The Coronavirus Aid, Relief, and Economic Security Act (“CARES” or “the Act”) allows certain eligible companies and individuals to obtain loans of up to $10 million or 2.5 times the average monthly payroll costs over the last year, whichever is less, from the Small Business Administration (“SBA”). Although the necessary forms and processes are not yet available, it is expected that prior SBA disaster assistance application procedures will be closely followed. The Act further specifies the SBA regulations that will be used as a baseline to determine eligibility, although the Act has, in some instances, expanded these eligibility standards.

Who is Eligible?

At the outset, to be eligible for a covered loan, a company must have been in operation on February 15, 2020 (the start date of the “covered period,” which extends through June 30, 2020), and must have or have had employees for whom the company paid salaries and payroll taxes or independent contractors to which 1099s were issued.

The company must also be an eligible small business (including their affiliates). There are multiple paths to qualifying. Companies that currently qualify as small under the SBA regulations in 13 C.F.R. Part 121 are eligible based on their primary North American Industry Classification System (NAICS) code. (NAICS codes and corresponding size standards are available here.) Some NAICS codes determine eligibility based on average revenue over the last three years while others use the average number of employees over the last calendar year. Under the CARES Act, eligibility has also been expanded to any company with no more than 500 employees that wouldn’t otherwise qualify under its primary NAICS code. Finally, a higher threshold was put in place for restaurants and hotels (those companies under NAICS Code 72, Accommodation and Food Services). For those companies only, the relevant eligibility standard is whether they have fewer than 500 employees per physical location.

Under SBA regulations, the number of qualifying employees is calculated by taking an average of the number of employees (full or part time) for each of the pay periods over the preceding completed twelve calendar months and adding the average number of employees of any affiliates (more below on this) over the same period. See 13 C.F.R. 121.106. Some have suggested that the number of employees as of the date of application should be the appropriate measure, however use of this date would incentivize companies to lay off employees in order to become eligible. Initial indications are that SBA will continue to calculate number of employees based on the twelve -month period set out in 13 C.F.R. 121.106 and 121.302(a). The latter specifies that the date to be used to determine size status is the date the disaster commenced which under the Act is February 15, 2020.

How Do Affiliation Rules Come Into Play?

Except with regards to Accommodation and Food Services businesses, when calculating both average revenue and number of employees, a company must include the revenues and employees of any “affiliates.” As defined under the SBA regulations, affiliates include companies under common ownership, companies owned and managed by investors, and the holdings of venture capital investors.

The Act specifies that the SBA affiliation rules in 13 C.F.R. 121.103 are to be used in connection with the eligibility analysis under the CARES Act. Under those rules, companies are considered to be affiliates “when one controls or has the power to control the other, or a third party, or parties, controls or has the power to control both.” 13 C.F.R. 121.103(a)(1). Control is considered to be present whether or not exercised, and may be affirmative or negative. 13 C.F.R. 121.103(a)(1), (a)(3). The SBA looks at the “totality of the circumstances” to determine affiliation, with no one factor being dispositive. 13 C.F.R. 121.103(a)(5).

The following circumstances create affiliation and the affiliates’ revenues/employees must be included in the calculation of average revenues/number of employees for purposes of determining eligibility:

• Any person (individual or a concern or other entity) that owns or has the power to control 50 percent or more of a concern’s voting stock, or has a block of voting stock that is large compared to other outstanding blocks of voting stock, is considered to control or have the power to control the concern.
• If two or more persons (including any individual, concern or other entity) each owns, controls, or has the power to control less than 50 percent of a concern’s voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, SBA presumes that each such person controls or has the power to control the concern whose size is at issue. This presumption may be rebutted by a showing that such control or power to control does not in fact exist.
• If a concern’s voting stock is widely held and no single block of stock is large as compared with all other stock holdings, the concern’s Board of Directors and CEO or President will be deemed to have the power to control the concern in the absence of evidence to the contrary.
• With some limited exceptions, SBA considers stock options, convertible securities, and agreements to merge (including agreements in principle) to have a present effect on the power to control a concern. SBA treats such options, convertible securities, and agreements as though the rights granted have been exercised.
• Affiliation also arises where the officers, directors, managers or partners who control the board of directors and/or management of one concern also control the board of directors or management of one or more other concerns.
• Affiliation may arise among two or more persons with an identity of interest, meaning shared business or economic interests. This would include family members, individuals or firms with common investments, or firms that are economically dependent through contractual or other relationships. In this regard, concerns owned by married couples, parents, children and siblings are subject to a rebuttable presumption of affiliation. Likewise, SBA presumes an identity of interest based on economic dependence if one company has derived 70 percent or more of its receipts from another over the prior three years.
• A newly created company organized by former officers, directors, principal stockholders, managing members, or key employees of one concern in the same or related industry or field of operation may also be considered an affiliate of the former company.
• In certain highly specific situations, parties to joint ventures may also be considered affiliates of one another.
• Franchisees and licensees will also often be considered affiliates.

