An Updated Practical Guide for Small Businesses to Obtain a Paycheck Protection Loan Under CARES Act

SBA Interim Final Rules Issued April 2, 2020 and April 4, 2020

On April 2, 2020 and April 4, 2020, the Small Business Administration (SBA) issued unusual interim final rules (the Rules) providing further detail regarding Paycheck Protection Program loans under the CARES Act. The Rules will take effect immediately upon publication in the Federal Register. However, SBA may revise the Rules  based on public comments submitted within 30 days after publication. SBA relied on Section 1114 of the CARES Act to issue the Rules without following the usual notice-and-comment procedure.This updated client alert is meant to supplement and amend information provided in our client alert dated March 30, 2020, based on the Rules which relate specifically to the matters described below. These updates are highlighted in article below in bold.

Introduction

Due to the economic uncertainty and disruption caused by the COVID-19 outbreak, Congress has passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide relief for small businesses that are undergoing extreme challenges. The Act as passed includes relief to small businesses across the country in the form of a $349 billion Paycheck Protection Program (Program) for Small Business Administration (SBA) eligible businesses and expands the SBA’s current loan program and eligibility requirements in order for businesses to pay employees and keep them on payroll during the current COVID-19 crisis.

Where can you apply for a loan under the Program?

There are numerous lenders that already participate in the SBA’s lending programs. Most SBA lenders tend to be community banks and credit unions. The Act provides that the authority to make loans under the Program can be extended to additional lenders. We suggest you contact your existing banking relationships or other local bank or credit union to see if they are already approved.

When is the application deadline?

Applicants are eligible to apply for loans under the Program until June 30, 2020. We recommend applying for a loan as soon as possible so that proceeds can be used at the earliest opportunity. Loans under the Program are first come, first served.

Who is eligible to apply for these loans?

Any business concern, nonprofit organization, veterans organization or tribal business concern that (i) was operating on February 15, 2020; (ii) had employees for whom it paid salaries and payroll taxes, or paid independent contractors; (iii) has 500 or fewer employees (with exceptions noted below) whose principal place of residence is in the United States; (iv) has a physical place of business in the United States and transacts business in the United States; and (v) has been substantially impacted by COVID-19. Although the eligibility criteria includes a business with “paid independent contractors,” payments to independent contractors are not included in payroll cost calculations. See “Are Amounts Paid to Independent Contractors Included in Determining Payroll Costs and the Amount You Can Borrow” below.

What does that mean? It means if your business meets the criteria described in (i)–(v) above, you are eligible to apply regardless of the form your business takes—whether it’s a C Corporation, an S Corporation, an LLC, a nonprofit or a franchisee. Sole proprietorships, independent contractors and certain self-employed individuals are also eligible to apply.

You must also submit such payroll documentation as is necessary to establish eligibility such as payroll processor records, payroll tax filings, or Form 1099- MISC, or income and expenses from a sole proprietorship. For borrowers that do not have any such documentation, the borrower must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount.

Who is ineligible?

Ineligible businesses include those engaged in illegal activities, loan packaging, speculation, multi-sales distribution, gambling, investment or lending, or where the owner is on parole. This means that firms involved in lending activities and firms involved in illegal activities (e.g., cannabis companies) are not eligible to participate in the paycheck protection program. For more information on businesses that are not eligible for loans under the Program, see 13 CFR 120.110 and the SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2 (but note that nonprofit organizations authorized under the Act are eligible). 

Are there any exceptions to those criteria?

A few exceptions are as follows:

• If your business is in an industry with an SBA standard that is greater than 500 employees, the 500-employee limit does not apply. For example, telecommunications carriers have a size standard of 1,500 employees, book and newspaper publishers have a standard size of 1,000 employees, and music publishers have a size standard of 750 employees. The SBA size standards tool can be found at https://www.sba.gov/size-standards/.
• And if your business provides accommodation and food services with more than one physical location, and the total number of employees is greater than 500, that criterion is waived if you employ 500 or fewer employees per location.

Do part-time and other non-full-time employees count in the 500-employee determination?

Yes, part-time employees and employees working on a basis other than full time or part time (which we expect includes employees who work irregular schedules or do on-call or project-based work) are counted in the 500-employee determination.

What other nuances surround the 500-employee determination?

The SBA eligibility rules apply an “affiliation” test for determining whether the 500-employee threshold is exceeded. This means a borrower’s “affiliates” are considered when determining eligibility for an SBA loan. The affiliation analysis can be very complex. For example, a lender may group together portfolio companies of a venture capital or private equity firm in determining whether a borrower has more than 500 employees.

