On April 3, 2020, the Small Business Administration (SBA) and the Treasury launched the Payroll Protection Program (PPP). This program, established under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), provides $349 billion for small business loans to cover qualified payroll costs, rent, utilities, and interest on mortgage and other debt obligations. (For more details about PPP, see our alert here.)
The CARES Act's loan forgiveness provision is undoubtedly a primary benefit of the PPP loan. In short, a borrower may apply for loan forgiveness for the first 8 weeks of qualified payroll costs, rent, utilities, and interest on mortgage payments. According to the Interim Final Rule published in the Federal Register on April 15, 2020, the amount of loan forgiveness can be up to the full principal amount plus any accrued interest, as long as the borrower uses the loan proceeds for forgivable purposes.
Accordingly, as lenders begin approving applications, and funds are disbursed, borrowers should take steps to maximize the likelihood that they will be eligible for loan forgiveness. The SBA has stated that it will issue specific guidance on loan forgiveness, and it is inevitable that fact-specific questions will arise as the loan forgiveness process evolves. However, borrowers should keep the following general considerations in mind.
Ensure the funds are being used for permissible purposes
In the Interim Final Rule, the government instructed that at least 75% of the loan proceeds must be used for payroll costs – regardless of whether a borrower ultimately seeks loan forgiveness. Payroll costs include:
- Employees' salary or similar compensation (excluding annualized salaries in excess of $100,000);
- Payments of cash tips;
- Payments for vacation, parental, family, or medical or sick leave;
- Severance payments;
- Payments required for group healthcare benefits (including insurance premiums);
- Retirement benefits; and
- State and local employment taxes.
The remaining 25% of the loan proceeds may be used for:
- Interest payments on mortgage obligations incurred before February 15, 2020 (but not any payments or prepayments of principal);
- Rent payments on leases dated before February 15, 2020;
- Utility payments under service agreements dated before February 15, 2020;
- Interest payments on other debt obligations incurred before February 15, 2020; or
- Refinancing an existing SBA EIDL loan made between January 31, 2020 and April 3, 2020.
However, the remaining 25% of loan forgiveness can be comprised only of qualified payments for rent, utilities, and interest on mortgage obligations.
PPP loan proceeds used for purposes other than those described above will have to be paid back. Moreover, if the funds were "knowingly" used for unauthorized purposes, the borrower may be subject to additional liability. Personal liability may be imposed on a company's shareholders, members, or partners who use PPP funds for unauthorized purposes. Accordingly, additional controls should be implemented. For example, the PPP funds should be safeguarded from potential commingling or misuse – whether intentional or accidental – by placing the funds in a dedicated account used only for the permissible purposes set forth in the Act or by otherwise segregating the loan proceeds.
Keep good records
PPP funds must be carefully tracked. The SBA's Interim Final Rule expressly requires borrowers to "document the proceeds used for payroll costs in order to determine the amount of forgiveness." The CARES Act describes some of the documentation required for an application for loan forgiveness, including documentation to verify the number of full-time equivalent employees on payroll and salaries for relevant time periods (such as payroll tax filings reported to the IRS and state income, payroll, and unemployment insurance filings), as well as documentation to verify payments on covered mortgage obligations, rent, and utilities (such as cancelled checks, payment receipts, or transcripts of accounts). Moreover, borrowers will be required to attest "that [the borrower] has accurately verified the payments for eligible costs." Without the required documentation, the loan is not eligible for forgiveness. Accordingly, recordkeeping policies, procedures, and practices should be carefully reviewed and adjusted as necessary.
Properly calculate the forgiveness amount (and circle June 30, 2020 on the calendar)
Loan forgiveness is available for qualified costs incurred and payments made during the first eight weeks following the loan origination.1 Subject to the rules above, no more than 25% of the loan forgiveness amount may be for non-payroll costs.
Generally, when calculating the forgiveness amount, borrowers will need to reduce proportionally for (a) the reduction of full-time equivalent employees (FTEs), as measured by dividing the average number of FTEs per month during the 8-week post-disbursement period by the average number of FTEs per month during the period of February 15, 2019 through June 30, 2019 or the average number of FTEs per month during the period of January 1, 2020 through February 29, 2020, and any (b) reductions in wages or salary, as compared to the previous quarter, by more than 25% for any employee who made up to $100,000 annualized. However, for any reductions that occur between February 15, 2020 and April 26, 2020, borrowers will have until June 30, 2020 to restore the number of FTEs or the amount of total salary or wages to the same level they were on February 15, 2020 to avoid reductions to the forgiveness amount.
Additionally, if a borrower received an advance up to $10,000 on an Economic Injury Disaster Loan, the proceeds from the advance will be deducted from the loan forgiveness amount.
Watch out for additional guidance from the SBA or your lender
The SBA stated in the Interim Final Rule that it would issue additional guidance on loan forgiveness, which may provide additional details about specific calculations or required documentation. Your lender may also have its own requirements. Borrowers should be on the lookout for more information as it becomes available. Under the CARES Act, a lender has 60 days to render a decision on a loan forgiveness application, so in order to receive funds as quickly as possible, borrowers should submit timely (and complete) forgiveness applications.
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1 According to the SBA's Frequently Asked Questions, the eight-week period begins at the time the loan is disbursed.