Doug Alrutz, member of the Firm’s Bankruptcy and Creditors’ Rights Team, authored a guest column for the Memphis Business Journal entitled “Congress has simplified Chapter 11 for small businesses.” Click here to read the article.
President Trump has signed into law the Paycheck Protection Program Flexibility Act of 2020 (Flex Act). In the wake of criticism from many business owners, the Flex Act seeks to address a number of shortcomings of the Paycheck Protection Program (PPP). Most notably, the new legislation is targeted at two requirements of the PPP—the 8-week Covered Period and 75% payroll requirement—which have resulted in businesses being forced to use loan proceeds to cover payroll despite reduced or entirely shuttered operations.
Accordingly, the Flex Act extends the 8-week Covered Period—the original measurement period in which funds were required to be expended in order to be forgiven—to 24 weeks or until the end of the year, whichever comes first. Borrowers are still permitted to utilize the original 8-week Covered Period at their discretion. Additionally, the threshold requirement that 75% of PPP loan proceeds be expended on eligible payroll costs has been lowered to 60%. Consequently, the recipients of PPP loans will now have more flexibility to use a greater proportion of proceeds to cover non-payroll eligible expenditures—such as utilities, rent, and mortgage interest payments.
While the above changes are assuredly welcome reprieves from the rigidity of the PPP, the Flex Act is not without its own unique challenges. In the absence of further regulations or guidance, the Flex Act appears to create a “cliff effect” as it relates to the 60% payroll cost mandate. As written, the Flex Act will only permit forgiveness for borrowers who utilize “at least 60%” on payroll costs which represents a departure from the CARES Act. Thus, if a borrower comes up short of the 60% mark, the entirety of the loan is ineligible for forgiveness rather than simply resulting in a proportional reduction of eligible forgiveness. Moreover, it must be acknowledged that the passage of the Flex Act at this point will greatly disadvantage those early recipients of PPP loans as those who received funding in early April have already expended a majority of the proceeds while operating on the 8-week Covered Period timeline.
The Flex Act additionally provides for the following:
- Creates a minimum maturity date of five years for PPP loans originated on or after the passage of the Flex Act—borrowers who have already received PPP loans may want to discuss with lenders whether maturity dates could be amended in light of this change.
- Extends the workforce restoration period from June 30th to December 31st. In conjunction with the extended Covered Period, employers will now have until 12/31/2020 to restore total employee headcount to pre-pandemic levels.
- Extends the deferral period for making payments on the loan for those who do not have the proceeds forgiven. Rather than a 6-month deferral, the Flex Act would not require repayment until 10 months after the last day of the Covered Period.
- Permits PPP loan recipients to delay payment of the employer portion of social security taxes for all payroll paid from March 27, 2020, through the end of 2020. Borrowers will now be able to defer the payment until 2021 when 50% will be due with the other 50% becoming due in 2022.
Borrowers who have already received PPP loans may want to discuss with their lenders whether their existing loan documentation could be amended in light of the above changes.
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.
The Department of the Treasury (Treasury) and Small Business Administration (SBA) celebrated the holiday weekend early by releasing new Interim Final Rules (Rules) concerning the Paycheck Protection Program’s (PPP) forgiveness calculation. In general, the Rules build upon the application for forgiveness which was released on May 15, but do not address the biggest concerns of businesses—an expansion of the 8-week Covered Period or an elimination of the 75% payroll cost mandate. While both the Senate and House are expected to vote on bills this week which will address those aforementioned concerns, meaningful resolution of those issues will likely not come quick enough for those PPP recipients who received loans in early to mid-April. As of May 23, the SBA had authorized 4,426,118 loans for a total of $511,231,948,095 leaving about $138 billion authorized and available PPP funds remaining.
- Alternative Method for Covered Period – Borrowers with pay cycles of biweekly or more frequent are permitted to elect an alternative payroll Covered Period which allows for a Borrower’s Covered Period to commence on the first day of the pay period following receipt of PPP funds.
- Inclusion of Bonus or Hazard Pay – The Rules expand the definition of eligible payroll costs to include bonuses or hazard pay so long as those payments do not cause an employee’s pro-rated payroll costs to exceed the $100,000 threshold.
- Self-Employed and Owner-Employee Cap – The Rules established a cap on the amount of loan forgiveness available which is limited to the lesser of 8/52 of 2019 compensation (i.e., no more than 15.38% of 2019 compensation) or $15,385 per individual in total.
- When is a non-payroll cost ‘incurred’? – Importantly, the Rules provide much needed clarification that non-payroll costs must be paid or incurred during the 8-week Covered Period and paid on or before the next regular billing date—even if that date is beyond the Covered Period. Additionally, the Rules reiterate that advance payments on mortgage interest are not eligible for forgiveness.
