This Legal Update summarizes welcome changes to the U.S. Small Business Administration (SBA) Economic Injury Disaster Loan (EIDL), SBA Express Loans, and the creation of the Paycheck Protection Program (PPP) — a new type of small business loan under 7(a) of the Small Business Act. PPPs work best for taxpayers with higher payroll, especially if they will use the proceeds to fund Payroll Costs (as defined below) over the eight weeks following the date the PPP is made. On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, available here. CARES provides an additional $349 billion in funding for SBA grant and loan programs.
Many readers may already be familiar with the SBA’s 7(a) loan guaranty program. It provides federal government guarantees for small business loans originated by approved lenders. CARES expands the 7(a) program with the addition of the PPP.[1] A PPP loan specifically addresses business disruption caused by COVID-19 by enabling any eligible businesses to retain their employees. Most small businesses in operation on February 15th, 2020 will be eligible and there are targeted changes to expand eligibility to the hard-hit restaurant and hospitality industry.[2]
PPP loans differ from (and are much better than) traditional 7(a) loans in several important ways. First, and most significantly, there are no personal guarantee or collateral requirements. Second, applicants need not establish that they are unable to obtain credit via traditional lending channels (eliminating the so called “credit elsewhere” rule). Indeed, PPP lenders will not even evaluate repayment ability. Because these loans are 100% federally guaranteed, lenders will only consider whether the business was operational on February 15, 2020, and had employees for whom it paid salaries and payroll taxes, or paid independent contractors.
Eligible recipients i.e., borrowers, include not just the traditional “small business concerns”[3] but also any other business concern (including IRC 501(c)(3) nonprofits, 501(c)(19) veteran’s organizations, and Tribal concerns) provided they employ not more than the greater of:
(i) 500 employees, or
(ii) the applicable industry size standard.[4]
Additionally, individuals who operate under a sole proprietorship or as an independent contractor, and certain self-employed individuals, are eligible.
PPP applicants must certify, in good faith, that the loans are required to continue operations due to the current economic circumstances and acknowledge that the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments, and that the applicant does not have other “covered loan” applications pending for similar or duplicative purposes.
Proceeds must be used to fund:
“Payroll Costs” — this is a key term for PPP loans and it includes virtually all compensation paid to service providers (employees and independent contractors) as salaries, commissions or similar compensations, including tips, vacation pay, family/parental leave and sick leave [5] but ignoring amounts to the extent they exceed $100,000 per year for any particular person and not taking into account payroll taxes imposed on the employer or withheld from the employee,[6] plus
Any State or local taxes assessed on the compensation of employees,
Severance pay (“allowance for dismissal or separation”),[7]
Costs related to the continuation of group health benefits and any retirement benefits (presumably including all COBRA benefits),
Payments of interest on any pre-existing debt or mortgage obligation (but not payment or prepayment of principal on such obligations),[8]
Rent (including rent under an equipment or other lease), and
Utilities.
The definition of Payroll Costs also includes compensation or income of a sole proprietor or independent contractor that is a wage, commission, income or net earnings from self-employment, again capped at $100,000 pro-rated for the covered period.
PPP loans are available in amounts up to the lesser of:
(i) $10,000,000 or
(ii) an amount equal to one month of Payroll Costs, calculated above (subject to the $100k cap per employee) and on a trailing 12-month average basis multiplied by 2.5.
Example: Assuming a PPP loan made on May 1, 2020, to a business with average monthly Payroll Costs for the period May 1, 2019, to April 30, 2020, of $1,000,000, then the maximum loan amount would be $2,500,000. Special rules apply for seasonal employers who can look to the average total monthly payments for payroll over a 12-week period beginning on certain specified dates.
PPP loans are capped at 4% interest with a maximum maturity of 10 years. There are no prepayment penalties or loan fees payable by the borrower. Because at this time all borrowers are deemed to be economically effected by the pandemic, principal and interest payments are deferred for at least six months, but not more than a year (but interest will continue to accrue during the deferral period.) Presumably some lenders will offer a full year of deferral whereas others may only offer six months. PPP loans can also include the outstanding amount of an EIDL made between January 31, 2020, and the date on which such loan may be refinanced with a PPP loan. But wait, there’s more….
Perhaps most significantly, PPP loans are eligible for forgiveness. Most eligible businesses negatively impacted by the pandemic should qualify for forgiveness of loan principal up to the amount paid by the business, during the eight-week period after the loan is made, for the following operational expenditures:
(i) qualifying Payroll Costs,
(ii) interest payment on any mortgage (including mortgages on personal property),[9]
(iii) covered rent, and
(iv) covered utilities (gas, water, transportation, telephone and internet)
— in each case to the extent those obligations existed as of February 15, 2020, as demonstrated by verified documentation borrowers must submit to their lender as part of obtaining forgiveness. The SBA will pay the lender for amounts forgiven.
The amount of the loan subject to forgiveness may be reduced if employees are terminated during the covered period or compensation is reduced by more than 25%. Any amounts forgiven are excluded from gross income for tax purposes. Who to Contact to Get Your Loan PPP loans will be offered through the same lenders approved to offer 7(a) loans. Lenders that are not currently approved to make 7(a) loans may apply for authority to offer PPP loans through the U.S. Department of the Treasury. We know that many financial institutions that are not already SBA lenders are considering entering this space. Lenders are compensated by a percentage of the loan size on a sliding scale from 5% of loans under $350,000 to 1% of loans over $2,000,000.
As a brief but important side note, the CARES Act also expands the 7(a) Express program to increase the maximum loan amount. The SBA 7(a) Express Program provides for lending decisions to be turned around in 36 hours (compared with multi-week processing for most 7(a) loans). The CARES Act raises the limit for the 7(a) Express Program from $350,000 to $1,000,000.
CARES also dramatically expands the availability of EIDL loans and streamlines the application process. EIDL loans are now available throughout the U.S. (previously only in declared disaster areas) in amounts up to $2,000,000. Unlike 7(a) loans, small businesses apply for an EIDL loan directly through the SBA via online portal here.
(i) a business with not more than 500 employees; (ii) Tribal businesses, cooperatives and ESOPs with not more than 500 employees; (iii) any individual operating as a sole proprietor or an independent contractor; and (iv) private nonprofits and small agricultural cooperatives. Additionally, for EIDL loans completed before December 31, 2020, SBA will no longer require personal guarantees for those loans (or advances) under $200,000.
The SBA has also changed the requirement that borrowers must be in business for a full year to require only that borrowers be in business as of January 31, 2020. Also, like the 7(a) modifications described above, they will no longer require borrowers to demonstrate that they are unable to obtain credit elsewhere. For EIDL loans that close before December 31, 2020, all credit decisions will be made solely based on the credit score of the applicant or an appropriate method establishing the borrower’s ability to pay. This change alone should significantly streamline the approval process. EIDL applicants may also request an emergency grant directly from SBA of up to $10,000. Such advances are considered grants rather than loans and are not subject to repayment, even if the EIDL is later denied. Currently these advances are committed to be provided within three days after the SBA receives the loan application. If an EIDL recipient later refinances into a PPP loan, any advances would be offset against any payroll related loan forgiveness. Applicants with immediate financing needs may consider applying for an EIDL first, then seek to refinance with a PPP loan.