It is currently unclear whether and how lenders may impose this aggregation test—such an aggregation could have the unfortunate effect of excluding many startup and emerging growth companies from relief under the Act. NOTE that it was widely expected that the SBA would issue guidance regarding the existing affiliation rules which would make a number of these entities potentially eligible under the Program. However, the SBA Interim Final Rules issued on April 4, 2020 did not provide such anticipated guidance and largely summarized the existing affiliation rules without material change. It is hoped that further clarification from the SBA will be forthcoming. The Act, however, specifically waives these affiliation rules for (i) borrowers in the accommodation and food services industry, (ii) franchises with multiple locations, and (iii) businesses that receive financing through the Small Business Investment Company (SBIC) program. In addition, the SBA Interim Final Rules issued on April 4, 2020 waive these affiliation rules for qualified faith-based organizations as defined under the SBA regulations, where the application of the affiliation rules would substantially burden those organizations’ religious exercise.

While we advise borrowers to consult with counsel before determining whether a business that potentially has affiliates is eligible for a loan under the Program, the SBA’s guide on size and affiliation rules can be accessed at https://www.ecfr.gov/cgi-bin/text-idx?rgn=div5;node=13%3A1.0.1.1.17#se13.1.121_1103.

Does the lender itself or the SBA determine whether you are eligible to apply for a loan under the Program?

The SBA has delegated authority to lenders themselves to make eligibility determinations without needing to go through SBA channels. These determinations are to be based only on the eligibility criteria above, and ability to repay should not be considered an eligibility criterion.

Does eligibility mean you will be approved and/or approved quickly for the loan?

Not necessarily. There is still an approval process that is undertaken by the lender, as well as specific paperwork which must be filed. For a standard Section 7(a) loan, the SBA turnaround time is five to 10 days, although it is reasonable to assume the typical approval process timeline may be shortened due to the needs addressed by the Act.

As noted above, the SBA REGS specifically state that the loans will be on a “first come, first served” basis. Borrowers will be required to make good faith certification that (i) they have been affected by COVID-19; (ii) they will use funds to retain workers and maintain payroll or make mortgage payments, lease payments, utility payments and interest payments on other debt obligations; and (iii) they do not have another application pending for the same type of loan and have not received the same type of loan. However, a borrower does not need to show it is unable to obtain credit elsewhere, which is usually a factor in obtaining SBA loans.

The borrower must submit SBA Form 2483 (Paycheck Protection Program Application Form) and payroll documentation, as described above. The lender must submit SBA Form 2484 (Paycheck Protection Program Lender’s Application for 7(a) Loan Guaranty) electronically in accordance with program requirements and maintain the forms and supporting documentation in its files.

On the Paycheck Protection Program application, an authorized representative of the borrower must certify in good faith to all of the below:

1. The applicant was in operation on February 15, 2020 and had employees for whom it paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC.
2. Current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant.
3. 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 1 A representative of the applicant can certify for the business as a whole if the representative is legally authorized to do so. 18 fraud. As explained above, not more than 25 percent of loan proceeds may be used for non-payroll costs.
4. 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.
5. 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 percent of the forgiven amount may be for non-payroll costs.
6. During the period beginning on February 15, 2020 and ending on December 31, 2020, the applicant has not and will not receive another loan under this program.
7. 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. 19 viii. 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.

How much can an applicant borrow under the Program?

The maximum amount any eligible business may borrow is the lesser of (i) the business’s average total monthly payroll costs during the one-year period prior to the loan being made multiplied by 2.5, plus the outstanding amount of an SBA disaster loan that was made between January 31, 2020, and the date that such loan is financed with a loan under the Act; or (ii) $10 million.

• If a business was not operating during the period beginning February 15, 2019, through June 30, 2019, then the calculation of average total monthly payroll cost should be for the period beginning January 1, 2020, through February 29, 2020. So, if the loan is made April 1, 2020, the one-year period will be calculated for the period April 1, 2019, to March 31, 2020.
• For seasonal businesses (businesses that hire employees seasonally, such as for summer or winter only), the business’s average total monthly payment for payroll costs will be measured using a 12-week period beginning February 15, 2019, or the period beginning March 1, 2019, and ending June 30, 2019, whichever the seasonal employer chooses.

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 twelve 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 January 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).

What is included in determining payroll costs?

