Highlights of the Coronavirus Aid, Relief, and Economic Security Act (Part 1 of 2)

On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which is intended to provide financial relief to people and businesses in response to the economic fallout from the coronavirus (“COVID-19”) pandemic.

In an effort to help our clients and colleagues minimize the adverse financial consequences that COVID-19 has created, we have highlighted specific opportunities available to businesses and individuals under the CARES Act.   

Paycheck Protection Program

In General

One of the fundamental components of the CARES Act is the allocation of $349 billion in funds for small businesses through federally backed loans under a modified and expanded Small Business Administration (“SBA”) Section 7(a) loan guaranty program called the Paycheck Protection Program (the “Program”). Congress has designed the Program to make loans (“Paycheck Protection Loans” or “PPLs”) available to qualifying businesses quickly through approved banks and nonbank lenders. The Department of Treasury has posted the Paycheck Protection Program loan application form and program application information for businesses.

The U.S. Department of Treasury’s Paycheck Protection Program information sheet also provides a very useful summary, as does the Internal Revenue Service’s fact-sheet on the Program posted on its CARES Act resource page. In addition, the Treasury Department has issued interim rules implementing the Program (13 CFR Part 120; the “Interim Guidance”).

Businesses that qualify for the Paycheck Protection Loans

Generally, any business in operation on February 15, 2020, with no more than 500 employees is eligible to participate in the Program and receive a Paycheck Protection Loan.

This includes small businesses, as well as qualified nonprofit organizations, sole proprietorships, independent contractors, and self-employed individuals. The term “employee” includes individuals employed on a full-time, part-time, or other basis. A business in the accommodation and food services industry with more than one physical location qualifies if it employs no more than 500 employees at each location.

For purposes of eligibility, the SBA’s affiliate rules are waived for businesses in the hospitality and restaurant industries, franchises approved on the SBA’s Franchise Directory, and small businesses that receive financing through the Small Business Investment Company program.   

The maximum loan amount that a business can receive through the Paycheck Protection Program

Each business can receive the lesser of $10 million or an amount equal to 2.5 times their average total monthly payroll costs, measured over the prior twelve months. Businesses that received an economic injury disaster loan under Section 636(b)(2) of the of the Small Business Act after January 31, 2020, may also include the outstanding balance of that loan in a Payroll Protection Loan.

Use of Paycheck Protection Loan Proceeds

Businesses can use funds from the Paycheck Protection Loans to cover expenses including:

• Payroll costs, including compensation to employees; payments for vacation, parental, family, medical or sick leave; severance payments; payments required for group health care benefits (including insurance premiums), retirement benefits, and state and local employment taxes. However, eligible payroll costs do not include compensation of individual employees, independent contractors, or sole proprietors in excess of an annual salary of $100,000; compensation of employees with a principal place of residence outside the United States; or leave wages already covered by the Families First Coronavirus Response Act.

• Interest payments on any mortgage obligations or other debt obligations incurred before February 15, 2020 (but not any interest payments or payments of principal).

• Rent.

• Utilities.

• Refinancing an SBA Economic Injury Disaster Loan (“EIDL”; discussed below) made between January 31, 2020, and April 3, 2020. (EIDL loan proceeds used for payroll costs must be refinanced by a borrower’s PPL.)

Note that to the extent that PPL funds are used for unauthorized purposes, that portion of the PPL is not subject forgiveness (discussed below). If such funds are knowingly used for unauthorized purposes, the borrower can be subject to additional liability, including charges for fraud. The SBA will also have recourse against a borrower’s shareholders, members, partners who use PPL funds for unauthorized purposes.

Differences between Paycheck Protection Loans and traditional SBA 7(a) loans

Unlike traditional SBA 7(a) loans, no personal guaranties or collateral pledges will be required to receive funds, and there is no requirement that a business show that it cannot obtain credit elsewhere. Borrowers must certify that (i) the PPL is necessary due to the uncertainty of current economic conditions; (ii) they will use the funds to retain workers, maintain payroll, or make lease, mortgage, and utility payments; and (iii) they are not receiving duplicative funds for the same uses.

Payroll Protection Loans will be nonrecourse against borrowers, except where the borrower has used the loan proceeds for a non-allowable purpose. For borrowers that are taxed as “S” corporations or partnerships (including limited liability companies taxed as partnerships), these nonrecourse loans can impact basis and at-risk amounts.

The SBA will not collect any yearly or guarantee fees for a Payroll Protection Loan, and all prepayment penalties will be waived.

How to obtain a Paycheck Protection Loan

Paycheck Protection Loans are made by SBA certified lenders or who are approved by the SBA and the Treasury Department to become Paycheck Protection Program lenders through delegated authority from the SBA. SBA certified lenders are only required to consider whether an applicant was in operation on February 15, 2020, and either had employees for whom it paid salaries and payroll taxes or paid independent contractors.

Unlike other SBA 7(a) loans, applicants are not required to show that credit is unavailable elsewhere or demonstrate repayment ability. Under the CARES Act, the loan period for this program would begin on February 15, 2020, and end on December 31, 2020, during which time any application must be submitted. Beginning April 3, 2020, small businesses and sole proprietorships can apply.

Independent contractors and self-employed individuals can apply beginning April 10, 2020.

Best Practices Tip: We encourage you to apply as early as you can because there is a funding cap on the availability of Payroll Protection Loans. Unless additional funds are made available by Congress, the Program is limited to $349 Billion, and PPLs are available on a first-come, first-serve basis.

