On April 2nd, at exactly 6:47pm, the Small Business Administration (SBA) issued interim final rules providing additional guidance for borrowers and lenders on what may be the most anticipated lending facility ever created – the SBA PPP. The application process starts Friday, April 3. Potential borrowers may be in for a bumpy ride as the recently released program rules are complicated and new to lenders.
The SBA interim final rule is effective immediately and provides several items of additional clarity for both borrowers and lenders including:
- Eligibility of the borrower, including additional affiliation guidance;
- Required documentation required from a borrower;
- The borrower’s certification process;
- Examples of payroll based formulas used to compute the loan amount;
- Examples of payroll cost and payments of a general business concern to independent contractors;
- The final interest rate and term of the loan;
- Order of funding operations;
- Ability to use e-signatures; and
- Additional restrictions on the amounts eligible to be forgiven by the borrower.
Critical information
Under the PPP, borrowers can obtain low-interest, forgivable loans in the amount of 2.5x qualified payroll costs plus the outstanding amounts of an Economic Injury Disaster Loan (EIDL) made between Jan. 31, 2020 and April 3, 2020 (less the amounts of any EIDL disaster advance), or $10 million, whichever is less.
The SBA guidance, released yesterday evening (April 2, 2020), also clarifies program details for borrowers. Critical clarification for lenders and borrowers includes the ability for lenders to rely on certifications of the borrower in order to determine eligibility of the borrower and use of loan proceeds. Lenders can rely upon specified documents provided by the borrower to determine qualifying loan amount and eligibility for forgiveness.
However, not all lenders will have time to respond to this guidance and potential borrowers should be prepared for a rocky start to the program. We expect confusion in the marketplace on required documentation and ability to access the lender application platforms today.
The guidance also confirms that the PPP is ‘first-come, first-served’ and provides that the amount of forgiveness can be up to the full principal amount of the loan and any accrued interest. The interest rate has been set at 1% and the maturity is two years.
Required documentation for a borrower includes SBA Form 2483 (PPP Application) and payroll documentation. Treasury has also posted the final application form for borrowers. Potential borrowers should determine the appropriate process and required documentation that their lender will require as application processes may vary by lender. In addition, some lenders have indicated that they will not begin their application process on April 3, 2020, as they seek additional guidance from the SBA. Potential borrowers should confirm with their lender on final application procedures and timing. Note the SBA allows e-signatures or e-consents if a borrower has multiple owners.
Eligibility documentation, as described in the interim final rule, includes payroll processor records, payroll tax filings, or Form(s) 1099-MISC or income and expenses from a sole proprietorship. Again, potential borrowers should confirm documentation requirements with their lender due to the fast moving nature of this lending facility. Many potential borrowers are requesting these reports from their payroll providers to expedite the process. However, not all payroll providers appear to be using consistent approaches so information should be reviewed carefully.
Prior guidance issued by the SBA and Treasury has not provided enough detail regarding the SBA affiliation rules and their applicability. The SBA intends to issue additional applicability guidance promptly but did not do so in this guidance. For example, venture capital and others have advocated these affiliation rules be relaxed under the PPP. Update – On April 3, 2020, the SBA and Treasury issued additional guidance on the affiliation rules, which provide additional clarity (see an overview of the rules published by the SBA and Treasury), as well as provide that faith-based organizations are also waived from the affiliation rules if the relationship is based on a religious teaching or belief or otherwise constitutes a part of the exercise of religion. Helpfully, the interim final rule summarizes four criteria, based on control, to determine affiliation under the PPP.
- Affiliation based on ownership
- Affiliation arising under stock options, convertible securities and agreements to merge
- Affiliation based on management
- Affiliation based on identity of interest
The CARES Act waives the affiliation rules for certain otherwise eligible borrowers. As provided elsewhere, but worth repeating, the guidance from the SBA provides the following:
The affiliation rules described above are waived for
- Any business concern with not more than 500 employees that, as of the date on which the loan is disbursed, is assigned a North American Industry Classification System code beginning with 72;
- Any business concern operating as a franchise that is assigned a franchise identifier code by the SBA; and
- Any business concern that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act of 1958 (15 U.S.C. 681) [an SBIC].
While the immediate guidance does not appear to address the concerns of private equity, the clarity on the rules may assist those entities in making the affiliation determination.