• Under the Act, payroll costs include:
  • Salaries, wages, tips andcommissions
  • Payments for vacations, family, medical or sick leave
  • Group health benefit insurance premiums
  • Retirement benefits and separation payments
  • State and local taxes assessed on the compensation of employees
  • For an independent contractor or sole proprietor, wage, commissions, income, or net earnings from self-employment or similar compensation.
• Payroll costs, however, do not include compensation paid to an individual in excess of an annual salary of $100,000, as prorated for the relevant period, or to individuals with a principal residence outside the U.S.
• Therefore, only the salary of an individual employee in excess of an annual salary of $100,000 as prorated for the period is excluded.

Are Amounts Paid to Independent Contractors Included in Determining Payroll Costs and the Amount You Can Borrow?

No, 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.

Is there anything that is expressly excluded from the definition of payroll costs?

Yes. 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 February 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).

Are there any other nuances with respect to amounts that may be borrowed?

Yes—If you received an SBA EIDL loan from January 31, 2020 through April 3, 2020, you can apply for a PPP loan. If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. If your EIDL loan was used for payroll costs, your PPP loan must be used to refinance your EIDL loan. Proceeds from any advance of up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan. However, at least 75% of the PPP loan proceeds shall be used for payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included.

What are the general terms of a loan made under the Program?

The specific terms of a loan made under the Program are negotiated between a borrower and a lender. However, the Act sets forth certain limits and requirements for such loans, including the following:

• Interest rate of  1%.
• You will not have to make any payments for six months following the date of disbursement of the loan. However, interest will continue to accrue on PPP loans during this six-month deferment.
• Loan term of two years.
• Government guarantee of the loan at 100%.
• Collateral requirements and personal guarantees are waived.
• No SBA application fees.
• The loan may be eligible for partial or total forgiveness (see below).
• No prepayment penalties.

How can a borrower use a loan made under the Program?

In addition to existing allowable uses under the SBA’s Section 7(a) loan program, the proceeds of a paycheck protection loan may be used for payroll costs (see discussion above); mortgage interest payments (but not mortgage prepayments or principal payments); rent, utilities and group healthcare benefits; and interest on any other debt obligations incurred prior to February 15, 2020. At least 75% of the PPP loan proceeds must be used for payroll costs.

The loan can also be used to refinance an earlier SBA loan made during the period beginning on January 31, 2020. Although there is generally no personal liability for a borrower of a paycheck protection loan, a borrower can be held liable if there is an unauthorized use of proceeds.

While a business may use the proceeds of a paycheck protection loan for any of the purposes set forth above, amounts used for purposes other than those set forth below (under “Does the Act provide for forgiveness of any part of the amount borrowed under the Program?”) will not be eligible for forgiveness.

I received an EIDL. Can I still get a paycheck protection loan?

If you received an SBA EIDL loan from January 31, 2020 through April 3, 2020, you can apply for a PPP loan. If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. If your EIDL loan was used for payroll costs, your PPP loan must be used to refinance your EIDL loan. Proceeds from any advance of up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan. However, at least 75% of the PPP loan proceeds must be used for payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included.

If an EIDL was made on or after January 31, 2020, the borrower can refinance the EIDL into a paycheck protection loan and receive loan forgiveness benefits on the refinanced amount. Portions of an EIDL that are not refinanced would remain an EIDL.

Did the Act change requirements of the EIDL program?

The Act also waives (i) rules relating to personal guarantees on EIDLs up to $200,000, (ii) the requirement that a borrower has been in business for at least one year, and (iii) the requirement that a borrower is unable to obtain credit elsewhere.

Note: The EIDL application link at the SBA can be accessed at covid19relief.sba.gov/#/ 

Does the Act provide for forgiveness of any part of the amount borrowed under the Program?

Yes—the Act provides for loan forgiveness as follows:

• The amount of loan forgiveness can be up to the full principal amount of the loan and any accrued interest. That is, the borrower will not be responsible for any loan payment if the borrower uses all of the loan proceeds for forgivable purposes described below and employee and compensation levels are maintained.
• Borrowers will be eligible to apply for forgiveness on a loan under the Program in an amount equal to the amount spent by the borrower during the eight-week period after the origination date of the loan on payroll costs (see discussion above); interest (not principal) payments on any mortgage existing prior to February 15, 2020; payment of rent on any lease in force prior to February 15, 2020; and payment on any utility for which service began before February 15, 2020. However, not more than 25% of the loan forgiveness amount may be attributable to nonpayroll costs.
• As stated above, while loan proceeds can be for other permissible business-related expenses, such as inventory, the portion of the loan used for such purpose will not be forgiven.
• The amount forgiven may not exceed the principal amount of the loan. If the full principal of the loan is forgiven, the borrower is not responsible for the interest accrued in the eight-week covered period. The remainder of the loan that is not forgiven will operate according to the loan terms agreed upon between the borrower and the lender.
• Any sick leave or family or medical leave pay for which the borrower receives loss forgiveness is not eligible for tax credits under the Families First Coronavirus Response Act.

