Where is Main Street?—Fed Provides Guidance on the Main Street Lending Program

On April 9, 2020, the Federal Reserve announced additional programs under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) to provide up to $2.3 trillion in loans and other investments to support the U.S. economy. One of the programs established a new $600 billion Main Street Lending Program, aimed to ensure credit flows to small and mid-sized businesses that were in good standing before the COVID-19 pandemic (the “Main Street Lending Program” or “Program”). The Department of the Treasury will use funding from the $454 billion appropriated under Title IV, Section 4003(b)(4) of the CARES Act to provide $75 billion in equity to the Program, utilizing a special purpose vehicle (the “SPV”) operated by the Federal Reserve Bank of Boston. The Main Street Lending Program will leverage this $75 billion from Treasury up to eight times, for up to $600 billion in term loans for eligible borrowers.

In our Client Alert on the Main Street Lending Program dated April 13 (see here), we described the basic requirements of the program as set forth in the term sheets released by the Federal Reserve on April 9 (the “April 9 Term Sheets”). The April 9 Term Sheets described how an eligible borrower may elect to borrow new term loans under the Main Street New Loan Facility (“New Loan Facility”), or upsize an existing eligible term loan under the Main Street Expanded Loan Facility (“Expanded Loan Facility”). The April 9 Term Sheets raised many questions and concerns from potential borrowers and lenders. By the end of the one-week comment period, the Federal Reserve had received over 2,200 letters from individuals, businesses, and nonprofits requesting clarification of, and suggesting changes to, the terms of the New Loan Facility and Expanded Loan Facility.

On April 30, 2020, the Federal Reserve released updated term sheets for the New Loan Facility (see here) and the Expanded Loan Facility (see here), and released a term sheet for a third type of facility, the Main Street Priority Lending Facility (“Priority Loan Facility”) (see here). The term sheets released on April 30 are referred to in this alert as the “April 30 Term Sheets.” The Federal Reserve also released the Main Street Lending Program Frequently Asked Questions, effective April 30, 2020 (the “FAQ”) (see here). This client alert describes the main terms under the loan facilities, how the Federal Reserve has addressed many of the issues and questions raised by the April 9 Term Sheets, and identifies some of the issues and questions that remain unresolved. With respect to certain issues, the Federal Reserve stated that further guidance will be forthcoming.

Who is an Eligible Lender?

The definition of “Eligible Lender” was expanded to include a U.S. branch or agency of a foreign bank and a U.S. intermediate holding company of a foreign banking institution, in addition to the previously authorized lenders that are U.S. federally-insured depository institutions (including banks, savings associations, and credit unions), U.S. bank holding companies, and U.S. savings and loan holding companies. The FAQ states that nonbank financial institutions are not considered Eligible Lenders for purposes of the Program at this time. However, the Federal Reserve indicated it is considering expanding the list of Eligible Lenders in the future.

Who is an Eligible Borrower?

What types of entities are eligible?

An Eligible Borrower under the Program must be a business. The Federal Reserve clarified that, for purposes of the Program, “Business” is defined as an entity organized for profit as a partnership, a limited liability company, a corporation, an association, a trust, a cooperative, a joint venture with no more than 49 percent participation by foreign business entities, or a tribal business concern.

At this time, non-profit organizations are not eligible borrowers, primarily because the main metric for measuring loan eligibility is adjusted 2019 earnings before interest, taxes, depreciation, and amortization (“EBITDA”) and non-profit organizations generally do not have EBITDA. The April 30 guidance indicates that the Federal Reserve and Treasury Department are evaluating the feasibility of adjusting the borrower eligibility criteria and loan eligibility metrics of the Program for non-profit organizations. Further, the April 30 Term Sheets and FAQ state that other forms of organizations may be included as eligible Businesses at the discretion of the Federal Reserve.

