
Q22: What about other debt I may already have?
Debt associated with the Paycheck Protection Program is unsecured and thus last in line as a creditor. If you have some agreement requiring you to notify a third party that you are taking on additional debt or to secure their approval you should still comply with that agreement.
Q23: What steps do I need to take internally to approve securing this money?
Many venture-backed or private equity owned companies have stringent board and shareholder control provisions. That is, certain actions – usually including taking on debt – require certain approvals. Each business should be sure that it complies with its existing contractual and corporate governance obligations. Many small businesses or sole proprietorships needn’t worry about this as they are likely solely controlled by their owner.
Q24: What is the SBA and its Section 7(a) or 7(b) loan program?
The SBA is an agency of the United States government founded in 1953 to support the growth and development of American small business. The SBA is governed by the Small Business Act which is codified in 15 U.S.C. § 633. Regulations for SBA’s loan programs are found in Part 120 of Title 13 in the Code of Federal Regulations (C.F.R.). The agency provides a variety of counseling and advisory services, but it also works to extend credit directly, in the case of disaster loans, or facilitate the extension of credit to small business from banking institutions – largely through federal guarantee of credit facilities. Typically, the SBA involvement enables the extension of credit where it might not have been available or on more favorable terms with longer repayment periods.
Section 7(a) is the SBA’s flagship program wherein the SBA guarantees portions of loans extended to small business by third party lenders so long as the loans meet the SBA’s criteria. Section 7(a) refers to the Section of the Small Business Act which authorizes loans to small businesses. The new Paycheck Protection Program is an enormous expansion of the traditional 7(a) program.
Section 7(b) is SBA program used to extend credit to disaster-stricken areas. Initial Corona Virus relief was approved through this program – see our update here. As mentioned above, accessing relief under Section 7(b) disqualifies a business from relief under Section 7(a).
Q25: Am I eligible if my business is venture backed?
As of the passage of the Act – maybe. Speak with your legal counsel and lead investor(s) to determine if you have an issue.
Many venture-backed businesses – startups and emerging growth companies – will meet the headcount criteria for the paycheck protection program. While the paycheck protection program is a new stand-alone loan program, it is subject to existing SBA loan guidelines and rules. Those rules include most of the existing affiliation disqualifications. These rules essentially amount to the idea that businesses which are backed by deep pockets (perhaps a VC, private equity fund, or even a wealthy dominant shareholder) should not be able to avail themselves of the preferential debt terms available through the SBA. This logic may hold true in normal times but in the age of a pandemic the rule could have the effect of disqualifying some of the most promising and innovative businesses from help under the paycheck protection program.
We will watch what level of scrutiny lenders and the SBA apply to share ownership structures and the affiliation rules.
Even if an analysis of a business’s affiliations yields a disqualifying result, know that there are a variety of interested groups working to secure an administrative exemption to these rules. We will keep you apprised on any updates.
Q26: Will there be enough money for all small businesses?
The Act authorizes up to $349 billion in loans to be made to various businesses and nonprofits, all in increments not to exceed the lesser of $10,000,000 (or 2.5x monthly payroll). Even assuming that every business that applies will receive the maximum amount (i.e., $10,000,000), that would mean roughly 35,000 businesses would receive loans. This obviously won’t be the end result (i.e., not every applicant will receive $10,000,000), but these numbers do mean that there will not be an endless amount of money available for businesses, so it will be better to get your application in as soon as possible after lenders begin accepting applications, because the loans will likely be available on a first-come, first-served basis (though nothing in the Act expressly indicates that is how the funds will be rationed). As mentioned earlier, that’s why it is very important to stay in constant contact with your banker (or any banker) to ensure you get your application submitted in a timely manner.
Q27: Are there any other changes to the EIDL program I need to know about?
Yes. Section 1110 of the Act also changes the economic injury disaster loan (EIDL) program to make it substantially easier to receive proceeds until December 30, 2020. See the link to our prior update above but be aware of the following changes to that program immediately:
- Broader Application. In addition to small business concerns and private nonprofits, the Act also makes the EIDLs available to sole proprietors, cooperatives and ESOPs as long as they were in business on January 31, 2020, though they still must be considered a small business – see the link to the SBA size tool above.
- Loosened Standards. The following requirements are waived: (a) personal guarantees (for loans up to $200,000), (b) the applicant must have been in business for 1 year and (c) the applicant must establish that it cannot obtain credit elsewhere.
The Act also authorizes the SBA to skip reviewing the applicant’s tax returns and rely solely on a credit score or other information available to the SBA. Again, the goal is to speed delivery of these funds.
$10,000 Grant. An applicant may request an immediate advance on their loan when applying for an EIDL, and the Act requires the SBA to remit it within 3 days of receipt of the application (assuming the applicant self certifies that it is eligible for an EIDL). Even if the full EIDL is denied the applicant may keep the $10,000 grant and will not have to repay it – though that amount would be considered in any application under the 7(a) Paycheck Protection Program described above, and such amount would be reduced from the loan forgiveness amount for a loan for payroll costs under the Paycheck Protection Program. The $10,000 grant can be used for any allowable purposes that a typical EIDL can be used for, including payroll, sick leave, rent and mortgage payments and other working capital expenses.
Each of these requirements were major impediments to broad application of the EIDL program, despite all states having been approved as disaster areas. Other than the $10,000 grant, which does not need to repaid (even if the loan application is denied), this EIDL program does not – as written – qualify for payroll forgiveness available under Section 7(a), unlike the Paycheck Protection Program
Q28: If I have an existing SBA loan that was made before the Act was enacted, can I defer principal and interest payments of that loan?
Yes. Section 1112 of the Act allows lenders to defer payments by borrowers on existing SBA loans for six months, beginning on the next payment date or, if the loan is already deferred, beginning on the first payment date after the deferment period. In such event, the SBA will pay the principal, interest and any associated fees owed directly to lenders during such 6-month period, and the borrower will not be responsible for such payments.
 The SBA is required to release guidance on deferment within 30 days.