Congress Approves New Funding for PPP Loans and EIDLs; SBA Issues Updated FAQ Regarding “Necessity”

Overview and Preliminary Observations

The SBA released a PPP loan application form (Form 2483, which is available here) on April 2, 2020. This application and other information may be gathered by a lender via an online portal, and the details of the loan application process may vary from lender to lender Since applicants are required to submit PPP loan applications to lenders approved to issue PPP loans, applicants should work directly with their lenders to determine the specific bank certifications or other application requirements that the lender may ask for, but note the following with respect to the application process:

• First-come, first-served. The Initial Interim Final Rule confirmed that PPP loans will be made on a first-come, first-served basis. There has been concern on behalf of the public and the U.S. Congress that banks processed applications from existing customers first. Although the bill did not include any additional rules on this point, lenders’ compliance with this requirement is likely to be highly scrutinized.
• One application per borrower. The Initial Interim Final Rule confirmed that no eligible borrower may receive more than one PPP loan. Accordingly, the SBA encourages borrowers to consider applying for the maximum amount (for more on how to calculate the maximum amount, see the “Maximum Loan Amount” section above).
• Permitted lenders. Existing SBA-certified lenders were given delegated authority to process PPP loans. In addition, the following institutions may participate in the program after applying and being approved by the SBA: all federally insured depository institutions, federally insured credit unions, Farm Credit System institutions, non-bank lenders, and non-insured depository institutions.
• Payment of agent fees. The interim final rule included guidance providing that lenders, and not borrowers, should be paying any agent fees associated with applying for PPP loans. The SBA has provided for fees to be paid to SBA lenders, and lenders are to pay the agent fees out of the fees the lender receives from the SBA.

Application Form

• Required certifications. In preparing and signing the Form 2483, an authorized representative of the applicant must certify in good faith that the following are each true and correct in all material respects as of the date of the application under penalty of federal criminal prosecution:
  • The applicant was in operation on February 15, 2020, and had employees for whom it paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC
  • The current economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant (for additional guidance on what constitutes a “necessity” that is sufficient to make this certification, please see the FAQ section below)
  • The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments, and that if the funds are knowingly used for unauthorized purposes, the federal government may hold such business or representative legally liable, including for fraud
  • The applicant has not and will not receive another loan under the PPP loan program
  • To the extent feasible, it will only purchase American-made equipment and products
  • That it is eligible to receive the loan under the rules in effect at the time of the application (companies with VC/PE investors should take note of this and the potential penalties described below in the “Borrower Eligibility” section)
  • The applicant is not engaged in any activity that is illegal under federal, state, or local law
  • That the applicant has not already and will not receive another PPP loan

In addition, an authorized representative of the applicant must certify in good faith that documentation supporting the following is true and correct in all material respects under penalty of federal criminal prosecution, including the potential for imprisonment and/or fines:

• • The number of full-time equivalent employees on payroll as well as the dollar amounts of payroll costs
  • Covered mortgage interest payments
  • Covered rent payments
  • Covered utilities (each of the foregoing with respect to the eight-week period following the loan disbursement)
  • Tax documents confirming the eligible loan amount
• Questions 1 through 3 of the PPP loan application ask information about “owners.” The instructions to the application describe the following as owners: (1) for a sole proprietorship, the sole proprietor, (2) for a partnership, all general partners, and all limited partners owning 20% or more of the equity of the partnership, (3) for a corporation, all owners of 20% or more of the corporation, (4) for limited liability companies, all members owning 20% or more of the company, and (5) if the applicant is a trust, any trustor.
• Question 3 requires the applicant to disclose on Addendum A any other business that is controlled or under common management with the applicant or the owner of an applicant. The applicant should include a list of all affiliates of the applicant and a description of their relationships to the applicant. The applicant is also required to list all other businesses owned by any 20% direct owner. In cases where this list would be extensive or difficult to track down, applicants are urged to consult with counsel to determine what information to provide.
• Borrowers and their owners may have liability for knowingly using PPP loans for unauthorized purposes or for making false statements or otherwise acting in bad faith in applying for a PPP loan. The Initial Interim Final Rule provided that, “If you use PPP funds for unauthorized purposes, SBA will direct you to repay those amounts.” It also provided that, if funds are knowingly used for unauthorized purposes, businesses and individuals may be subject to additional liability, such as fraud charges. The applicant and/or the individual certifying the application may be subject to civil and/or criminal liability (e.g., under the False Claims Act) for false statements made knowingly, recklessly, or with deliberate ignorance of the truth. If an equity holder, member, or partner of an applicant business uses PPP funds for unauthorized purposes, the SBA will have recourse against such individual for the unauthorized use. Borrowers will be required to deliver evidence to support the use of proceeds possibly including IRS payroll tax filings, state income, payroll, and unemployment insurance filings, and cancelled checks. For this reason, we encourage applicants to deposit the proceeds of PPP loans in a segregated account that will only be used for payroll and other permitted uses (note that at least 75% of the proceeds must be used for payroll costs). This will also streamline the forgiveness calculations.
• Guidance on required documentation. The Initial Interim Final Rule included suggestions regarding the kinds of documentation that could be used to establish eligibility for a PPP loan. This includes payroll processor records, payroll tax filings, Form 1099-MISC for independent contractor applicants, or records of income and expenses from a sole proprietorship applicant. In the absence of such documentation, lenders may rely on other supporting documentation, such as bank records, that are sufficient to demonstrate the qualifying payroll amount. For businesses involving tipped employees, the records could include the employer’s records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate. It will be important for borrowers to ensure that this documentation is consistent with any tax reporting to the IRS. An additional interim final rule issued on April 14, 2020, offered guidance for documentation to be provided by individuals with self-employment income who file a Form 1040, Schedule C with the IRS, calling for them to calculate their loan amount based on their 2019 IRS Form 1040, Schedule C, line 31 net profit amount. The April 14, 2020, interim final rule also clarified that partnerships may apply for PPP loans without requiring each individual partner to apply for their own PPP loan.
• Form of promissory note varies by lender. Since the terms of the promissory note may be determined by the lender, it is important to carefully review the specific terms included. We have noted important variations in sample promissory notes we have seen, and the sample promissory note made available by the SBA did not comply with the terms of the PPP loans, in that it refers to personal guarantees and collateral.

Only the types of business concerns described below are eligible to receive PPP loans:

• A business (or nonprofit organization or veterans’ organization) that, together with its affiliates, has 500 or fewer employees whose principal place of residence is in the United States
• A business whose primary NAICS code starts with 72 (accommodations and food service), and that has, together with its affiliates, 500 or fewer employees per location
• A business (or nonprofit organization or veterans’ organization) that, on its own, meets the size standard (employee-based or receipts-based) established by the SBA for the NAICS code applicable to its primary industry, and, together with its affiliates, meets the size standards established by the SBA for the NAICS code applicable to its primary industry or the primary industry of itself and its affiliates on a combined basis, whichever is higher (see SBA size standards)
• A business that, together with its affiliates, is a “small business concern” in that it has a tangible net worth not in excess of $15 million as of March 27, 2020, and an average net income after federal income taxes (excluding carry-over losses) for the two full fiscal years before the date of the application not in excess of $5 million[1]
• Sole proprietors, independent contractors, and self-employed persons
• A business operating as a franchise that is assigned a franchise identifier code by the SBA
• Any business that has received financial support from a Small Business Investment Company (SBIC)

Affiliation Analysis

For purposes of determining the number of employees that an applicant has in order to evaluate whether it is eligible for a PPP loan, the applicant must aggregate its employees with all of the employees of its affiliates. The affiliation analysis is focused on whether another entity has the right to control the applicant, whether through its ownership of voting securities or negative control covenants over ordinary course business decisions (as opposed to extraordinary business decisions). As a general matter, the SBA deems entities to be affiliated with each other when one controls or has the power to control the other, or when a third party controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists. This topic was a source of concern for many companies with institutional investors, including venture capital and private equity funds, and the National Venture Capital Association (NVCA) requested rulemaking to clarify the application of the affiliation rules under to PPP loans.

On April 3, 2020, the SBA published an interim final rule addressing that issue, but the affiliation interim final rule did not provide an exception to affiliation rules for companies with venture capital or private equity fund investors. The affiliation rules are critical to an applicant’s analysis of whether it is eligible for a PPP loan based on its size status. For example, to determine whether an applicant meets the first test above, i.e., 500 or fewer employees, the applicant must aggregate its own number of employees with the number of employees of all of its affiliates for purposes of determining eligibility. The affiliation rules applicable to PPP loan eligibility are summarized as follows:

• Affiliation based on ownership. Any individual or entity that owns more than 50% of the voting securities of an applicant is deemed an affiliate. Such individual or entity must aggregate together its employees, along with the employees of any other entities that it controls, together with the number of employees employed by the applicant, in order to determine whether the applicant has more than 500 employees.