Eligibility of foreign-owned U.S. businesses remains unclear. The FAQ limits foreign ownership of joint ventures to 49%, but does not define what constitutes a joint venture, and does not expressly impose any such limitation on other types of businesses. Under Small Business Administration (“SBA”) rules (13 CFR 121.103(h)—which is not one of the SBA rules cited in the FAQ), a “joint venture” is defined as an association with limited purpose, engaging in no more than three business ventures over a two-year period. It is not clear whether the FAQ’s reference to joint ventures is intended to follow the SBA definition, or why the Program would exclude limited purpose entities but not exclude more permanent structures that are majority-owned, or wholly owned, by non-U.S. persons. Further guidance is needed on this topic to determine whether foreign-owned U.S. businesses are eligible under the Program.

Which Businesses are Eligible Borrowers?

In addition to satisfying the definition of “Business,” an Eligible Borrower is one that:

• was established prior to March 13, 2020;
• is not an “Ineligible Business”;
• meets at least one of the following two conditions: (i) has 15,000 employees or fewer, or (ii) had 2019 annual revenues of $5 billion or less;
• is created or organized in the United States or under the laws of the United States with significant operations in and a majority of its employees based in the United States;
• does not also participate in the another Main Street Lending Program or the Primary Market Corporate Credit Facility (for a summary of this facility, see our client alert here); and
• has not received specific support pursuant to Section 4003(b)(1)-(3) of Subtitle A of Title IV of the CARES Act (i.e., any Title IV programs for air carriers and related businesses, cargo air carriers, and businesses critical to maintaining national security).

“Ineligible Business” has the same meaning as under the SBA regulations and guidelines implementing the Paycheck Protection Program under the CARES Act (“PPP”) on or before April 24, 2020. Key ineligible industries include businesses primarily engaged in lending or investment and passive investment in real estate. The April 30 Term Sheets and FAQ indicate the Federal Reserve may further modify the application of these restrictions. (For the SBA regulations on ineligible businesses cited in the FAQ, see here, and the interim final PPP rules here, here and here). For up to date information about the PPP, see our latest client alert here.)

To expand borrower eligibility, the April 30 Term Sheets increased the maximum number of employees from 10,000 to 15,000 employees, and increased maximum 2019 annual revenues from $2.5 billion to $5 billion. However, inclusion of the affiliation rules discussed below in determining the number of employees and annual revenues will limit the number of Businesses eligible under the Program, particularly in the case of private equity funds and their portfolio companies.

How are employees counted when determining eligibility?

The FAQ clarifies how a Business should count its employees, again borrowing from the regulations issued by the SBA and provisions of the PPP (see here as cited in the FAQ). Businesses should count all full-time, part-time, seasonal, or otherwise employed persons as employees, but exclude volunteers and independent contractors. Further, businesses are required to count their own employees and persons employed by their affiliates. Under the applicable SBA rule (13 CFR 121.301(f), as in effect on January 1, 2019) (see here as cited in the FAQ), entities are considered affiliates when one controls or has the power to control the other or such entities are under common control. Control is broadly defined to encompass affirmative and negative control rights, as well as equity-based and contractual control rights, including affiliation based on a management agreement. In order to determine the applicable number of employees, businesses should use the average of the total number of persons employed by the Eligible Borrower and its affiliates for each pay period over the 12 months prior to the origination or upsizing of the loan.

How are 2019 annual revenues calculated when determining eligibility?

Businesses must aggregate their revenues with those of their affiliates. Businesses may use either of the following methods to calculate 2019 annual revenues for purposes of determining eligibility: (1) its (and its affiliates’) annual “revenue” per its 2019 GAAP audited financial statements; or (2) its (and its affiliates’) annual “receipts” for fiscal year 2019, as reported to the Internal Revenue Service. For purposes of the Program, the term “receipts” has the same meaning as in the SBA regulations under 13 CFR 121.104(a) (see here as cited in the FAQ). If a potential Eligible Borrower does not have audited financial statements or annual receipts for 2019, it can use its most recent audited financial statements or annual receipts.

Terms of Eligible Loans

All Eligible Loans under the Program will have the following terms:

• 4 year maturity;
• principal and interest payments will be deferred for one year (unpaid interest will be capitalized);
• adjustable rate of LIBOR (1 or 3 months) plus 300 basis points; and
• prepayments permitted without penalty.

