The CARES Act mid-size and large business loan program dividend restriction is written as if all eligible businesses have common stock and may pay dividends. Pass-through entities that obtain CARES Act loans from the mid-size and large business loan program will need to negotiate tax distribution provisions in their loan agreements.

IN DEPTH

The Coronavirus Aid, Relief, and Economic Security (CARES) Act requires that loan agreements for mid-size and large business CARES Act loans provide that the eligible business borrower shall not pay dividends or make other capital distributions with respect to the common stock of the eligible business. (The dividend restriction does not apply to small business loans administered by the Small Business Administration.) Taxes on the income of pass-through entities such as limited liability companies (LLCs) and S corporations are imposed on the members of the LLC or the shareholders of the S corporation and not on the entities themselves. Commercial loan agreements that restrict dividends typically permit LLC equity distributions or S corporation dividends sufficient to enable members and shareholders to pay taxes incurred on their shares of the entities’ income. These provisions result from borrowers’ reasonable arguments that if the borrowers were taxable C corporations, they would pay income taxes before making debt service payments, and so should be permitted to make distributions to enable owners to pay taxes in order to be treated comparably to C corporation borrowers.

Practice Point: The CARES Act mid-size and large business loan program dividend restriction is written as if all eligible businesses have common stock and may pay dividends. Pass-through entities that obtain mid-size and large business CARES Act loans will need to negotiate tax distribution provisions in their loan agreements. They may also need to persuade the Department of the Treasury that the intent of the CARES Act requirement that borrowers not pay dividends is met by allowing pass-through entities to make tax distributions.