On April 2, 2020, the U.S. Small Business Administration (SBA) released its Interim Final Rule^[1], which provides further guidance on the Paycheck Protection Program (PPP) as enacted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. On April 2, 2020 the SBA also issued an updated sample application form.

The SBA’s Interim Final Rule clarifies, contradicts and provides additional interpretative guidance related to the CARES Act.  We highlight the following:

A. Eligibility and Application Supporting Documentation

In addition to a business qualifying as a “small business concern” under the Small Business Act, any business concern, nonprofit organization^[2], veterans organization, or tribal businesses (each, a Covered Entity) is eligible to receive a PPP loan during the period starting on February 15, 2020 and ending on June 30, 2020 (the Covered Period) if the Covered Entity employs the greater of (i) 500 employees^[3] whose principal place of residence is in the United States or (ii) if applicable, the size standard in number of employees established by the SBA for the industry in which the Covered Entity operates.  While the Interim Final Rule omits to reference eligibility based on the SBA’s size standard based on revenue, we believe statutory authority is clear that any “small business concern” meeting a SBA revenue test applicable to the industry in which it operates is eligible to receive a PPP loan.

Individuals who operate under a sole proprietorship, as an independent contractor or who are self-employed (subject to certain restrictions under the Interim Finale Rule) are also eligible to participate in the PPP.

With respect to affiliation within the context of eligibility, the Interim Final Rule indicates that the applicant is subject to the SBA’s affiliation rules under 13 CFR 121.301(f) unless specifically waived in the CARES Act.  The Interim Final Rule adds, however, that the SBA intends to promptly issue additional guidance with regard to the applicability of affiliation rules at 13 CFR 121.103 and 13 CFR 121.301 to PPP loans.

An applicant is ineligible for a PPP loan if any of the following applies: (i) the applicant is engaged in any activity that is illegal under federal, state, or local law; (ii) the applicant is a household employer (e.g., individuals who employ household employees such as nannies or housekeepers); (iii) an owner of 20% or more of the equity of the applicant is incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years; or (iv) the applicant has obtained a direct or guaranteed loan from the SBA or any other federal agency that is delinquent at the time of application or has defaulted within the last 7 years and caused a loss to the government.

The applicant must submit documentation necessary to establish eligibility, such as payroll processor records, payroll tax filings, Form 1099-MISC (for an independent contractor) and/or income and expenses (for a sole proprietorship).  Any applicant that does not have any such documentation must provide other supporting documentation (e.g., bank records) sufficient to demonstrate the qualifying payroll amount.

B. Interest Rate

Under the Interim Final Rule, lenders can charge a maximum fixed interest rate of 1.0% per annum, notwithstanding that the CARES Act permitted lenders to charge an interest rate up to 4% per annum.

C. Maturity Date

The Interim Final Rule states that the maturity date, after any applicable loan forgiveness, is 2 years, notwithstanding that the CARES Act permitted lenders to establish loan tenor of up to 10 years.  Read together with the CARES Act, the maturity date is calculated starting from the date on which the borrower applies for loan forgiveness.

D. Calculating Payroll Costs in Determining the Maximum Loan Amount

To calculate “payroll costs” to determine the maximum loan amount a borrower is entitled to receive under the PPP, the Interim Final Rule provides the following step-by-step process:

Step 1: Aggregate the total payroll costs^[4] from the last 12 months for employees whose principal place of residence is the United States.

Step 2: Subtract any compensation paid to an employee^[5] in excess of an annual compensation (including salary, wages and tips) of $100,000.

Step 3: Calculate the average monthly payroll costs (divide the amount from Step 2 by 12).

Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.

Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, after deducting the amount of any advance under an EIDL COVID-19 loan (since it does not have to be repaid).

With respect to the calculation of the average monthly payroll costs under Step 1, we note that the Interim Final Rule is inconsistent with the CARES Act.  Under the Interim Final Rule, the average monthly payroll costs are calculated as incurred from the preceding calendar year, whereas the average monthly payroll costs under the CARES Act are calculated based on the one year period before the date on which the loan is funded.

Payroll costs, however, exclude the following: (i) any compensation of an employee whose principal residence is outside of the United States; (ii) compensation of any individual in excess of $100,000 (though the first $100,000 for those employees is counted): (iii) FICA taxes paid between February 15, 2020 and June 30, 2020; and (iv) qualified sick and family leave wages for which a credit is allowed under section 7001 and 7003 of the Families First Coronavirus Response Act.

