UPDATE: As of April 16, 2020, the initial $349 billion in funds available through the PPP has been depleted, and the SBA is no longer accepting new applications. Discussions are currently in progress to inject additional capital into the program.
Additionally, some of the ambiguity surrounding payroll costs has also been cleared up by subsequent Treasury guidance. First, certain fringes, including group healthcare coverage and retirement benefits, are included in payroll costs. Furthermore, distributive shares from LLCs or S corporations and guaranteed payments from LLCs are included as payroll costs at the partnership level. It has been clarified that partners are not eligible to file for PPP loans as self-employed individuals.
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act" or the "Act"). The Act is a $2.2 trillion swiss army knife of economic relief provisions meant to reduce the impact of the COVID-19 pandemic on various parts of the U.S. economy. Among these provisions is the $349 billion Paycheck Protection Program (the "PPP"), an expansion of the Small Business Administration Economic Injury Disaster Loan program (the "SBA"). The purpose of the PPP is to help small and middle market businesses pay their employees and otherwise keep the lights on during the economic slowdown. As entertainment productions grind to a halt worldwide as a result of COVID-19, the PPP may be a welcome boon for entertainment businesses trying to stay afloat during this challenging time.
Before addressing the rules, it should be emphasized that taxpayers should file their PPP loan applications ASAP. It is anticipated that the $349 billion allocation to the PPP will be quickly absorbed and accounted for by applications submitted by this Friday (April 3), which means that applications filed next week may be out of luck unless Congress elects to expand the size of the PPP fund. With that as our background, we continue with a general description of the PPP.
Covered Loans Under the PPP
The PPP makes available up to $10 million per qualifying employer of "covered loans." While $10 million is the cap for each loan, most employers will likely end up receiving a smaller loan in the amount of 2.5 times their average monthly payroll (capped at $100,000 per employee). There is a limit of one covered loan per employer. The interest rate on such loans may be up to 1%. All covered loans are subject to a 2-year term. Covered loans will be made available through existing SBA lenders, such as banks and credit unions. The proceeds from covered loans are generally usable for: payroll costs, including salaries, wages, commissions, or other similar compensation; continuation of group health care benefits during periods of paid sick, medical, or family leave, or insurance premiums; mortgage interest; rent; utilities; and interest on other outstanding debt. Additionally, covered loans may be used to refinance existing Section 7(a) loans. No personal guarantee or collateral will be required for any covered loans. No recourse for non-payment will be available to the SBA against any individual shareholders, members, or partners of a qualifying business, except to the extent such person uses covered loan proceeds for an unauthorized purpose.
There is some ambiguity regarding how a business would calculate payroll costs for purposes of the PPP. As outlined above, wages, salaries, commissions, and "similar compensation" are included in the calculation. Accordingly, it is clear that any W-2 compensation would generally be included. Less clear is whether businesses should include in payroll costs bonuses or fringes in excess of base salary, distributive shares from LLCs or S corporations, or guaranteed payments from LLCs. With respect to bonuses, it is arguable that bonuses are similar to commissions and therefore would be picked up by the "similar compensation" language in the legislation. With respect to fringes, distributive shares, and guaranteed payments, it is unlikely that such payments would be within the scope of payroll costs; however, the partner receiving the guaranteed payments may be able to file for a PPP loan in his/her capacity as a self-employed person. Importantly, even if all the above are included in payroll costs, businesses will still be subject to the cap of $100,000 per employee. Accordingly, in calculating the 2.5 times payroll amount for purposes of determining the PPP covered loan for which they are eligible, businesses likely would limit such calculation to standard W-2 payroll costs and potentially bonuses, the latter being a more fact-specific inquiry. Further, and while not free from doubt, it seems likely that employees paid through a payroll company (rather than directly by the applicant) should still be counted for purposes of calculating the applicant's payroll costs as well as toward the 500-employee limit because, while such employees are technically being paid by the payroll company, the applicant retains the right to hire and fire such employees.
