This Legal Update summarizes welcome changes to the U.S. Small Business Administration (SBA) Economic Injury Disaster Loan (EIDL), SBA Express Loans, and the creation of the Paycheck Protection Program (PPP) — a new type of small business loan under 7(a) of the Small Business Act. PPPs work best for taxpayers with higher payroll, especially if they will use the proceeds to fund Payroll Costs (as defined below) over the eight weeks following the date the PPP is made.
On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, available here. CARES provides an additional $349 billion in funding for SBA grant and loan programs.
Many readers may already be familiar with the SBA’s 7(a) loan guaranty program. It provides federal government guarantees for small business loans originated by approved lenders. CARES expands the 7(a) program with the addition of the PPP.1 A PPP loan specifically addresses business disruption caused by COVID-19 by enabling any eligible businesses to retain their employees. Most small businesses in operation on February 15th, 2020 will be eligible and there are targeted changes to expand eligibility to the hard-hit restaurant and hospitality industry.2
PPP loans differ from (and are much better than) traditional 7(a) loans in several important ways. First, and most significantly, there are no personal guarantee or collateral requirements. Second, applicants need not establish that they are unable to obtain credit via traditional lending channels (eliminating the so called “credit elsewhere” rule). Indeed, PPP lenders will not even evaluate repayment ability. Because these loans are 100% federally guaranteed, lenders will only consider whether the business was operational on February 15, 2020, and had employees for whom it paid salaries and payroll taxes, or paid independent contractors.
Eligible recipients i.e., borrowers, include not just the traditional “small business concerns”3 but also any other business concern (including IRC 501(c)(3) nonprofits, 501(c)(19) veteran’s organizations, and Tribal concerns) provided they employ not more than the greater of:
(i) 500 employees, or
(ii) the applicable industry size standard.4
Additionally, individuals who operate under a sole proprietorship or as an independent contractor, and certain self-employed individuals, are eligible.
Use of Loan Proceeds
PPP applicants must certify, in good faith, that the loans are required to continue operations due to the current economic circumstances and acknowledge that the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments, and that the applicant does not have other “covered loan” applications pending for similar or duplicative purposes.
Proceeds must be used to fund:
The definition of Payroll Costs also includes compensation or income of a sole proprietor or independent contractor that is a wage, commission, income or net earnings from self-employment, again capped at $100,000 pro-rated for the covered period.
Maximum Loan Amount
PPP loans are available in amounts up to the lesser of:
(i) $10,000,000 or
(ii) an amount equal to one month of Payroll Costs, calculated above (subject to the $100k cap per employee) and on a trailing 12-month average basis multiplied by 2.5.
Example: Assuming a PPP loan made on May 1, 2020, to a business with average monthly Payroll Costs for the period May 1, 2019, to April 30, 2020, of $1,000,000, then the maximum loan amount would be $2,500,000. Special rules apply for seasonal employers who can look to the average total monthly payments for payroll over a 12-week period beginning on certain specified dates.
PPP loans are capped at 4% interest with a maximum maturity of 10 years. There are no prepayment penalties or loan fees payable by the borrower. Because at this time all borrowers are deemed to be economically affected by the pandemic, principal and interest payments are deferred for at least six months, but not more than a year (but interest will continue to accrue during the deferral period.) Presumably some lenders will offer a full year of deferral whereas others may only offer six months. PPP loans can also include the outstanding amount of an EIDL made between January 31, 2020, and the date on which such loan may be refinanced with a PPP loan.
But wait, there’s more….
Perhaps most significantly, PPP loans are eligible for forgiveness. Most eligible businesses negatively impacted by the pandemic should qualify for forgiveness of loan principal up to the amount paid by the business, during the eight-week period after the loan is made, for the following operational expenditures:
(i) qualifying Payroll Costs,
(ii) interest payment on any mortgage (including mortgages on personal property),9
(iii) covered rent, and
(iv) covered utilities (gas, water, transportation, telephone and internet)
— in each case to the extent those obligations existed as of February 15, 2020, as demonstrated by verified documentation borrowers must submit to their lender as part of obtaining forgiveness. The SBA will pay the lender for amounts forgiven.
The amount of the loan subject to forgiveness may be reduced if employees are terminated during the covered period or compensation is reduced by more than 25%.
Any amounts forgiven are excluded from gross income for tax purposes.