• Equity holders seeking to sever affiliation through the relinquishment of control should be mindful that temporary relinquishment of control, combined with a provision that restores the prior status quo once it is no longer necessary for PPP loan eligibility, very likely would not prevent affiliation.

• The chart below describes rights that the OHA has found in particular cases to indicate affiliation, as well as the rights that do not typically create affiliation. However, note that the OHA has suggested that a single indication of negative control is not necessarily, by itself, sufficient to find affiliation. Thus, whether negative control exists depends on the specific facts and circumstances of the individual company. Determining whether a particular company has affiliates under the negative control test thus requires a case-by-case analysis.

• Affiliation based on common management. Affiliation based on common management arises where the CEO or president of the applicant (or other officers, managing members, or partners who control the management of the applicant) also controls the management of one or more other businesses. Affiliation also arises where a single individual, concern, or entity that controls the board of directors or management of one applicant also controls the board of directors or management of one or more other businesses. Affiliation also arises where a single individual, concern or entity controls the management of the applicant concern through a management agreement. Therefore, prospective applicants should carefully evaluate with their management team and controlling board members, and with any entities which have control over the applicant pursuant to a management agreement, whether any such persons control any other entities.
• Affiliation based on identity of interest. Affiliation based on identity of interest arises when there is an identity of interest between close relatives, as defined in 13 CFR 120.10, with identical or substantially identical business or economic interests (such as where the close relatives operate concerns in the same or a similar industry in the same geographic area). Where the SBA determines that such interests between close relatives should be aggregated, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one are in fact separate. For example, two family members who collectively own 60% of the voting securities of an applicant may be deemed affiliates of each other, and since they own more than 50% of the voting securities of the applicant, each would need to add the employees of any other entities they respectively control to the number of employees employed by the applicant, for purposes of determining eligibility for a PPP loan.[2]
• Severing affiliation. The SBA has provided guidance that a minority equity holder can sever its affiliation with an applicant by irrevocably waiving or relinquishing any existing rights specified in 13 CFR 131.301(f)(1), assuming that such rights were the only rights causing the affiliation. Venture capital and private equity-backed companies should take note that such rights must be irrevocably waived. Any rights that “snap back” are likely to be given present effect, and the affiliation would not be severed.

• Affiliation as applied to the Alternative Size Standards. As noted under “Eligibility” above, a business that, together with its affiliates, is a “small business concern” is also an eligible borrower if it meets both tests in the SBA’s “alternative size standard”. In an FAQ released on April 8, the SBA provided that a business could meet those tests if, as of March 27, 2020: (1) maximum tangible net worth of the business is not more than $15 million; and (2) the average net income after federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than $5 million. The SBA clarified in the April 8 FAQ that the affiliation rules must be applied to the alternative size standard. This has provided an opening for private equity and venture capital investors to consider whether, after applying the affiliation rules, a portfolio company will meet those tests because the tangible net work and net income of the entire affiliated group meets those standards. The SBA has not issued any guidance on this approach, but absent additional guidance, it appears that institutional investors may rely on the alternative size standard for portfolio companies that are otherwise able to make the necessary certifications. This raises questions, such as whether to count the funds, whether to count the management company, whether to calculate net income on a book or tax basis and whether negative amounts can be netted against positive amounts. There is no place on the application for the alternative size standard so applicants relying on the alternative size standard should use Addendum A to articulate the basis of its eligibility. Addendum A should clearly describe the calculations as applied to each affiliate company, descriptions of any assumptions it is making and any other relevant facts.