Two of the main benefits of PPP covered loans are payment deferral and tax-free loan forgiveness. First, lenders are required to provide complete payment deferral for a period of not less than six months and not more than one year for any borrowers that were in existence as of February 15, 2020. Second, and more significantly, borrowers are eligible for loan forgiveness for up to the full loan amount for loan proceeds expended during an 8-week period beginning from the date of receipt of such proceeds. Forgiveness is available for any proceeds used to pay for payroll costs (capped at $100,000 per employee), mortgage interest, rent, and utilities. Not more than 25% of the forgiven amount may be for non-payroll costs. The amount of loan forgiveness will be reduced by (a) the total drop in employees of the borrower (compared to either February 15, 2019 through June 20, 2019, or January 1, 2020, through February 29, 2020, as selected by the borrower), and (b) any reduction of more than 25% in wages or salary of each employee (excluding employees compensated at an annual rate above $100,000) compared to the most recent full quarter such employee was employed. However, an employer will still receive the full forgiveness amount notwithstanding making either or both of the above reductions if the employer eliminates such reductions by June 30, 2020. It should be noted, however, that even if a loan is not fully forgiven, the relatively low 1% interest rate means that any unforgiven loan proceeds hopefully will not unduly burden a borrower.
Any amount of a covered loan that is forgiven will also be excluded from gross income for federal income tax purposes. Note that California and New York have not yet conformed their tax laws to permit loan forgiveness, although we are hopeful that will happen in the near future. Until that occurs, the loan forgiveness will be taxable at the state level.
Qualifying for the PPP
Businesses will be eligible for covered loans under the PPP if, on the date of the loan application, they employ not more than the greater of (i) 500 employees, or (ii) a size standard established in the regulations for that specific industry. Special affiliation rules apply, which may result in the aggregation of employees for various affiliated entities. Also eligible are individuals who operate under a sole proprietorship, as an independent contractor, or are self-employed. Applications for such loans are made through a qualified SBA lender. For purposes of qualifying for a covered loan, "employee" includes individuals employed on a full-time, part-time, or other basis. Applicants must also certify that the uncertainty of current economic conditions makes the loan necessary to support the applicant's ongoing operations and that the proceeds will be used to retain workers and maintain payroll, make mortgage payments, pay utilities, and pay other necessary expenses.
Covered Loans for Entertainment Businesses
The broad scope of the PPP legislation suggests that many kinds of businesses within the entertainment industry will be able to avail themselves of loan proceeds under the program. For instance, production companies should qualify for covered loans so long as they meet the size restrictions (analyzed in more detail below). The suspension of film and television productions all over the world as a direct result of the COVID-19 pandemic should constitute sufficient "uncertainty of current economic conditions" for purposes of allowing production companies and other entertainment businesses to certify that they require aid under the PPP.
The treatment of temporary or otherwise itinerant workers for purposes of the 500-employee limit and the calculation of average monthly payroll is an open issue that may affect production companies and other entertainment businesses that rely on extensive use of such workers. Many production companies may set up a special-purpose production subsidiary to physically produce a particular project and to employ all production personnel. While such employees are not part of the regular "staff" of the production company, and are really being hired in a "free-lance" capacity at the project level, such employees, including part-time employees and those employed on an "other" basis, may be required to be counted for purposes of the 500-employee limit and also included in calculating the average employee compensation. It is not clear what constitutes employment on an "other" basis, but it is not unreasonable that temporary employment would constitute a form of "other" employment under a conservative reading of this provision. Accordingly, production companies and other entertainment businesses that employ a number of temporary personnel on the date such businesses apply for a PPP loan should be cognizant of the potential impact of such personnel on loan eligibility under the PPP. If the productions were shut down and the employees terminated at the time of the application, the production employees should not be counted towards the 500-employee limit, but their compensation may be included in the average compensation statistics over the 12-month testing period (which would likely serve to bring down the average compensation per employee).
Traditional loan-out companies should also qualify for covered loans under the PPP, as virtually all entertainment talent, both in front of and behind the camera, have been adversely affected by the pandemic, as virtually all productions have been canceled or put on hiatus.
Two issues in the loan-out context are: (1) necessity of the loan to support ongoing operations and (2) the $100,000 compensation cap. First, some loan-outs may have overall term deals in place with a studio under which the loan-out's overhead costs (including personnel) are covered. Assuming that the term deal has not been terminated under a force majeure clause, the loan-out may not be able to claim that it needs the PPP loan to support ongoing operations, unless special circumstances are present. Second, the $100,000 per employee compensation cap on covered loans limits the benefit of such loans for most talent, especially where the talent is the only employee of the loan-out. On the other hand, where a loan-out employs some staff (most of whom likely would not be subject to the $100,000 cap), a greater loan amount may be available.
Finally, it should be noted that the provision of covered loans, including the identity of the borrowers, will be public information, and there will be an enforcement agency created with respect to these loans. Clients should consider the possible public relations impact of applying for a PPP loan, especially in light of the fact that many other deserving businesses may be denied a loan because the program caps out.
Venable will continue to monitor developments with respect to the CARES Act and the PPP, and we stand ready to address any questions or concerns clients may have with respect to this legislation.