Who to Contact to Get Your Loan
PPP loans will be offered through the same lenders approved to offer 7(a) loans. Click here to find an approved lender. Lenders that are not currently approved to make 7(a) loans may apply for authority to offer PPP loans through the U.S. Department of the Treasury. We know that many financial institutions that are not already SBA lenders are considering entering this space. Lenders are compensated by a percentage of the loan size on a sliding scale from 5% of loans under $350,000 to 1% of loans over $2,000,000.
As a brief but important side note, the CARES Act also expands the 7(a) Express program to increase the maximum loan amount. The SBA 7(a) Express Program provides for lending decisions to be turned around in 36 hours (compared with multi-week processing for most 7(a) loans). The CARES Act raises the limit for the 7(a) Express Program from $350,000 to $1,000,000.
CARES also dramatically expands the availability of EIDL loans and streamlines the application process. EIDL loans are now available throughout the U.S. (previously only in declared disaster areas) in amounts up to $2,000,000. Unlike 7(a) loans, small businesses apply for an EIDL loan directly through the SBA via online portal here.
CARES expands eligibility for EIDL loans beyond the previous definition of “Small Businesses” to include: (i) a business with not more than 500 employees; (ii) Tribal businesses, cooperatives and ESOPs with not more than 500 employees; (iii) any individual operating as a sole proprietor or an independent contractor; and (iv) private nonprofits and small agricultural cooperatives. Additionally, for EIDL loans completed before December 31, 2020, SBA will no longer require personal guarantees for those loans (or advances) under $200,000.
The SBA has also changed the requirement that borrowers must be in business for a full year to require only that borrowers be in business as of January 31, 2020. Also, like the 7(a) modifications described above, they will no longer require borrowers to demonstrate that they are unable to obtain credit elsewhere. For EIDL loans that close before December 31, 2020, all credit decisions will be made solely based on the credit score of the applicant or an appropriate method establishing the borrower’s ability to pay. This change alone should significantly streamline the approval process.
EIDL applicants may also request an emergency grant directly from SBA of up to $10,000. Such advances are considered grants rather than loans and are not subject to repayment, even if the EIDL is later denied. Currently these advances are committed to be provided within three days after the SBA receives the loan application. If an EIDL recipient later refinances into a PPP loan, any advances would be offset against any payroll related loan forgiveness.
Applicants with immediate financing needs may consider applying for an EIDL first, then seek to refinance with a PPP loan.
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1 CARES Act Section 1102 provides for the PPP program; loan forgiveness provisions are included in sections 1106 and 1109.
2 Before CARES, affiliate companies controlled by the same principals were counted as one in determining whether a business qualifies as “small.” After CARES, the affiliation rules are waived for: (i) the hospitality and restaurant industries; franchises that are approved on the SBA’s Franchise Directory; and (iii) small businesses that receive financing through the Small Business Investment Company (SBIC) program. The 500 employee limit is also applied to each location for concerns assigned a NAICS code beginning with 72 at the time of disbursal.
3 A “small business concern” is defined by reference to section 3 of the Small Business Act, 15 U.S.C. 636. But again, CARES PPP loans expand that definition to include more than the traditionally defined small business concerns.
4 The SBA industry size standards are available here.
5 PPP loan proceeds cannot be used to compensate individual employees, independent contractors, or sole proprietors in excess of an annual salary of $100,000 per person, determined on a prorated basis between February 15, 2020 and June 30, 2020. The definition of Payroll Costs expressly excludes amounts paid to compensate an employee whose principal place of residence is outside the U.S. (which leaves open the question of independent contractors resident outside the US). Proceeds of PPP loans cannot be used to duplicate wages already covered by the Families First Coronavirus Response Act. CARES Act section 1102(a)(2).
6 Exclusion of payroll taxes is strange because the employer must pay these amounts, but does not get credit. Thus, for example, the Payroll Costs for an independent contractor paid $50,000 are higher than those of an employee paid $50,000.
7 No, we are not making this up; the paycheck protection program allows use of funds to pay severance as a payroll cost. See CARES Act section 1102(a)(2) relating to the addition to 15 U.S.C. (the Small Business Act) section 7(a)(36)(A)(viii)(I)(aa)(DD)).
8 Actually, the representation related to debt is that amounts are used to pay mortgages, without distinguishing between principal and interest and excluding non-mortgage debt. But forgiveness is permitted to the extent the proceeds are used to pay any interest, including mortgage interest. Prepaid principal does not count but it seems that interest paid upon prepayment under a yield-to-maturity provision could be forgiven upon a prepayment of the mortgage debt.
9 Note that while non-mortgage debt obligation payments are an authorized use of PPP loan proceeds, such payments are ineligible for forgiveness.
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