Unanswered questions remain, particularly around the exact computation of ‘payroll costs’ to determine the maximum loan amount. Specifically, the exact amounts to use to determine the payroll costs to be excluded over $100,000, as prorated and whether guaranteed payments to a partner are confirmed as qualified compensation for purposes of ‘payroll costs’. The guidance does however, confirm that payments to independent contractors do not count as ‘employee’ payroll costs.
We have noted inconsistency between the guidance in the interim final rule and the statutory language with respect to how to calculate payroll. We hope the SBA clarifies shortly to address the issues surrounding how to compute the appropriate amount of payroll to be used in determining the amount of the loan. Our advisors should take care in providing any determination of qualified amounts.
There is some confusion surrounding the aggregate payroll costs measurement period. While the guidance and the CARES Act states that the aggregate payroll costs for most applicants is to be from the last 12 months before the date on which the loan is made. However, the SBA application states, “For purposes of calculating ‘Average Monthly Payroll,’ most Applicants will use the average monthly payroll for 2019, excluding costs over $100,000 on an annualized basis for each employee.” Interested borrowers should be aware of these discrepancies and should be prepared to have both sets of data available for the application process.
Eligibility
Certain businesses are eligible if they have 500 or fewer employees whose principal place of residence is in the United States, or are a business that operates in a certain industry and meets the applicable SBA employee-based size standards for that industry (see SBA size standards tool), and:
- A small business concern, as defined in section 3 of the Small Business Act, and subject to SBA’s affiliation rules unless specifically waived;
- A tax-exempt nonprofit organization described in section 501(c)(3) of the Internal Revenue Code (the Code), a tax-exempt veterans organization described in section 501(c)(10) of the Code, a Tribal business concern described in section 31(b)(2)(C) of the Small Business Act, or any other business.
A business concern that employees not more than 500 employees per physical location of the business concern and that is assigned a North American Industry Classification System (NAICS) code beginning with 72 at the time of disbursal is eligible to receive a covered loan. The affiliation rules are specifically waived for business concerns with not more than 500 employees with an NAICS code beginning with 72, any business concern operating as a franchise that is assigned a franchise identifier code, and any business concern that receives financial assistance from an SBIC. Other groups, such as churches, have requested clarity that they are eligible for the PPP (but now see the above affiliation waiver from the April 3, 2020 SBA update).
An eligible entity must have been in operation on Feb. 15, 2020 and either had employees that it paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC. In addition, an individual who operates under a sole proprietorship or as an independent contractor or eligible self-employed individual.
Ineligible entities generally include those that engage in activity that is illegal under federal, state or local law; household employers; entities for which a 20% or greater owner is jailed or on probation, subject to criminal charges, or convicted of a felony within the last five years; or if the entity or any business controlled by the owners is seriously delinquent or has defaulted on an SBA or other Federal agency loan in the last seven years and caused a loss to the government. The cannabis industry has, however, requested relief under the ineligibility rules.
Other ineligible business can be found in the SBA regulations and also the SBA SOP 50 10, except that nonprofit organizations authorized under the Act are eligible.
Certifications
An authorized representative of the borrower must certify in good faith that:
- The applicant was in operation on Feb. 15, 2020 and had employees for whom it paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC.
- Current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant.
- The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments and utility payments.
- “I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable such as for charges of fraud. As explained above, not more than 25% of loan proceeds may be used for non-payroll costs.”
- Documentation verifying the number of full-time equivalent employees on payroll as well as the dollar amounts of payroll costs, covered mortgage interest payments, covered rent payments and covered utilities for the eight week period following this loan will be provided to the lender.
- Loan forgiveness will be provided for the sum of documented payroll costs, covered mortgage interest payments, covered rent payments and covered utilities. As explained above, not more than 25% of the forgiven amount may be for non-payroll costs.
- During the period beginning on Feb. 15, 2020 and ending on Dec. 31, 2020, the applicant has not and will not receive another loan under this program.
- “I further certify that the information provided in this application and the information provided in all supporting documents and forms is true and accurate in all material respects. I understand that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.”
- “I acknowledge that the lender will confirm the eligible loan amount using tax documents I have submitted. I affirm that these tax documents are identical to those submitted to the Internal Revenue Service. I also understand, acknowledge, and agree that the Lender can share the tax information with SBA’s authorized representatives, including authorized representatives of the SBA Office of Inspector General, for the purpose of compliance with SBA Loan Program Requirements and all SBA reviews.”