- Refusal to be Rehired – The Rules further expand upon the de minimis exception provided by Question 40 of the FAQs concerning employees who refuse to be rehired following an offer of employment. In particular, the Rules reaffirm that such a reduction of employees will not affect a Borrower’s request for forgiveness so long as the Borrower can demonstrate: (i) the Borrower made a good faith, written offer to rehire; (ii) the offer was for the same salary or wages and same number of hours; (iii) the offer was rejected by the employee; (iv) the Borrower maintained the record documenting the offer; and (v) the Borrower informed the applicable state unemployment insurance office of the rejected offer.
- Definition of Full-Time Equivalent – Due to the CARES Act failing to provide a definition of full-time equivalents, the Rules provide that a full-time equivalent employee is one working 40 hours per week. Additionally, the Rules elaborate on the method for calculating less than full-time employees using the following example:
“For example, if an employee were paid for 30 hours per week on average during the covered period, the employee could be considered to be an FTE employee of 0.75. Similarly, if an employee were paid for ten hours per week on average during the covered period, the employee could be considered to be an FTE employee of 0.25.”
- Proportional Reduction related to 75% Payroll Requirement – Perhaps the most important piece of information to come out of the Rules relates to the dreaded 75% payroll expense requirement. After much uncertainty, the Rules clarify that a Borrower who does not use the PPP loan proceeds to pay 75% towards eligible payroll costs will not suffer a ‘cliff effect’ from a forgiveness standpoint. Rather, the amount eligible to be forgiven is simply reduced according to a percentage calculation based on full-time equivalents during the reference period divided by full-time equivalents during the Covered Period.
- Reduction in Wages or Employees – Finally, the Rules provide further guidance by way of an example to prevent Borrowers from being doubly penalized for reductions:
“Example: An hourly wage employee had been working 40 hours per week during the borrower selected reference period (FTE employee of 1.0) and the borrower reduced the employee’s hours to 20 hours per week during the covered period (FTE employee of 0.5). There was no change to the employee’s hourly wage during the covered period. Because the hourly wage did not change, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction and the borrower is not required to conduct a salary/wage reduction calculation for that employee.”
Interim Final Rules issued by the Small Business Administration and Treasury Department late Friday night provide additional guidance to lenders on forgiveness of loans made under the Paycheck Protection Program. Under the rules:
Lender’s Duties With Respect to Forgiveness Applications. For all loan forgiveness applications, the lender will be required to confirm receipt of the borrower certifications contained in the application and the documentation borrowers must submit to aid in verifying payroll and non-payroll costs, as well as confirm the borrower’s calculations on the application. Lenders also must confirm that the borrower made the loan forgiveness calculation correctly, by dividing the borrower’s eligible payroll costs claimed by 0.75. Lenders are expected to perform a good-faith review, in a reasonable time, of the borrower’s calculations and supporting documents.
Reliance on Borrower Representations. The rules provide that lenders may rely on borrower representations. However, if the lender identifies errors in the borrower’s calculation or a material lack of substantiation in the borrower’s supporting documents, the lender must work with the borrower to remedy the issue. Lenders will not need to independently verify the borrower’s reported information if the borrower submits documentation supporting its forgiveness request and attests that it accurately verified the payments for eligible costs.
Decisions on Loan Forgiveness Applications. The lender must issue a decision to the SBA on a loan forgiveness application not later than 60 days after receipt of a complete application from the borrower. That decision may take the form of an approval in whole or in part, denial, or, if directed by the SBA, a denial without prejudice due to a pending SBA review of the loan. In the case of a denial without prejudice, the borrower may subsequently request that the lender reconsider its application unless the SBA has determined that the borrower is ineligible.
When the lender issues its decision to the SBA, it must request payment from the SBA and include the loan forgiveness calculation form and Schedule A. Subject to any SBA review of the loan or loan application, the SBA will remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, within 90 days. If the lender determines that the borrower is not entitled to forgiveness in any amount, the lender must provide the SBA copies of Schedule A and the PPP borrower demographic information form (if submitted to the lender). In either case, the lender must confirm that the information provided by the lender to the SBA accurately reflects its records for the loan, and that the lender made its decision in accordance with applicable requirements. The lender must also notify the borrower in writing that the lender has issued a decision to the SBA denying the loan forgiveness application.
SBA Review of PPP Loans. The SBA may review any PPP loan at any time in its discretion. That review may examine the borrower’s eligibility, the calculation of the loan amount, whether the borrower used the loan proceeds for allowable uses and whether the borrower is entitled to loan forgiveness in the amount claimed in the borrower’s loan forgiveness application. If the SBA undertakes such a review, the SBA will notify the lender in writing and the lender must then notify the borrower. In addition, the lender will be required to transmit to the SBA, among other things, electronic copies of the borrower application (SBA Form 2483 or lender’s equivalent form), and the loan forgiveness application, if any (SBA Form 3508 or lender’s equivalent form), as well as all supporting documentation provided by the borrower. The lender must also request that the borrower provide a copy of the Schedule A worksheet to the loan forgiveness application and submit the worksheet to the SBA.
