The deep economic shocks emanating from the shelter-in-place orders caused by the Covid-19 pandemic are still reverberating through the nation’s economy. While discussions of further stimulus have begun in Washington, it is unlikely any further legislation passed will contain programs as substantial for businesses as the Paycheck Protection Program (PPP) and other programs implemented by the CARES Act. At the time of this writing, the PPP has provided over 4.4 million loans to small businesses across the United States totaling more than $510 billion; however, many argue that does not go far enough to aid businesses. Due to restrictions placed on the use of PPP loan proceeds for forgiveness, recipients must expend at least 75% of PPP loan proceeds on eligible payroll costs. While such restriction is intended to ensure that Americans are employed, the 75% mandate does not leave a significant sum for business owners trying to meet rent/mortgage, utilities, and other obligations. Furthermore, unless the forgiveness period for using the PPP loan proceeds is extended beyond the initial eight-week period to a much longer period, restaurants and other recipients that cannot fully staff operations due to safety concerns and governmental restrictions will not fully benefit from the intended forgiveness provisions. Borrowers that do not receive forgiveness will then find the loan term of two years very challenging.
Accordingly, in addition to the PPP, many business owners have applied for Economic Injury Disaster Loans (EIDL) administered by the Small Business Administration (SBA). The intent of the EIDL was to provide capital at a reasonable interest rate to businesses to help them through limited operations due to the pandemic. Terms include:
- Historically, the maximum loan amount was $2 million dollars. With the pandemic and increased demand, loans are now capped at $150,000. This lower amount makes the EIDL less appealing to many businesses, especially when coupled with the other terms described below.
- EIDLs may be used for ‘working capital’ such as costs due to supply chain interruption, to pay obligations that cannot be met due to revenue loss and for other uses, but only to alleviate economic injury caused by disaster occurring in the month of January 31, 2020 and continuing thereafter. In addition to other remedies, any misapplication of loan proceeds could result in civil liability to SBA for one and one-half times the proceeds disbursed.
- No personal guarantee is required because the loan is less than $200,000.
- Fixed interest rates of 3.75% for small businesses and 2.75% for nonprofit entities.
- Typically payments commence after 1 year and the maturity date is in 30 years, although the borrower may prepay the loan in part or in full at any time, without penalty.
While EIDLs offer additional flexibility for business owners in need of funds, there are important restrictions that applicants must be aware of, some of which may interfere with a business’ operations in the normal course.
One important consideration is that for EIDLs in excess of $25,000, the SBA will take a security interest in all ‘Collateral’ defined as:
“all tangible and intangible personal property, including, but not limited to: (a) inventory, (b) equipment, (c) instruments, including promissory notes (d) chattel paper, including tangible chattel paper and electronic chattel paper, (e) documents, (f) letter of credit rights, (g) accounts, including health-care insurance receivables and credit card receivables, (h) deposit accounts, (i) commercial tort claims, (j) general intangibles, including payment intangibles and software and (k) as-extracted collateral as such terms may from time to time be defined in the Uniform Commercial Code.”
Borrowers must determine whether obtaining the EIDL and providing a security interest in the Collateral is a violation of any existing loans, thereby requiring the prior consent of existing lenders. Borrowers will be charged for Uniform Commercial Code (UCC) lien filing fees after including the indebtedness tax and a third-party UCC handling charge of $100, all of which will be deducted from the EIDL proceeds.
Borrowers need to be aware that the SBA EIDL documents restrict the sale or transfer of any collateral (except for normal inventory turnover in the ordinary course of business) without prior written consent of the SBA. If borrowers keep the loan for the entire term, disposing of obsolete Collateral will be a cumbersome process.
More importantly, many borrowers have existing lines of credit secured by some or all of the Collateral. Because any such preexisting line of credit will have a superior lien compared to the SBA’s security interest, and after receipt of an EIDL, the business will need the consent of the SBA to utilize the line of credit for any purpose, including inventory purchases or other regular business operations, there will be delays in normal business operations. Borrowers must therefore be aware that until they repay the EIDL in full, they are likely to be prohibited from seeking or accepting any future advances under existing lines of credit, and that other lenders may be hesitant to extend new lines of credit when they will not have a first priority position in the Collateral. This has the, perhaps unanticipated, effect of either making lines of credit unavailable to borrowers, or causing unaware or desperate borrowers to breach the terms of their EIDL and possibly their existing lines of credit.
While these restrictions, and numerous others included in the EIDL documents, may not ultimately cause a business owner to decline an EIDL, it is important to understand the implications and restrictions prior to accepting the loan. Any default could result in the entirety of the loan balance becoming immediately due and payable, and any false statement or misrepresentation may result in criminal, civil or administrative sanctions.