Are there limits to the amount of the loan that can be forgiven?

Yes—there are limits to the amount of the loan that can be forgiven.

• The amount of loan forgiveness will be reduced in proportion to any reduction in the number of employees that you employed during the 8-week period as compared to the number of persons you employed during either  (a) the period beginning February 15, 2019, through June 30, 2019, or (b) the period beginning January 1, 2020, through February 29, 2020.
• The amount forgiven is also reduced by the reduction in pay of any employee in excess of 25% of the employee’s compensation during the most recent quarter during which the employee was employed before the eight-week period. Reductions in pay for employees with annualized salary of more than $100,000 are not considered in this calculation.
• Note that there may be implications for loan forgiveness for borrowers who have fired or furloughed employees, or who are considering firing or furloughing employees, and who are considering rehiring these employees. These are fact-specific questions that should be discussed with an attorney to determine the proper course of action for a borrower to maximize the eight-week measurement period for loan forgiveness.
• Borrowers that rehire workers previously laid off from February 15, 2020, through April 26, 2020, or that make up for wage reductions during such period by June 30, 2020, will not be penalized for having reduced staffing or payroll at the beginning of the period. For full details regarding rehiring fired or furloughed employees and the loan forgiveness calculation, see Congressional Action in Response to the Global Pandemic—Lending Programs and Relief Provisions Under the CARES Act
• The loan forgiveness program has positive implications for business owners, as the portion of the loan amount forgiven will not be taxed as income.

Is loan forgiveness automatic?

No—it must be specifically applied for and approved by the lender.

To apply for loan forgiveness, the borrower must submit to the lender that is servicing the loan an application that includes (i) payroll tax filings and state filings and payment receipts for mortgage, rent, and utilities; (ii) a breakdown of how the loan amount was utilized among the areas of employee retention, mortgage, rent and utilities; and (iii) certification from an officer that the amount for which forgiveness is requested was used to retain employees, make payments on covered rent obligations or make covered utility payments.

Lenders will decide whether to accept a borrower’s application for forgiveness within 60 days of receipt.

Documentation of the foregoing will likely be critical to loan forgiveness, and careful attention should be paid to specifically track uses of loan proceeds.

Please note that the Act also addresses other lending programs available in response to the global pandemic. These include:

• Those smaller EIDLs referenced above. EIDLs are loans in an amount up to $2 million that the SBA will also provide to businesses with not more than 500 employees, agricultural cooperatives, and private nonprofit organizations that meet the SBA’s industry-specific business size limitations in declared disaster areas (all 50 states and Washington D.C.) and that have suffered substantial economic damage as a result of COVID-19 for the period of January 31, 2020, to December 31, 2020.
• The Act also allows businesses that self-certify as eligible to apply for an EIDL advance, in an amount up to $10,000, to be provided within three days after receipt of the application. Advances can be applied to any allowable purpose under the Program. Note: If an applicant that receives an advance is subsequently denied an EIDL, the advance is forgiven. If an applicant receives such an advance and received a loan under the Program, the advance amount is reduced from the loan forgiveness for a loan under the Program. Also note: These advances appear relatively simple to apply for, and Congress has designated $10 billion for these immediate grants.

How Manatt’s SBA/CARES Act Response Group Can Help: Comprised of experienced attorneys representing a cross section of practice disciplines, the Manatt SBA/CARES Act Response Group  provides borrowers and lenders with practical advice regarding the provisions of the CARES Act and assists these clients to navigate and obtain relief under the Act.

For More Information: Please contact any of the following professionals:

• Katherine J. Blair, Partner, Capital Markets, at kblair@manatt.com or 310.312.4252.
• David W. Herbst, Partner, Tax, Employee Benefits and Executive Compensation, at dherbst@manatt.com or 650.812.1320.
• Brian S. Korn, Partner, Manatt Financial Services, at bkorn@manatt.com or 212.790.4510.
• Thomas J. Poletti, Partner, Capital Markets, at tpoletti@manatt.com or 714.371.2501.
• William T. Quicksilver, Partner, Corporate and Finance, at wquicksilver@manatt.com or 310.312.4210.
• Emily P. Gelman, Associate, Corporate and Finance, at egelman@manatt.com or 310.312.4322.
• Veronica Lah, Associate, Corporate and Finance, at vlah@manatt.com or 310.312.4130.