Applicable Interest Rate. In response to potential loan participants’ comments, the Federal Reserve determined that requiring lenders to issue loans based on SOFR (Secured Overnight Financing Rate) at this time would divert resources from challenges related to the pandemic. Therefore LIBOR, the primary reference rate historically used for business loans, will be the applicable rate. Because LIBOR may not be published after the end of 2021, the FAQ encourages Eligible Lenders and Eligible Borrowers to include reference rate fallback language in Program loan documentation consistent with the recommendations of the Alternative Reference Rates Committee, should LIBOR become unavailable during the term of the loan.

No interest payments are required during the first year and unpaid interest will be capitalized. Beyond the first year, payment-in-kind (PIK) interest is not permitted under any of the loan facilities, despite some potential participants having advocated for PIK interest.

Facility Specific Terms. The following chart summarizes the terms applicable to the New Loan Facility, the Priority Loan Facility, and the Expanded Loan Facility.

How is 2019 Adjusted EBITDA Calculated?

The April 9 Term Sheets applied a leverage test based on EBITDA, with no mention of permissible adjustments. Many commenters on the April 9 Term Sheets suggested that EBITDA should be calculated to better reflect loan market practice by allowing certain “add-backs” to arrive at a calculation of adjusted EBITDA commonly used in credit facility leverage tests. The Federal Reserve responded to these comments by replacing EBITDA with “adjusted EBITDA” in the April 30 Term Sheets.

For the New Loan Facility and Priority Loan Facility, an Eligible Lender must use a methodology it previously used for adjusting EBITDA when extending credit to the Eligible Borrower or to similarly situated borrowers on or before April 24, 2020. The fact that Eligible Lenders are required to use a methodology they previously used for adjusting EBITDA when extending credit to “similarly situated borrowers” suggests that the Federal Reserve is relying on Eligible Lenders to engage in sound banking and underwriting practices. However, this guidance is likely to result in various different methodologies used by Eligible Lenders in determining adjusted EBITDA under the New Loan Facility and Priority Loan Facility.

For Eligible Loans under the Expanded Loan Facility, the methodology used by the Eligible Lender to calculate adjusted 2019 EBITDA must be the methodology it previously used for adjusting EBITDA when originating or amending the underlying term loan or revolving credit facility on or before April 24, 2020. The FAQ does not indicate what methodology should be used if the underlying term loan or revolving credit facility did not include the concept of EBITDA on or before April 24, 2020. It is possible that such loan or credit facility would not be eligible for the Expanded Loan Facility, on the grounds that EBITDA is the key underwriting metric for determining eligibility under the Program. It is conceivable that the “similarly situated borrower” methodology applicable to the other Program facilities could be applied to an Expanded Loan Facility in that situation, but the Federal Reserve guidance does not state this, and the applicable Eligible Lender certification, discussed below, does not provide for such an alternative methodology.

Alternatives to EBITDA?

As indicated above, EBITDA is the key underwriting metric required for determining Eligible Loans under the Program. In the FAQ, the Federal Reserve acknowledged that the credit risk of asset-based borrowers, as a matter of practice, is generally not evaluated on the basis of EBITDA and stated that the Federal Reserve and the Treasury Department will be evaluating the feasibility of adjusting the loan eligibility metrics of the Program for such borrowers.

How is “existing outstanding and undrawn available debt” calculated?

“Existing outstanding and undrawn available debt” includes all amounts borrowed under any loan facility, including unsecured or secured loans from any bank, non-bank financial institution, or private lender, as well as any publicly issued bonds or private placement facilities. It also includes all unused commitments under any loan facility, excluding (1) any undrawn commitment that serves as a backup line for commercial paper issuance, (2) any undrawn commitment that is used to finance receivables (including seasonal financing of inventory), (3) any undrawn commitment that cannot be drawn without additional collateral, and (4) any undrawn commitment that is no longer available due to a change in circumstance. Existing outstanding and undrawn available debt should be calculated as of the date of the loan application.

