Loans for US small businesses to keep employees on payroll during business slowdowns resulting from the coronavirus (COVID-19) pandemic became available April 3 under the Paycheck Protection Program. Loan forgiveness may be available if businesses meet certain requirements.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted on March 27, provides broad economic stimulus and relief for businesses affected by the COVID-19 pandemic. Among the more significant provisions of the CARES Act is the Paycheck Protection Program, which provides federally guaranteed loans to small businesses through the Small Business Administration (SBA) for payroll expenses incurred during the pandemic.
Notably, these small business payroll loans are eligible for forgiveness if the small business meets certain requirements. The purpose of the loan and forgiveness provisions is to provide expeditious relief to small businesses, particularly for payroll costs. The SBA published interim final rules on April 2, answering some, but not all, of the questions and issues regarding these provisions, and on April 6, the SBA published a Q&A answering some additional questions (the SBA Q&A) (see our previous LawFlash). Additional guidance is expected from the SBA. There have also been reports that Congress is considering passing new legislation to increase the amount of funds available for loans because of the large number of initial applicants to the program.
The discussion below details the requirements for small businesses to qualify for the Paycheck Protection Program and loan forgiveness, which loans first became available on April 3 and are offered on a first-come, first-served basis. Please see our previous LawFlash discussing the CARES Act provisions that address retirement plan, health plan, and payroll tax and fringe benefit changes intended to help businesses and individuals.
Paycheck Protection Program (Section 1102)
The CARES Act amended Section 7(a) of the Small Business Act (the Act) to provide that the SBA will guarantee 100% of “covered loans” to an “eligible recipient.”
A covered loan is a loan made during the period beginning on February 15, 2020 and ending June 30, 2020 (the covered period), with the amount of the loan generally tied to 2.5 times the borrower’s average monthly payroll costs (excluding compensation over $100,000) incurred by the business for the past 12 months, capped at $10 million.
An eligible recipient is not limited to small business concerns that are generally covered by the Act, but any business concern (including sole proprietors, independent contractors, and other self-employed individuals who provide requisite documentation), nonprofit organization, veterans organization, or tribal business concern that employs not more than 500 employees and whose principal place of residence is in the United States (or such greater amount established by the SBA for the industry in which the business concern, nonprofit organization, veterans organization, or tribal business concern operates).
In order to be eligible, the business must have been in operation on February 15, 2020, and had employees who were paid salaries and payroll taxes or paid independent contractors. Any business concern that employs not more than 500 employees per physical location and that is assigned a North American Industry Classification System (NAICS) code beginning with 72 (e.g., hotels, restaurants, and other food services businesses) will be eligible to receive a covered loan. However, any employer that receives a Paycheck Protection loan is prohibited from using the employee retention credit under Section 2301 of the CARES Act (see our previous LawFlash discussing the employee retention credit under Section 2301 of the CARES Act). Certain borrowers may also need to consider the impact of the SBA affiliation rules (see our previous LawFlash discussing the affiliation rules under the CARES Act and see the Interim Final Rule, Interim Final Rule on Affiliation, and Applicable Affiliation Rules).
An eligible recipient does not include, among other exclusions, (1) any business engaged in illegal activity, (2) a household employer (individuals who employ household employees such as nannies or housekeepers), (3) businesses with owners with criminal convictions, or (4) any business or business owner that is currently delinquent or has defaulted within the last seven years on a loan from the SBA or other federal agency causing a loss to the government.
In addition to allowable uses under Section 7(a) of the Act, the covered loans may be used to cover the following expenses (although the interim rules provide that at least 75% of the loan proceeds shall be used for payroll costs).
