CARES Act: Paycheck Protection Program

On March 27, 2020, Congress passed and the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act provides an approximately $2 trillion stimulus package that includes direct payments to individual taxpayers, small business loans, increased unemployment benefits, and a variety of tax breaks.

Specifically for small businesses and eligible nonprofits, including 501(c)(3) nonprofit organizations as well as eligible veterans organizations and tribal businesses, the CARES Act establishes a Paycheck Protection Program. This is a $349 billion small business loan and loan forgiveness program which expands eligibility for Small Business Administration (“SBA”) loans under Section 7(a) of the Small Business Act. The program is intended to allow businesses to continue functioning while maintaining their current workforce during the period of uncertainty caused by the COVID-19 pandemic and its provisions are retroactive to February 15, 2020. This retroactivity is intended to encourage re-hiring.  

The loans are 100% guaranteed by SBA. The SBA’s application and processing fees are waived, as are the SBA’s personal guarantee and collateral requirements. The SBA is also waiving its credit-elsewhere test, meaning that small businesses with credit available elsewhere remain eligible for loans under the Paycheck Protection Program. The loans are non-recourse, meaning the SBA shall have no recourse against any individual shareholder, member or partner of an eligible recipient of a program loan for non-payment, except to the extent that loan proceeds are used for any unauthorized purpose. Loan payments are deferred for at least six months (and not more than one year.) Interest rates on program loans shall not exceed 4% and there shall not be any prepayment penalty.

Eligibility for the SBA Loans

The threshold issue under the Paycheck Protection Program will be eligibility. In order to be eligible to receive a Section 7(a) loan under the Paycheck Protection Program an applicant must have been in operation on February 15, 2020, and either:

  1. Have no more than 500 employees; or
  2. Qualify underotherwiseexistingeligibilityrulesforSBA loans based on the appropriate industry size standard. The table in 13 C.F.R. § 121.201 lists for each North American Industry Classification code (“NAICS code”) whether the size standard is receipts-based or employee-based.
    • If the applicable size standard is employee-based, the SBA counts all individuals employed on a full-time, part-time, or other basis.
    • If the applicable size standard is receipts-based, then the business will need to calculate its annual receipts for its three most recently completed fiscal years and divide by three.

Eligibility may also be established under the SBA’s “alternative size standard.”  A business satisfies the alternative size standard if (i) the maximum tangible net worth of the applicant is not more than $15 million; and (ii) the average net income after Federal income taxes (excluding any carry-over losses) of the applicant for the two full fiscal years before the date of the application is not more than $5 million.

An eligible recipient applying for a covered loan shall make a good faith certification that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient and acknowledging that the loan funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments. 

A borrower cannot receive a PPP loan in addition to an Economic Injury Disaster Loan (EIDL) through the SBA for the same purposes.  However, a borrower who has an EIDL loan unrelated to COVID-19 may apply for a PPP loan (with an option to refinance the EIDL loan into the PPP loan). The emergency EIDL grant award of up to $10,000 would be subtracted from the amount forgiven under the Paycheck Protection Program.

Affiliation Rules

In almost all cases, Section 7(a) loan eligibility is subject to the SBA’s rules on affiliation.  This means that when determining the total annual receipts, number of employees, or the alternative size standard, the SBA aggregates the total for the applicant’s business and its affiliates. 

The SBA regulations provide that entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. In other words, a business owned or controlled by another must count the employees and finances of its parent company against its threshold numbers when determining eligibility. In determining control, the SBA exercises subjective judgment and considers a number of factors listed in its regulations such as ownership, management, previous relationships with or ties to another concern, and contractual relationships.

The CARES Act waives the affiliation rules for any business concern with 500 employees or fewer that operates under NAICS code 72 (the Accommodation and Food Services sector). The CARES Act also provides that any business operating under NAICS code 72 that has 500 or fewer employees per physical location will be eligible to receive a Section 7(a) loan under the Paycheck Protection Program;

Affiliation rules are also waived for any business concern operated 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 to operate as a small business investment company (“SBIC”) under section 301 of the Small Business Investment Act of 1958 (15 U.S.C. 681).

Benefits of the Loan

The Paycheck Protection Program increases the maximum loan amount for loans made under Section 7(a) of the Small Business Act to $10 million and states that eligible applicants will receive the lesser of (i) the average monthly “payroll costs”[1] for the one-year period ending on the date the loan was made multiplied by 2.5[2] or (ii) $10 million.  All loans will have a maximum maturity of 10 years from the date on which the borrower applies for loan forgiveness. 