Calculating the Leverage Ratio. While the April 30 guidance gives the Eligible Lender some leeway to determine EBITDA based on the methodology used in the underlying term loan or revolving credit facility, or the methodology used by the Eligible Lender with similarly situated borrowers, as applicable, it does not provide for such flexibility in respect of other components of the leverage test beyond the definition of EBITDA. For example, the leverage ratio calculation described in the April 30 Term Sheets and the FAQ does not include a cash netting feature, a relatively common feature in leveraged loan facilities that reduces the amount of debt in the leverage test by the amount of the borrower’s unrestricted cash. It is unclear whether such a feature would be permitted in a Program loan, even if the underlying facility has such a feature or if the Eligible Lender typically uses such a feature with similarly situated borrowers.

Collateral Requirements. The loans under all facilities can be secured or unsecured, assuming in the case of the Priority Loan Facility and Expanded Loan Facility that the other applicable priority requirements are met. This is a change from the April 9 Term Sheets.

Collateral under the Expanded Loan Facility. An upsized tranche under the Expanded Loan Facility must be secured if the underlying term loan or revolving credit facility is secured. The upsized loan will be secured on a pro rata basis with the underlying term loan or credit facility, such that the Eligible Lender and the existing facility lenders will share equally in any collateral available to support the loan relative to their proportional interests (including the Expanded Loan Facility upsized tranche). Eligible Lenders can require Eligible Borrowers to pledge additional collateral to secure an Expanded Loan Facility upsized tranche as a condition of approval. It remains unclear exactly how the “pro rata” security requirement is to be implemented under an Expanded Loan Facility. Presumably an intercreditor agreement will be required between the secured parties under the existing loan or credit facility and the Eligible Lender on behalf of itself and the SPV.

Guarantees. Although the April 30 Term Sheets and FAQ do not indicate that the loans under the Program must be guaranteed, if an existing loan to be upsized under the Expanded Loan Facility is guaranteed, it seems likely the upsized tranche would be guaranteed as well.

Priority of Eligible Loans Under the New Loan Facility. Under the New Loan Facility, Eligible Loans must not be contractually subordinated in terms of priority to any of the Eligible Borrower’s other loans or debt instruments at origination and throughout the term of the Eligible Loan. As explained in the FAQ, this means that the Eligible Loan may not be junior in priority in bankruptcy to the Eligible Borrower’s other unsecured loans or debt instruments. This provision does not prevent:

• the issuance of a New Loan Facility loan that is secured (including in a second lien or other capacity), whether or not the Eligible Borrower has an outstanding secured loan of any lien priority;
• the issuance of a New Loan Facility loan that is unsecured, regardless of the secured or unsecured status of the Eligible Borrower’s existing indebtedness; or
• the Eligible Borrower from taking on new secured or unsecured debt after receiving a New Loan Facility loan, provided the new debt would not have higher contractual priority in bankruptcy than the New Loan Facility loan.

Priority of Eligible Loans Under the Priority Loan Facility and Expanded Loan Facility. Under the Priority Loan Facility and the Expanded Loan Facility, at the time of origination or upsizing, as applicable, and at all times the Eligible Loan is outstanding, the Eligible Loan must be senior to or pari passu with, in terms of priority and security, the Eligible Borrower’s other loans or debt instruments, other than mortgage debt. The lien priority requirement could be difficult to achieve under certain financing structures involving multiple liens. For example, in a typical “split-lien” term loan and revolving credit facility arrangement, the revolver has a first lien on current assets (primarily receivables and inventory) and a second lien on other collateral, and the term loan has the converse lien priority on collateral. Because each component of the split-lien structure has some extent of junior lien status with respect to the other, neither component would seem to qualify on its own for the add-on tranche under the Expanded Loan Facility. One potential workaround could be for both the revolver and term loan lenders to permit the add-on tranche to have a first priority lien on all collateral, though this would effectively give the add-on tranche more than the “pro rata” treatment required under the Expanded Loan Facility term sheet.