The following sorts of companies are exceptions to these affiliation rules and are not to be considered to create affiliation:

• Businesses owned by a particular type of licensed investment company under the Small Business Investment Act of 1958
• Businesses owned by Native American tribes or Alaska native or Hawaiian native corporations.
• Businesses that lease employees or use co-employer arrangements under a Professional Employer Organization (PEO).
• For business concerns with investors that fit very specific defined criteria, including “venture capital operating companies,” state or federal employee pensions or benefit plans, charitable trusts, or foundations, etc., the investors are not to be considered affiliates.
• Mentor-protégé arrangements under SBA regulations.

SBA provides additional guidance on affiliation considerations in this resource guide.

How Can the Money be Used and What are the Terms?

Loan funds can be used to pay payroll costs, mortgage loan interest for business property, interests on any other debt obligations that were incurred before the covered period, rent for business, utilities, and health benefits costs.

The loans are non-recourse, and no collateral or personal guarantee is required. However, applicants need to submit a certification attesting to their eligibility (including their size status), specifying that the loan is necessary to support ongoing obligations and asserting that the funds will be used for permitted purposes. Any requirement that the applicant not have access to credit elsewhere is waived during the covered period.

The maximum interest rate that may be charged is 4 percent and the maximum maturity will be ten years from the date on which borrower applies.

The Act also contains a loan forgiveness program which allows a certain portion of the loans equal to payroll costs, rent, and mortgage payments to be forgiven.

What is the Process for Applying?

The SBA is tasked under the Act with creating implementing rules and regulations. These are not yet in effect, but one could expect that they would closely parallel the processes for SBA disaster loans. The SBA’s Disaster Loan application website, with links to the forms used for that process is available here. Among the items required to be provided at the time of application are:

• Tax Information Authorization (IRS Form 4506T), completed and signed by each applicant; each principal owning 20 percent or more of the applicant business; each general partner or managing member; and for any owner who has greater than 50 percent ownership in an affiliate business. Affiliates include, but are not limited to, business parents, subsidiaries, and/or other businesses with common ownership or management.
• Complete copies, including all schedules, of the most recent Federal income tax returns for the applicant business and an explanation if not available .
• Personal Financial Statement (SBA Form 413) completed, signed, and dated by the applicant, each principal owning 20 percent or more of the applicant business, and each general partner or managing member.
• Schedule of Liabilities listing all fixed debts (SBA Form 2202 may be used).

Form 5 further states that the following may be required to be submitted if SBA requests in the future (although we advise gathering these documents as soon as possible):

• Complete copy, including all schedules, of the most recent Federal income tax return for each principal owning 20 percent or more, each general partner or managing member, and each affiliate when any owner has more than 50 percent ownership in the affiliate business. Affiliates include, but are not limited to, business parents, subsidiaries, and/or other businesses with common ownership or management.
• If the most recent Federal income tax return has not been filed, a year-end profit-and-loss statement and balance sheet for that tax year.
• A current year-to-date profit-and-loss statement.
• Additional Filing Requirements (SBA Form 1368) providing monthly sales will generally be required when requesting an increase in the amount of economic injury.

Finally, as noted above, the SBA will also require a size certification with applications in which the company certifies that it meets the eligibility criteria.

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