In addition to the uses already allowed under the SBA’s Business Loan Program[3], loan recipients under the Paycheck Protection Program are permitted to use the loan proceeds for:

  1. Payroll costs[4];
  2. Payroll support costs, including costs related to the continuation of group healthcare benefits during periods of paid sick, medical, or family leave, and insurance premiums;
  3. Employee salaries, commissions, or similar compensations;
  4. Payments of mortgage interest;
  5. Rent and utility charges; and
  6. Debt interest obligations incurred before the covered period.

Loan Forgiveness

Section 1106 of the CARES Act provides that the loan is eligible for loan forgiveness equal to the following costs incurred and payments made during the eight week period after the loan has been granted:

  1. Payroll costs, as defined in the statute (capped at $100,000 in wages);
  2. Payments of mortgage interest (if the mortgage obligation was incurred before February 15, 2020);
  3. Lease and Rental payments (if in force before February 15, 2020); and
  4. Utility payments (if the utility service started prior to February 15, 2020.

Though Paycheck Protection Program funds may be expended for any use permitted for ordinary SBA 7(a) loans, the Program loan is forgivable only if proceeds are used to pay for the specific items listed above. 

The CARES Act provides that the amount of loan forgiveness will be reduced in proportion to any reduction in the number of employees and to any reduction in employees’ pay of greater than 25% during the period between February 15, 2020, and June 30, 2020.  If the company reduces its workforce or reduces salary/wages during the period between February 15, 2020, and 30 days after enactment of the CARES Act, but subsequently rehires employees or eliminates salary/wage reductions by June 30, 2020, the limitations described above may not apply and the PPP Loans may again be eligible for forgiveness.

Any canceled indebtedness will not be included in the borrower’s taxable income.  However, note that a borrower whose loan is forgiven is not eligible for deferral of the payroll tax offered under Section 2302 of the CARES Act.[5]

Applying for a 7(a) Loan

After determining that your business may be eligible for the SBA’s 7(a) loan program, the next step will be confirming your business eligibility with your chosen lender. The SBA itself does not provide direct loans. Instead it works with lenders who process the application for submission  to the SBA and who provide the loan. The Small Business Administration website has several resources that will aid in working with your lender to file a loan application including a 7(a) Loan Application Checklist. 

What remains to be seen is how fast the SBA responds to what is sure to be an overwhelming number of requests to obtain loans under these programs.  As with all aspects of COVID-19, this is a fluid and rapidly changing environment and SBA loan applicants should closely monitor developments. Treasury Secretary Mnuchin has indicated that lenders should start issuing small business loans under the Paycheck Protection Program by Friday April 3, 2020. Additional guidance from the SBA is anticipated prior to April 11, 2020, as the CARES Act requires the SBA to issue implementing regulations for the Paycheck Protection Program within 15 days of the law’s enactment. 

[1] “Payroll costs” are defined to include payroll, mortgage payments, rent payments and interest payments made on any other debt obligations incurred in the one year period before the loan date, payments for vacation, parental and medical or sick leave, and retirement and healthcare benefits including health care premiums, but exclude the compensation of any individual employee to the extent such salary is in excess of an annual salary of $100,000 as prorated for the covered period and any compensation of employees whose principal place of residence is outside the United States. 

[2] If the applicant is a seasonal employer, the average total monthly payments for payroll shall be for the 12 week period beginning February 15, 2019, or at the election of the eligible recipient, March 1, 2019 and ending June 30, 2019.   For newer businesses not in business during the period February 15, 2019 and ending on June 30, 2019, the average total monthly payroll is determined beginning on January 1, 2020 and ending on February 29, 2020.   

[3] SBA 7(a) loans may be used for financing working capital, refinancing existing debt, and/or for financing the purchase of furniture, fixtures, machinery, equipment, land/buildings, or a business. Note that for certain uses, additional conditions may apply.

[4] See Note 1.

[5] Under Section 2302 of the CARES Act, the employer may significantly defer the deposit of the employer share of social security taxes (but not Medicare taxes).  Specifically, all employer social security taxes otherwise required to be deposited between the date of enactment and December 31, 2020, are not required to be deposited on the normal deposit schedule. Instead, half of such taxes would be required to be deposited by December 31, 2021. The remaining deferred social security taxes would be required to be deposited by December 31, 2022.