Multi-Lender and Syndicated Loan Facilities under the Expanded Loan Facility. If the term loan or revolving credit facility underlying an upsized tranche under the Expanded Loan Facility has multiple lenders, the Eligible Lender must be one of the lenders that holds an interest in the underlying loan or credit facility at the date of upsizing. Only the Eligible Lender for the upsized loan is required to meet the Eligible Lender criteria. Other members of the multi-lender facility are not required to be Eligible Lenders. Although the term sheet for the Expanded Loan Facility continues to state that an Eligible Loan must be “made” by an Eligible Lender, the April 30 Term Sheet revisions and the FAQ guidance regarding multi-lender facilities seem to indicate that an underlying loan or credit facility with only ineligible lenders could achieve Eligible Loan status by bringing in an Eligible Lender to hold an interest in the underlying loan or credit facility and originate the upsized tranche under the Expanded Loan Facility. Notably, the Federal Reserve guidance does not require a minimum amount of investment in the underlying loan or credit facility by the Eligible Lender, nor does it require that the investment in the underlying loan or credit facility be made at par value.

Considerations for Eligible Borrowers under Existing Debt Documentation. Eligible Borrowers will need to review their existing debt documents and other material agreements carefully to determine whether they will require the consent of counterparties to incur an upsized tranche under the Expanded Loan Facility, or to separately incur a new loan under the New Loan Facility or Priority Loan Facility. Existing debt documentation will likely contain restrictions on the incurrence or repayment of additional debt, or other covenants or requirements that either implicitly or explicitly contravene the specific provisions of the Program facility loan. If the Program facility is secured, additional modifications to existing debt documents or intercreditor agreements may be required to allow for the applicable lien priority of the Program facility loan.

Loan Classification. All Eligible Borrowers must have been in sound financial condition prior to the onset of the COVID-19 pandemic. In order for an Eligible Borrower to receive a loan under the Program, any existing loan it had outstanding with the Eligible Lender as of December 31, 2019, must have had an internal risk rating (based on the Eligible Lender’s risk rating system) that was equivalent to a “pass” in the Federal Financial Institutions Examination Council’s supervisory rating system as of that date.

Lender Certifications and Covenants

In addition to other certifications required by applicable statutes and regulations, the following certifications and covenants will be required from Eligible Lenders:

• The Eligible Lender must commit that it will not request that the Eligible Borrower repay debt extended by the Eligible Lender to the Eligible Borrower, or pay interest on such outstanding obligations, until the Eligible Loan is repaid in full, unless the debt or interest payment is mandatory and due, or in the case of default and acceleration.
• The Eligible Lender must commit that it will not cancel or reduce any existing committed lines of credit to the Eligible Borrower, except upon an event of default.
• For Eligible Loans under the New Loan Facility and Priority Loan Facility, the Eligible Lender must certify that the methodology used for calculating the Eligible Borrower’s adjusted 2019 EBITDA for the leverage requirement is the methodology it has previously used for adjusting EBITDA when extending credit to the Eligible Borrower or similarly situated borrowers on or before April 24, 2020. For upsized loans under the Expanded Loan Facility, the Eligible Lender must certify that the methodology used for calculating the Eligible Borrower’s adjusted 2019 EBITDA for the leverage requirement is the methodology it previously used when originating or amending the Eligible Loan on or before April 24, 2020.
• The Eligible Lender must certify that it is eligible to participate in the Program, including in light of the conflicts of interest prohibition in section 4019(b) of the CARES Act, which excludes the President, the Vice President, the head of an Executive Department, or members of Congress or certain of their respective family members from eligibility under Title IV programs (the “Conflicts of Interest Provision”).

Cancelation or Reduction of Committed Lines of Credit. The requirement that an Eligible Lender not cancel or reduce an existing committed line of credit does not prohibit the reduction or termination of uncommitted lines of credit, the expiration of existing lines of credit in accordance with their terms, or the reduction of availability under existing lines of credit in accordance with their terms due to changes in borrowing bases or reserves in asset-based or similar structures.