Excluded Borrowers

The following types of businesses are specifically excluded from PPP loan eligibility by one of the recent interim final rules, or are ineligible to receive such a loan based on statute:

• No PPP loans for “illegal” businesses. The Initial Interim Final Rule confirmed that businesses engaged in any activity that is illegal under federal, state, or local law are ineligible for PPP loans. For example, this may prevent cannabis companies from obtaining PPP loans.
• No PPP loans for businesses or business owners with prior government loan delinquencies or defaults. The Initial Interim Final Rule stated that any applicant, or any other businesses such applicant owns or that is controlled by it or any of its owners, is disqualified from a PPP loan if such applicant is currently delinquent on, or has defaulted within the last seven years on, a direct or guaranteed loan from the SBA or any other federal agency. For businesses with institutional investors, this may require diligence regarding whether any portfolio companies of such institutional investors are or have been delinquent or in default under any loans obtained from or guaranteed by the SBA or any other federal agency.
• Ineligible borrowers. The following non-exhaustive list of businesses are generally ineligible for SBA loans pursuant to 13 CFR §120.110, and they are also ineligible to receive PPP loans:
• • Financial businesses primarily engaged in lending (e.g., banks)
  • Life insurance companies
  • Businesses located in another country or owned by undocumented aliens
  • Pyramid sale distribution plans
  • Businesses involved in any illegal activity
  • Businesses in which the lender or an associate owns an equity interest
  • Businesses that derive more than one-third of their gross annual revenue from legal gambling
  • Private clubs and businesses which limit the number of memberships for reasons other than capacity
  • Government-owned entities (except businesses owned or controlled by a Native American tribe)
  • Businesses with an associate who is incarcerated, on probation or parole, or who has been indicted for a felony or crime of moral turpitude
  • Businesses primarily engaged in political or lobbying activities
  • Businesses which have a prurient or sexual nature

• Companies considering a PPP loan should review the entire list of ineligible businesses in 13 CFR § 120.110 and determine that they are not among the businesses made expressly ineligible.

Use of Proceeds and Loan Forgiveness

The CARES Act generally provides for forgiveness of loan proceeds that are used for permitted purposes. It is anticipated that the rules regarding forgiveness will be supplemented and may change as further rulemaking and guidance is issued. Such additional guidance is due to be issued by April 26, 2020.

• At least 75% of PPP loan proceeds must be used for Payroll Costs and no more than 25% of loan forgiveness may be attributable to non-Payroll Costs. The CARES Act provided that, in addition to Payroll Costs, PPP loans could be used for certain rent, utility, and mortgage interest payments and that all such uses of proceeds during the eight-week period following the disbursement of a PPP loan could be forgiven, subject to certain limitations. The Initial Interim Final Rule confirmed initial SBA and U.S. Department of the Treasury guidance that these non-Payroll Costs may not comprise more than 25% of the loan forgiveness amount and further provided that at least 75% of PPP loan proceeds must be used for Payroll Costs. The CARES Act would also permit PPP loans to be used for other purposes currently permitted for Section 7(a) loans, which include broad categories such as working capital, purchasing furniture and fixtures, inventory, and purchasing machinery or equipment; however, SBA guidance with respect to PPP loans has not provided any clarification as to whether there are PPP-specific limits on such uses that were previously permitted for Section 7(a) loans. Borrowers will be required to provide documentation verifying how proceeds are used. Note that this use of proceeds does not terminate after the eight-week loan forgiveness calculation period. If the proceeds are not fully utilized in those eight weeks, they still must be used for permitted purposes.
• Principal and interest may be forgiven. The CARES Act provides for forgiveness of all or a portion of the principal amount loaned under the PPP loans. The Initial Interim Final Rule indicated that interest accrued on a PPP loan may also be subject to forgiveness, subject to the limitations set forth in the CARES Act and elsewhere in the Initial Interim Final Rule. Lender promissory notes seem to vary on this point, so the terms of your lender’s specific promissory note may affect whether interest is subject to forgiveness.
• Reduction of the amount eligible for loan forgiveness. The amount of loan forgiveness may be reduced if a borrower has enacted layoffs, furloughs, or wage or salary reductions prior to its receipt of its PPP loan disbursement. It should not, however, subject the borrower to any specific scrutiny with respect to the loan as long as the borrower uses the proceeds for other permitted purposes. For borrowers that have already reduced their workforce or payroll costs, we see the following two primary considerations from a practical perspective.
  • First, reductions in headcount and/or reductions in wages and salaries lower a borrower’s “payroll costs” and thus may reduce a borrower’s amount of forgivable expenses. Consider how the loan amount compares to (1) the borrower’s payroll expenses at current staffing levels (excluding the portion paid as wages or salary to any employee that is paid in excess of $100,000 on an annualized basis), and (2) the borrower’s anticipated rent, mortgage interest, and utilities expenses for the eight-week period after the loan is received. Would eight weeks of payroll costs at the borrower’s current payroll rate equal at least 75% of the loan amount? The remainder of the PPP loan proceeds may be used for rent, mortgage interest, or utilities expenses (all for obligations incurred before February 15, 2020) and, as long as they do not exceed 25% of the total loan proceeds, such amounts may be eligible to be forgiven. If a borrower uses less than 75% of the loan proceeds on payroll costs, or if a borrower does not spend the full loan amount on these eligible expenses during the eight-week period, then the borrower will not qualify for full forgiveness. Instead, such borrower would qualify for forgiveness only for a reduced amount based on the amount actually spent on eligible expenses during the eight-week period immediately following the loan disbursement.
  • Second, there is a formulaic test under the CARES Act that determines the loan forgiveness amount. The loan forgiveness amount may be reduced if a borrower decreased its employee headcount and/or wages and salaries by more than 25% between February 15, 2020, and April 26, 2020. If the decreases occurred during this period, the additional reduction to the PPP loan amount to be forgiven could be avoided if the borrower reversed the decreases in employee headcount and/or wages and salaries by June 30, 2020. If the employee headcount and/or wage and salary decreases occurred before or after this time period, it is not clear under the CARES Act and subsequent guidance whether the borrower would be able to avoid a reduction to the amount of its PPP loan that would be forgiven. This reduction of loan forgiveness is separate from the practical limitations noted above and is based on a set of formulas contained in the CARES Act. To calculate this further reduction of forgiveness, a borrower would need to compare its average monthly full-time equivalent employee headcount and wage and salary amounts for individual employees in the time periods specified in the CARES Act, against its average monthly full-time equivalent employee headcount and the wage and salary amounts for such employees during the eight-week period after the PPP loan is disbursed. Again, for businesses that have reduced their employee headcount and/or salaries and wages between February 15, 2020, and April 26, 2020, this reduction to the amount of the PPP loan that may be forgiven may be avoided if the employee headcount and/or wage and salary reductions are reversed by June 30, 2020.