E. Additional Limitations on Use of Proceeds and Enforcement for Unauthorized Uses

The Interim Final Rule states that not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs.  In other words, borrowers are required to utilize 75% of the PPP loan proceeds for payroll costs.  The SBA has determined, in consultation with the Secretary of the U.S. Department of Treasury (Treasury), that 75% is an appropriate percentage in light of the CARES Act’s overarching focus on keeping workers paid and employed.

Borrowers will have to document the proceeds used for payroll costs in order to determine the amount of forgiveness.  If a borrower uses PPP loan funds for unauthorized purposes, then the SBA will direct the borrower to repay the PPP loan.  Further, if the borrower knowingly uses the funds for unauthorized purposes, then the borrower will be subject to additional liability such as charges for fraud.  If shareholders, members, or partners of borrowers use PPP loan funds for unauthorized purposes, then the SBA will have recourse against such shareholder, member, or partner for the unauthorized use of the PPP loan.

F. Loan Forgiveness

The SBA has determined that 7 weeks is the minimum period of time necessary for a lender to reasonably determine the expected forgiveness amount for a PPP loan.  In turn, the SBA will purchase the expected forgiveness amount of the PPP loans from the lender within 15 days of the date on which the SBA receives a complete report that demonstrates that the expected forgiveness amount is reasonable.

The SBA will issue additional guidance on loan forgiveness in the days and weeks to come.

G. Loan Payment Deferral

Under the Interim Final Rule, borrowers will not have to make any payments for 6 months following the date of disbursement of the PPP loan, notwithstanding that the CARES Act authorizes lenders to defer payments for up to 12 months.  Interest, however, will accrue on the principal balance of the PPP loan during the 6 month payment holiday.

H. Lender Responsibilities

In reviewing the lender’s PPP application, lenders are responsible for confirming: (i) receipt of applicant certifications contained in the sample PPP application form issued by the SBA; (ii) receipt of information demonstrating that an applicant had employees to whom the applicant paid salaries and for whom the applicant paid payroll taxes on or around February 15, 2020; and (iii) the dollar amount of average monthly payroll costs by reviewing the payroll documentation submitted with the application.  Lenders must also abide by the applicable requirements under the Bank Secrecy Act and its implementing regulations.  Each lender’s underwriting obligation under the PPP is limited to the above referenced items.

In order to determine eligibility and that loan proceeds will be used for authorized purposes, the SBA permits lenders to rely on the good faith certifications made by applicants in their application forms, provided that such application forms include the certifications required by the SBA in its sample PPP application form.  Lenders are also entitled to rely on specified documents provided by the applicants to determine their qualifying loan amount and eligibility for loan forgiveness.

I. Lender and Agent Fees

Lenders may not collect any fees from any PPP applicant.  The SBA will reimburse lenders directly for origination fees in the amounts prescribed by the CARES Act.  Agents also cannot collect any fees from any PPP applicant.  Lenders are solely responsible for paying the agent its fees.  The total amount that an agent may collect from a lender for assistance in preparing a PPP loan application (including referral to the lender) may not exceed: (i) 1% for loans of not more than $350,000; (ii) 0.50% for loans of more than $350,000 and less than $2 million and (iii) 0.25% for loans of at least $2 million.

Things are changing quickly and the measures and interpretations described here may change.  Our analysis is necessarily limited by the time sensitivities of the current crisis as well as the absence of precedent for some of what is contained here.  This analysis represents our best interpretation and recommendations based on where things currently stand.

Footnotes

[1] The Interim Final Rule is effective without advance notice and public comment because Section 1114 of the CARES Act authorizes SBA to issue regulations to implement the PPP without regard to notice requirements.
[2] Nonprofit organizations means organizations as described in section 501(c)(3) of the Internal Revenue Code.
[3] The definition of employees includes individuals employed on a full-time, part-time or other basis.  This includes employees obtained from a temporary employee agency, professional employee organization or leasing concern.
[4] Pursuant to the CARES Act, “payroll costs” consist of compensation to employees in the form of (i) salary, wages, commissions, or similar compensation; (ii) cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips); (iii) payment for vacation, parental, family, medical, or sick leave; (iv) allowance for separation or dismissal; (v) payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; (vi) retirement benefits; (vii) payment of state and local taxes assessed on compensation of employees; and (viii) for an independent contractor or sole proprietor, wage, commissions, income, or net earnings from self-employment or similar compensation.
[5] Since independent contractors have the ability to separately apply for a PPP loan, the Interim Final Rule does not count independent contractors as “employees” for purposes of determining a borrower’s qualifying loan amount.