Borrower Certifications and Covenants

In addition to other certifications required by applicable statutes and regulations, the following certifications and covenants will be required from Eligible Borrowers:

• The Eligible Borrower must commit to refrain from repaying the principal balance of, or paying any interest on, any debt until the Eligible Loan (or upsized tranche of an Eligible Loan) is repaid in full, unless the debt or interest payment is mandatory and due. For loans made under the Priority Loan Facility, the Eligible Borrower may, at the time of origination of the Eligible Loan, refinance existing debt owed by the Eligible Borrower to a lender that is not the Eligible Lender.
• The Eligible Borrower must commit that it will not seek to cancel or reduce any of its committed lines of credit with the Eligible Lender or any other lender.
• The Eligible Borrower must certify that it has a reasonable basis to believe that, as of the date of origination or upsizing of the Eligible Loan and after giving effect to such loan or upsizing, it has the ability to meet its financial obligations for at least the next 90 days and does not expect to file for bankruptcy during that time period. Notably, the April 30 Term Sheets removed the previous requirement for an Eligible Borrower to attest that it “requires financing due to the exigent circumstances” presented by the COVID-19 pandemic.
• The Eligible Borrower must commit that it will follow compensation, stock repurchase, and capital distribution restrictions that apply to direct loan programs under section 4003(c)(3)(A)(ii) of the CARES Act, except that an S corporation or other tax pass-through entity that is an Eligible Borrower may make distributions to the extent reasonably required to cover its owners’ tax obligations in respect of the entity’s earnings.
• The Eligible Borrower must certify that it is eligible to participate in the Program, including in light of the Conflicts of Interest Provision.

Repayment of Existing Debt. The covenant restricting an Eligible Borrower from repaying existing debt does not prohibit an Eligible Borrower from undertaking any of the following actions during the term of the Eligible Loan:

• repaying a line of credit (including a credit card) in accordance with the Eligible Borrower’s normal course of business usage for such line of credit;
• taking on and paying additional debt obligations required in the normal course of business and on standard terms, including inventory and equipment financing, provided that such debt is secured by newly acquired property (e.g., inventory or equipment), and, apart from such security, is of equal or lower priority than the Eligible Loan; or
• refinancing maturing debt.

Ability to Meet Financial Obligations. An Eligible Borrower is required to certify that “it has the ability to meet its financial obligations for at least the next 90 days and does not expect to file for bankruptcy during that time period,” because Eligible Borrowers cannot be “insolvent” pursuant to the Program’s authorization under Federal Reserve Act Section 13(3). The solvency certification requirement places Eligible Borrowers that are distressed in a difficult position. Accurately estimating forward-looking 90-day projections in the midst of the COVID-19 pandemic will be inherently challenging. Paradoxically, the Program would not exist but for the uncertainty, liquidity constraints, and massive disruption caused by the COVID-19 pandemic. (See below for a further discussion of Federal Reserve Act requirements.)

Elimination of Attestation of Need; Revision of Requirement to Retain Employees. The April 30 Term Sheets eliminated the requirement under the April 9 Term Sheets that an Eligible Borrower certify that it “requires financing” due to the exigent circumstances of the COVID-19 pandemic and that, “using the proceeds of the Eligible Loan, it will make reasonable efforts” to retain employees. Instead, the April 30 Term Sheets do not require any certification that financing is required, and require only that each Eligible Borrower that participates in the Program make “commercially reasonable efforts” to maintain its payroll and retain its employees during the term the Eligible Loan is outstanding. As explained in the FAQ, this means that an Eligible Borrower should undertake “good-faith efforts” to maintain payroll and retain employees, in light of its capacities, the economic environment, its available resources, and the business need for labor. Eligible Borrowers that have already laid off or furloughed workers as a result of the disruptions from COVID-19 are eligible to apply for a loan under the Program.

Compliance with compensation, stock repurchase, and capital distribution restrictions that apply to direct loan programs under section 4003(c)(3)(A)(ii) of the CARES Act.

The following restrictions apply to an Eligible Borrower until 12 months after the loan is no longer outstanding.