The interim final rules provides that an, “A representative of the applicant can certify for the business as a whole if the representative is legally authorized to do so.”
Borrowing
The following methodology, which is one of the methodologies contained in the Act, will be most useful for many applicants.
- Step 1: Aggregate payroll costs (defined in detail below) from the last 12 months for employees whose principal place of residence is the United States.
- Step 2: 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.
- Step 3: Calculate average monthly payroll costs (divide the amount from Step 2 by 12).
- Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.
- Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between Jan. 31, 2020 and April 3, 2020, less the amount of any ‘advance’ under an EIDL COVID-19 loan (because it does not have to be repaid).
Example 1 – No employees make more than $100,000
- Annual payroll: $120,000
- Average monthly payroll: $10,000
- Multiply by 2.5 = $25,000
- Maximum loan amount is $25,000
Example 2 – Some employees make more than $100,000
- Annual payroll: $1,500,000
- Subtract compensation amounts in excess of an annual salary of $100,000 ($300,000): $1,200,000
- Average monthly qualifying payroll: $100,000
- Multiply by 2.5 = $250,000
- Maximum loan amount is $250,000
Example 3 – No employees make more than $100,000, outstanding EIDL loan of $10,000.
- Annual payroll: $120,000
- Average monthly payroll: $10,000
- Multiply by 2.5 = $25,000
- Add EIDL loan of $10,000 = $35,000
- Maximum loan amount is $35,000
Example 4 – Some employees make more than $100,000, outstanding EIDL loan of $10,000.
- Annual payroll: $1,500,000
- Subtract compensation amounts in excess of an annual salary of $100,000 ($300,000): $1,200,000
- Average monthly qualifying payroll: $100,000
- Multiply by 2.5 = $250,000
- Add EIDL loan of $10,000 = $260,000
- Maximum loan amount is $260,000
Payroll costs consist of compensation to employees (whose principal place of residence is the United States) in the form of:
- Salary, wages, commissions or similar compensation;
- Cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips);
- Payment for vacation, parental, family, medical or sick leave;
- Allowance for separation or dismissal;
- Payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums and retirement;
- Payment of state and local taxes assessed on compensation of employees; and
- For an independent contractor or sole proprietor, wage, commissions, income or net earnings from self-employment or similar compensation.
The Act expressly excludes the following:
- Any compensation of an employee whose principal place of residence is outside of the United States;
- The compensation of an individual employee in excess of an annual salary of $100,000, prorated as necessary;
- Federal employment taxes imposed or withheld between Feb. 15, 2020 and June 30, 2020, including the employee’s and employer’s share of FICA (Federal Insurance Contributions Act) and Railroad Retirement Act taxes, and income taxes required to be withheld from employees; and
- Qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127).
Also, independent contractors have the ability to apply for a PPP loan on their own so they do not count for purposes of a borrower’s PPP loan calculation.
Loan Forgiveness
The reduction in loan forgiveness amounts in the CARES Act are confusing and difficult to navigate. The interim final rule provides that the SBA will issue additional guidance on loan forgiveness, but states that not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. We would expect the other forgiveness reduction provisions, such as the reduction in FTEs and/or reduction in employee salary or wages to be clarified in future guidance.
Also of benefit to borrowers, the CARES Act expressly provides that amounts forgiven under the PPP are excluded from gross income of the borrower. Typically when debt is cancelled or forgiven, the borrower must include such amounts in gross income for income tax purposes.
Use of loans
A PPP loan may be used for the following:
- Payroll costs (as defined in the Act and above);
- Costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave, and insurance premiums;
- Mortgage interest payments (but not mortgage prepayments or principal payments);
- Rent payments;
- Utility payments;
- Interest payments on any other debt obligations that were incurred before Feb. 15, 2020; and/or
- Refinancing an SBA Economic Injury Disaster Loan (EIDL) made between Jan. 31, 2020 and April 3, 2020.
If a borrower received an SBA EIDL loan from Jan. 31, 2020 through April 3, 2020, it can apply for a PPP loan. If the EIDL loan was not used for payroll costs, it does not affect eligibility for a PPP loan. If the EIDL loan was used for payroll costs, the PPP loan must be used to refinance your EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.
For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included. For purposes of loan forgiveness, however, the borrower will have to document the proceeds used for payroll costs in order to determine the amount of forgiveness.