As noted elsewhere in this update, further guidance on forgiveness is due to be provided by the SBA through rulemaking to be issued by April 26, 2020, which may clarify or modify the description provided above.

Endnotes

[1] The SBA FAQ issued on April 8, 2020, confirmed that a business that qualifies as a small business concern under section 3 of the Small Business Act, 15 U.S.C.632 may truthfully attest to its eligibility for PPP loans on the application unless otherwise ineligible. (Please see FAQ below for more information).

[2] Notably, the summary of affiliation rules applicable to the PPP Loans, which was published on the Treasury Department’s website on April 3, 2020, does not include the other bases for affiliation based on identity of interest set forth in 13 CFR 121.301(f)(4)(iii) and (iv) (common investments and economic dependence). As explained in an internal SBA memo dated April 4, 2020, the SBA has concluded that those bases for affiliation were made inapplicable to PPP loans by the CARES Act. The failure of the rule to include the common investments and economic dependence factors is more favorable for applicants with VC and PE fund equity holders.

• The amount of the PPP loan which is forgiven is not taxed as cancellation of debt income.
• Any company that receives a PPP loan is ineligible for the refundable employee retention tax credit authorized by the CARES Act.
• Even though the CARES Act permits a deferral of the employer’s share of Social Security taxes for this year, once all or a portion of the PPP loan is forgiven, the borrower loses its ability to defer future payments of its portion of Social Security taxes.

1. What should companies do next if they are interested in obtaining an EIDL? As with PPP loans, Perkins Coie can help answer questions about your eligibility for an EIDL, including how the affiliation rules may apply to your business. Applications for EIDLs can be made directly through the SBA’s website. As with PPP loans, applicants for EIDLs will need to consider what consents will be required to obtain an EIDL, including from any existing lenders.
2. Can a business obtain both a PPP loan and an EIDL? Yes, a company can obtain both a PPP loan and an EIDL, so long as any portion of an EIDL that was obtained between January 31, 2020 and April 3, 2020 and used for payroll costs is refinanced into a PPP loan. If your EIDL was not used for payroll costs, it does not affect your eligibility for a PPP loan.

As illustrated by the many changes noted above, eligibility requirements for PPP loans, the process for obtaining a PPP loan, and the terms of the PPP loans are all rapidly evolving.