Compensation Restrictions. An officer or employee whose “total compensation” exceeded $425,000 in calendar year 2019 may not receive:

• total compensation in a consecutive 12 month period that exceeds calendar year 2019 total compensation; or
• severance or other termination benefits that exceed two times calendar year 2019 total compensation.

An officer or employee whose total compensation exceeded $3 million in calendar year 2019 may not receive total compensation in a consecutive 12 month period that exceeds $3 million plus 50% of the excess over $3 million of calendar year 2019 total compensation. “Total compensation” includes all salary, bonuses, awards of stock, and other financial benefits provided to the officer or employee by the Eligible Borrower. Many questions remain as to exactly how total compensation should be calculated, including how “awards of stock” are valued, what are “other financial benefits” and how they are valued, and whether payments under defined benefit and actuarial pension plans or non-qualified deferred compensation plans count towards “total compensation.”

Stock Repurchases. Eligible Borrowers will be prohibited from engaging in buybacks of any nationally listed equity securities of the Eligible Borrower or any of its parent entities, unless contractually obligated prior to enactment of the CARES Act.

Capital Distributions. In response to the comments the Federal Reserve received surrounding the restrictions on the payment of dividends, an S corporation or other tax pass‐through entity that is an Eligible Borrower may make distributions to the extent reasonably required to cover its owners’ tax obligations in respect of the entity’s earnings. It is not clear whether distributions from Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs) to their equity owners would be permitted even though they are modified corporations treated as pass‐through entities. Further guidance from the Federal Reserve on this issue is warranted.

Eligible Lender’s Role in Verifying an Eligible Borrower’s Certifications and Covenants. As explained in the FAQ, the Eligible Lender is required to collect the required certifications and covenants from each Eligible Borrower at the time of origination or upsizing. The Eligible Lender may rely on the Eligible Borrower’s certifications and covenants, as well as any subsequent self-reporting by the Eligible Borrower. The Eligible Lender is not expected to independently verify the Eligible Borrower’s certifications or actively monitor ongoing compliance with covenants required for Eligible Borrowers under the April 30 Term Sheets. If the Eligible Lender becomes aware that the Eligible Borrower made a material misstatement or otherwise breached a covenant during the term of an Eligible Loan, the Eligible Lender should notify the Federal Reserve Bank of Boston.

Eligible Lender Underwriting Standards. Eligible Lenders have discretion in deciding whether to make a loan to a potential borrower and will apply their own underwriting standards in evaluating the financial condition and creditworthiness of a potential borrower. As noted in the FAQ, Eligible Lenders should view the eligibility criteria in the April 30 Term Sheets as the minimum requirements for the Program. Eligible Lenders are expected to conduct an assessment of each potential borrower’s financial condition at the time of the potential borrower’s application. An Eligible Lender may require additional information and documentation in making this evaluation and will ultimately determine whether an Eligible Borrower is approved for a loan in light of these considerations. Businesses that otherwise meet the Eligible Borrower requirements may not be approved for a loan or receive the maximum allowable amount.

Federal Reserve Act Requirements

The Main Street Lending Program was authorized by the Federal Reserve under Section 13(3) of the Federal Reserve Act, which requires certain conditions to justify the establishment of an emergency lending program. (See here and here.)

Insolvency. As noted above, under Federal Reserve Act Section 13(3) and related regulations under 12 CFR 201.4(d)(5), the Program may not involve the extension of credit to a person that is insolvent or to a person that is borrowing for the purpose of on-lending the proceeds to a person that is insolvent. Under the regulations, a person is “insolvent” if it is subject to a bankruptcy proceeding or other similar insolvency proceeding or is generally not paying undisputed debts as they come due during the 90-day period preceding participation in the authorized Program.

Indorsement or Other Security. Under Federal Reserve Act Section 13(3) and the related regulation under 12 CFR 201.4(d)(6), the Program must be “indorsed or otherwise secured” to the satisfaction of the Federal Reserve. Because the Program loans can be unsecured, presumably the Federal Reserve has determined that the $75 billion Treasury backstop using CARES Act funding constitutes adequate security to meet this requirement.