- Payroll costs, which consist of compensation for employees (whose principal place of residence is in the United States) in the form of salary, wages, commissions, or similar compensation; cash tips or the equivalent (based on employer records of past tips or, in the absence of such reasons, a reasonable, good-faith employer estimate of such tips); payment for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payment for the provision of employee benefits consisting of group healthcare coverage, including insurance premiums, and retirement; payment of state or local taxes assessed on compensation of employees; and for an independent contractor or sole proprietor, wage, commission, income, or net earnings from self-employment or similar compensation (but note that independent contractors providing services to a borrower do not count for purposes of the borrower’s loan calculation and, per the SBA Q&A, amounts paid by a borrower to an independent contractor or sole proprietor are excluded from the borrower’s payroll costs), as well as allowance for separation or dismissal; payment of state and local taxes assessed on compensation of employees; and for an independent contractor or sole proprietor, wage, commission, income, or net earnings from self-employment or similar compensation (but not including (1) compensation of an individual employee or independent contractor in excess of $100,000, as prorated for the covered period (but note that the April 6 SBA Q&A states that the exclusion only applies to cash compensation, not non-cash benefits, e.g., employer contributions to retirement plans, payment for benefits consisting of group health coverage including insurance premiums, and payment of state and local taxes assessed on compensation to employees); (2) federal employment taxes imposed or withheld between the covered period, including the employer’s share of FICA and Railroad Retirement Act taxes, and income taxes required to be withheld from employees; (3) compensation of an employee whose principal place of residence is outside of the United States; and (4) qualified sick leave wages and qualified family leave wages for which a credit is allowed under Section 7001 or 7003 of the Families First Coronavirus Response Act)
- Costs related to the continuation of group healthcare benefits during periods of paid sick, medical, or family leave, and insurance premiums
- Payment of interest on any mortgage obligation (but not prepayment of principal on a mortgage obligation)
- Rent (including under a lease agreement)
- Utilities
- Interest on any other debt obligations that were incurred before the covered period
For purposes of calculating the loan amount, it is the lesser of (1) $10 million or (2) the sum of (A) the product obtained by multiplying (x) the average total monthly payments by the applicant for payroll costs incurred during the one-year period before the date on which the loan is made (except that, in the case of a seasonal employer, the average total monthly payments for payroll for the 12-week period beginning February 15, 2019, or at the election of the recipient, March 1, 2019 and ending June 30, 2019) by (y) 2.5; and (B) the outstanding amount of a loan that was made during the period beginning on January 31, 2020 and ending on the date that the covered loans are made available, to be refinanced under the covered loan.
Additional terms for covered loans include the following:
- For “impacted borrowers” (i.e., generally, an eligible recipient that is in operation on February 15, 2020 and has an application for a covered loan approved/pending approval after enactment of the CARES Act), lenders are required to provide complete payment deferment relief for a period of six months under the interim final rules, with interest accruing during the deferment period
- The interim final rules provide that the maximum term of any loan will be two years
- Under the interim final rules, interest rate will be fixed at 1%
- There will be no upfront fees payable to the SBA by the borrower, no lender’s annual service fee payable to the SBA, no subsidy recoupment fee, and no fee payable to the SBA for any guarantee sold in the secondary market; agent fees will be paid by the lender out of the fees the lender receives from the SBA; and the SBA will pay lender fees in the amounts set forth in the interim final rules
- No requirement that the small business concern is unable to receive credit elsewhere
- No prepayment penalties on covered loans
- No personal guarantee or collateral is required, and the SBA will not have any recourse against any individual shareholder, member, or partner of an eligible recipient for nonpayment of a covered loan, except in cases where the proceeds from the covered loan are used for unauthorized purposes
- No eligible borrower may receive more than one loan
- Esignatures or econsents can be used
In order to receive a covered loan, eligible borrowers must make a good-faith certification that (1) the business was in operation on February 15, 2020 and had employees for whom it paid salaries and payroll taxes or paid independent contractors; (2) the uncertainty of current economic conditions makes the loan request necessary to support ongoing operations; (3) the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments (but not more than 25% of the loan proceeds may be used for non-payroll costs); (4) during the period between February 15, 2020 and December 31, 2020, no other loan under the program will be received; and (5) loan forgiveness will be provided for documented eligible costs; as well as provide (6) documentation to the lender verifying the number of full-time equivalent employees on payroll as well as the dollar amounts of payroll costs, covered mortgage interest payments, covered rent payment, and covered utilities for the eight-week period following the loan; (7) certification that the information provided in the application and supporting documents and forms is true and accurate in all material respects; and (8) an acknowledgment that the lender will confirm the eligible loan amount using tax documents that have been submitted.
If the funds are used for an unauthorized purpose, the SBA will direct the borrower to repay the loan, and if a borrower knowingly uses the funds for unauthorized purposes, the borrower will be subject to additional liability, including fraud. In addition, under the federal False Claims Act (FCA), the government or an individual whistleblower may bring claims against persons who knowingly, or with reckless disregard of the truth, submitted false claims to the federal government.
Because the Paycheck Protection loans will be submitted by lenders to the SBA, the FCA is applicable. Consequently, a false statement or a statement later judged to have been false could result in treble damages, and other penalties may be imposed. As a result, for employers (especially smaller employers) that qualify for the loan, it is recommended that the funds be placed in a separate account to ensure there is a clear paper trail showing that the loan was used for qualifying payments, and that the application be accurately completed.
An applicant must submit SBA Form 2483 (Paycheck Protection Program Application Form) and payroll documentation, as described above. The lender must submit SBA Form 2484 (Paycheck Protection Program Lender’s Application for 7(a) Loan Guaranty) electronically in accordance with program requirements and maintain the forms and supporting documentation in its files. Applications for loans will be processed on a first-come, first-served basis (the SBA’s loan application is posted on its website).
For additional guidance, see this Morgan Lewis LawFlash, Paycheck Protection Program Loans: Advice for Borrowers and Lenders.