If the loan documentation submitted to the SBA or any other information indicates that the borrower may be ineligible for a PPP loan or may be ineligible to receive the loan amount or loan forgiveness amount claimed, the lender will be required to contact the borrower to request additional information and provide any additional information provided to the SBA. If the SBA notifies the lender that it has commenced a loan review, the lender may not approve an application for loan forgiveness until the SBA notifies the lender in writing that it has completed its review.
SBA Denial of Forgiveness Application. The SBA may direct a lender to deny a loan forgiveness application if it determines that a borrower is ineligible for the PPP loan. It may direct a lender to deny an application, in whole or in part, if it determines that the borrower is ineligible for the loan amount or loan forgiveness amount claimed. It may also seek repayment of the outstanding PPP loan balance or pursue other available remedies.
Document Retention. Lenders must comply with applicable SBA requirements for records retention, which for Federally regulated lenders means compliance with the requirements of their federal financial institution regulator.
Eligibility for Processing Fees. Lenders will be required to forfeit and repay to the SBA any lender processing fee received for any SBA-reviewed PPP loan if, within one year after the loan was disbursed, the SBA determines that a borrower was ineligible based on the provisions of the CARES Act or applicable rules or guidance available at the time of the borrower’s loan application, or the terms of the loan application. If a lender fails to satisfy its applicable obligations, the SBA may also seek repayment of the lender processing fee from the lender and may determine that the loan is not eligible for a guaranty.
PPP Loan Forgiveness Checklist
Required Documentation for Borrower’s Forgiveness Application:
- confirm receipt of the borrower certifications contained in the forgiveness application
- confirm receipt and review the documentation borrower must submit to aid in verifying payroll and non-payroll costs
- check the borrower’s calculations on the application (divide the borrower’s eligible payroll costs claimed by 0.75)
- confirm the borrower has corrected any errors identified during the review
Within 60 days after receipt of complete Forgiveness Application:
- issue decision to the SBA of lender’s decision on the loan forgiveness application
- approval in whole or in part
- if directed by the SBA, a denial without prejudice due to a pending SBA review of the loan
Note: If the SBA notifies the lender that it has commenced a loan review, the lender may not approve an application for loan forgiveness until the SBA notifies the lender in writing that it has completed its review.
- request payment from the SBA and include the loan forgiveness calculation form and Schedule A
- provide the SBA copies of Schedule A and the PPP borrower demographic information form (if submitted to the lender) if there is a determination that the borrower is not entitled to forgiveness in any amount
- confirm that the information provided by the lender to the SBA accurately reflects its records for the loan, and that the lender made its decision in accordance with applicable requirements
- notify the borrower of the lender’s decision on the loan (written notice of denial required)
When the SBA undertakes a review of a PPP loan:
- notify the borrower if/when notified that SBA is undertaking review
- transmit to the SBA electronic copies of the borrower application and the loan forgiveness application, as well as all supporting documentation provided by the borrower
- request that the borrower provide a copy of the Schedule A worksheet to the loan forgiveness application and submit the worksheet to the SBA
- if required, contact the borrower to request additional information and provide any additional information provided to the SBA
The Small Business Administration (SBA), in consultation with the Department of Treasury (Treasury), took steps this week to alleviate confusion concerning the Paycheck Protection Program (PPP) which was instituted as part of the monumental CARES Act legislation. Since the introduction of the PPP, the SBA and Treasury have fast-tracked guidance for taxpayers and business owners through the issuance of a number of Frequently Asked Questions (FAQ).
In response to criticism received following stories that large public companies had claimed significant PPP loans, a new FAQ was issued on April 23, 2020 which was meant to remind companies of the required certifications made at the time of submitting a PPP loan. The answer to question 31 provided that any borrower who determined they did not meet such required certification was permitted to repay the loan without penalty by May 7, 2020. In conjunction with the issuance of this FAQ, Treasury Secretary Mnuchin publicly threatened that any company that received a loan in excess of $2 million would be subject to scrutiny and audit. Following those developments, widespread confusion gripped business owners who had already received loans or were contemplating submission of an application.
Following weeks of uncertainty about how and if audits would be conducted, FAQ 46 was issued on May 13, 2020 which clarified that “[a]ny borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.” This admission by the SBA and Treasury is important as it provides clarity for all PPP loan recipients who received loans of less than $2 million in total—including affiliates aggregated together. Additionally, the FAQ mitigated the severity of threatened audits for recipients in excess of $2 million as it explained that if the:
“SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request.”
Finally, FAQ 47 extended the repayment date for any borrower to May 18, 2020.