Loan Forgiveness

Borrowers of Paycheck Protection Loans are eligible for loan forgiveness for funds used for permitted purposes. Permitted purposes include payment of 8 weeks of payroll costs (commencing from origination date of the loan), interest payments on any mortgage (not including interest prepayments or payments of principal) incurred prior to February 15, 2020, payment of rent on any lease in force prior to February 15, 2020, and payment on any utility for which service began before February 15, 2020.

Payroll costs are subject to the same exclusions as noted above, including the cap on annualized compensation in excess of $100,000 for individual employees. The amount of a loan that may be forgiven cannot exceed the principal amount of the loan and any accrued interest. The SBA has advised that not more than 25 percent of the forgiven amount may be used for non-payroll costs.

The amount of loan forgiveness may be reduced if the employer reduces the number of employees as compared to the prior year, or if the employer reduces the pay of any employee by more than 25 percent as of the last calendar quarter. The amount of the loan that may be forgiven will be ratably reduced if the average number of full-time equivalent (“FTE”) employees during the eight-week forgiveness period is less than the average number of FTE employees at either: (i) the period February 15, 2019, through June 30, 2019; or (ii) the period January 1, 2020, to February 29, 2020.

To encourage employers to rehire workers laid off due to the COVID-19 crisis, employers that rehire previously laid-off workers will not be penalized for having a reduced payroll at the beginning of the forgiveness period. Accordingly, if during the period from February 15, 2020, through 30 days after enactment of the CARES Act (March 27, 2020), there is either a reduction in the number of or wages paid to FTE employees and the employer eliminates the reduction by June 30, 2020, the amount of loan forgiveness will be determined without regard to the reduction.

To apply for forgiveness, businesses must submit documentation regarding the eligible uses of loan funds (payroll costs, mortgage interest, utilities, etc.), a certification that such documents are true and correct, as well the amount to be forgiven, and any other documentation the SBA Administrator deems necessary. The SBA will purchase any loan forgiveness amounts from its certified lenders and this canceled indebtedness will not result in taxable income to the borrower.

To be eligible to receive loan forgiveness, a borrower must submit a complete application to the lender containing the following required documents:

• Documentation verifying the number of full-time equivalent employees on payroll and pay rates for pre- and post-covered periods, including payroll tax filings reported to the IRS and state income, payroll, and unemployment insurance filings;

• Documentation such as cancelled checks verifying mortgage interest, lease, and utility payments;

• Certification from a representative of the recipient that (a) the documentation presented is true and correct, and (b) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation or make covered utility payments; and

• Any other documentation the SBA deems necessary. 

Best Practices Tip:  We recommend that borrowers set up a separate bank account to hold and from which to disburse Payroll Protection Loan funds. This will allow borrowers to clearly demonstrate that loan proceeds are used for permitted purposes and should ease the loan forgiveness process.

Any loan amounts forgiven under the CARES Act will not create taxable income to the borrower. If a balance remains after the borrower receives loan forgiveness, the borrower will have to repay the balance plus accrued interest over a period of two (2) years.

The SBA has announced that further guidance on loan forgiveness will be forthcoming.  

Repayment of portion of Payroll Protection Loan amounts not forgiven

Payments of principal and interest will be deferred for six-months following the date of disbursement of the Payroll Protection Loan. However, interest will accrue on PPLs during the six-month deferment. Per the Interim Guidance, the interest rate on a PPL is one hundred (100) basis points or one percent.

According to the Interim Guidance, any portion of a Paycheck Protection Loan that is not forgiven (as described below) will have a term of two (2) years from the date the borrower applies for loan forgiveness. Unforgiven loans or the unforgiven portion of loans will amortize the same as SBA 7(a) loans, which are generally repaid with fixed monthly principal and interest payments over the loan’s term.

The CARES Act and other loans available to small businesses

Under the CARES Act, the maximum loan amount for an SBA Express loan is increased from $350,000 to $1 million.

The CARES Act also expands eligibility for borrowers applying for an Emergency Economic Injury Disaster Loan (“EIDL”). Under the CARES Act, emergency EIDLs are available for businesses or cooperatives with fewer than 500 employees, sole proprietors or independent contractors, or Employee Stock Ownership Plans (ESOPs) with fewer than 500 employees.

Additionally, the CARES Act waives requirements that (i) the borrower provide a personal guarantee for loans up to $200,000; (ii) that the eligible business be in operation for one year prior to the disaster; and (iii) that the borrower be unable to obtain credit elsewhere. The SBA is also empowered to approve applicants for small-dollar loans solely on the basis of their credit score or “alternative appropriate methods to determine an applicant’s ability to repay.”

For borrowers seeking an immediate influx of funds, borrowers may receive a $10,000 emergency advance within three days after applying for an EIDL. If the EIDL application is denied, the applicant is not required to repay the $10,000 advance. Emergency advance funds can be used for payroll costs, increased material costs, rent or mortgage payments, or for repaying obligations that cannot be met due to revenue losses. Note that receipt of an emergency advance will reduce the amount of loan forgiveness available with respect to a Payroll Protection Loan.

Borrowers may apply for an EIDL in addition to a loan under the Paycheck Protection Program, provided the loans are not used for the same purpose. If a borrower received a loan under Section (b)(2) of the Small Business Act after January 31, 2020, the borrower may refinance the outstanding balance as part of a loan under the Program. The SBA website COVID-19 EDIL Application can be found at https://covid19relief.sba.gov/#/.

For more information regarding the CARES Act, please read: More Highlights of the Coronavirus Aid, Relief, and Econsomic Security Act (Part 2 of 2).

Peter L. Ente is an attorney in our Corporate and Tax Planning Practice Groups.

This information provides an overview of a specific developing situation. It is not intended to be, and should not be construed as, legal advice for any particular fact or situation.