Loan Forgiveness (Section 1106)
Loans extended to borrowers by the SBA under the Paycheck Protection Program (i.e., Section 1102 of the CARES Act) are eligible for forgiveness of indebtedness on the covered loan in an amount equal to the following costs incurred and payments made during the “covered period”:
- Payroll costs (i.e., as such term is defined in Section 1102 of the CARES Act, including the same exclusions)
- Any payment of interest on any covered mortgage obligation (i.e., any indebtedness or debt instrument incurred in the ordinary course of business that (1) is the liability of the borrower, (2) is a mortgage on real or personal property, and (3) was incurred before February 15, 2020, but does not include payments of principal or prepayments on a covered mortgage)
- Any covered rent obligation (i.e., rent obligated under a leasing agreement in force before February 15, 2020)
- Any covered utility payment (i.e., payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which services began prior to February 15, 2020)
The interim final rules provide that the amount of loan forgiveness will be up to the full principal amount of the loan and any accrued interest; however, not more than 25% of the loan forgiveness amount may be used for non-payroll costs.
In order to receive forgiveness, certain specified documentation, as noted in Section 1106 of the CARES Act, is required to be provided to the lender. The portion of the covered loan that is forgiven under this program is excluded from gross income. The “covered period” is the eight-week period beginning on the date of the origination date of the covered loan.
The amount forgiven may not exceed the principal amount of the loan. Further, the amount of forgiveness will be reduced by multiplying the amount of the loan to be forgiven by the quotient obtained by dividing (1) the average number of full-time equivalent employees per month employed by the eligible recipient during the covered period by (2) at the election of the borrower, (x) the average number of full-time equivalent employees per month employed by the eligible recipient during the period between February 15, 2019 and June 30, 2019 or (y) the average number of full-time equivalent employees per month employed by the eligible recipient during the period between January 1, 2020 and February 29, 2020 (for seasonal employers, the average number of full-time equivalent employees per month employed by the eligible recipient during the period between February 15, 2019 and June 30, 2019). The number of full-time equivalent employees will be determined by calculating the average number of full-time equivalent employees for each pay period falling within a month.
The amount of loan forgiveness will also be reduced by the amount of any reduction in total salary or wages of any employee, during the covered period, that is in excess of 25% of the total salary or wages of such employee during the most recent full quarter during which the employee was employed before the covered period; provided that for this purpose, the employees are only those who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay more than $100,000. An eligible recipient with tipped employees described in Section 3(m)(2)(A) of the Fair Labor Standards Act may receive forgiveness for additional wages paid to those employees.
The amount of loan reduction will be determined without regard to a reduction in full-time employees or a reduction in the salary of employees during the period beginning on February 1, 2020 and ending on the date that is 30 days after the enactment of the CARES Act (the designated period) if the following conditions are met: (1) (A) during the designated period, there is a reduction, as compared to February 15, 2020, in the number of full-time equivalent employees and (B) not later than June 30, 2020, the eligible employer has eliminated the reduction in the number of full-time equivalent employees; (2) during the designated period, there is a reduction, as compared to February 15, 2020, in the salary or wages of one or more employees and (B) not later than June 30, 2020, the eligible employer has eliminated the reduction in the salary and wages; or (3) the events described in clauses (1) and (2) occur.
An employer that has a Paycheck Protection loan forgiven cannot use the 6.2% Old-Age, Survivors, and Disability Insurance (OASDI) tax deferral provided in Section 2302 of the CARES Act (see our previous LawFlash discussing OASDI deferral under Section 2302). However, it is not clear if an employer can “cancel” the deferral of its OASDI tax after learning that a Paycheck Protection loan may be forgiven without incurring significant penalty taxes on the OASDI tax deferral. It is possible that Congress may have meant that if an employer’s Paycheck Protection loan is forgiven, (1) a penalty will be imposed on the OASDI tax deferral, perhaps even retroactively to the prior calendar quarters in which the loan was outstanding; or (2) the OASDI tax deferred must be immediately repaid to avoid penalties (which may be challenging because no amount of the Paycheck Protection loan may be used to repay the deferred OASDI tax). Under either scenario, the risk of penalties on the deferred OASDI tax is significant, such that it may deter employers that take advantage of the OASDI tax deferral from trying to obtain Paycheck Protection loans if they intend to have any part of the loans forgiven.
Considerations and Comments
The purpose of the Paycheck Protection Program, in conjunction with loan forgiveness, is to provide small business borrowers with bridge financing so that they can pay their expenses, including payroll, while their businesses remain closed, but also to ensure that there is no continuing reduction of employees and permanent reduction of compensation. The program helps ensure that small businesses will not default on any obligations while their businesses temporarily cease operations and that they will be able to immediately resume operating after the crisis.
There are a number of open issues, and additional guidance from the SBA will be required, including on the following questions:
- Are payroll taxes that have been assessed before the covered period “imposed” during the covered period if they are outstanding during that period?
- Do payroll costs include nontaxable expense reimbursements?
Coronavirus COVID-19 Task Force
For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold.