Premium / Penalty Interest Rate. Regulations under 12 CFR 201.4(d)(7) require that the interest rate charged on emergency credit under the Program must be at a level that is a premium to the market rate in normal circumstances, affords liquidity in unusual and exigent circumstances, encourages repayment, and discourages use of the Program as unusual and exigent circumstances normalize. These regulations require the Federal Reserve to take into account various factors in establishing the “penalty rate,” including the condition of the affected markets and the financial system generally, the historical rate of interest for loans of comparable terms and maturity during normal times, the purpose of the program or facility, the risk of repayment, the collateral supporting the credit, the duration, terms and amount of the credit, and other factors relevant to ensuring taxpayers are appropriately compensated for the risks associated with the emergency credit. The interest rate of LIBOR plus 300 basis points chosen by the Federal Reserve arguably does not establish a premium over the market rate for similar loans originated prior to the onset of the COVID-19 pandemic, depending on the type of facility involved. Further, it is surprising that the same interest rate will be applicable to all Eligible Loans regardless of whether the Eligible Loan is secured or unsecured, whether the Eligible Borrower is more or less leveraged, or, for loans under the Expanded Loan Facility, what the interest rate is on the underlying credit facility. It appears the Federal Reserve has determined that the Program interest rate represents an appropriate premium based on its analysis of the affected markets and the financial system generally, and based on the terms of the Program facility loans.

Unavailability of Adequate Credit Accommodation. Regulations under 12 CFR 201.4(d)(8) require the Federal Reserve to obtain evidence that Program participants are unable to secure adequate credit accommodations from other banking institutions, which evidence can be based on participant certification. Under the April 30 Term Sheets, no such certification is required from the Eligible Borrowers or the Eligible Lenders. The applicable regulations give the Federal Reserve latitude to conclude that this requirement is satisfied as a result of general economic conditions in the loan markets. Absent further guidance or Program requirements, it appears the Federal Reserve has made a determination that the economic conditions resulting from the COVID-19 pandemic are such that no verifying certification from Eligible Borrowers and Eligible Lenders is necessary.

Equal Opportunity and Diversity. Federal regulations such as 12 CFR 201.4(d)(12) require that participation in any authorized program or facility will not be limited or conditioned on the basis of any legally prohibited basis, such as the race, religion, color, gender, national origin, age or disability of the borrower, and that the selection of any “third-party vendor used in the design, marketing or implementation of any program or facility, to the extent possible and consistent with law, shall involve a process designed to support equal opportunity and diversity.” The April 30 Term Sheets and FAQ do not include any provisions to support this requirement. Perhaps this requirement will be addressed in subsequent releases from the Federal Reserve and Treasury Department.

Loan Participations

The SPV will purchase at par a 95% participation in an Eligible Loan or upsized tranche (provided that it is upsized on or after April 24, 2020) of an Eligible Loan under the New Loan Facility and Expanded Loan Facility respectively, and an 85% participation in an Eligible Loan under the Priority Loan Facility. The SPV and the Eligible Lender will share risk in the Eligible Loan on a pari passu basis. For Eligible Loans under the New Loan Facility and Priority Loan Facility, the Eligible Lender must retain its 5% or 15% interest until the loan matures or the SPV sells all of its participation, whichever comes first.

For Eligible Loans under the Expanded Loan Facility, the Eligible Lender must retain its 5% portion of the upsized tranche of the Eligible Loan until the upsized tranche of the Eligible Loan matures or the SPV sells all of its 95% participation, whichever comes first. In addition, the Eligible Lender must also retain its interest in the underlying Eligible Loan until the underlying Eligible Loan matures, the upsized tranche of the Eligible Loan matures, or the SPV sells all of its 95% participation, whichever comes first.

The sale of a participation in all circumstances will be structured as a “true sale” and must be completed expeditiously after the Eligible Loan’s origination or upsizing, as applicable. At this time, it is unclear how the sale will be documented and whether the SPV will have voting rights or elevation rights common in participations. The Federal Reserve stated it will provide more details at a later date. However, according to the FAQ, the SPV will collect information on certifications, covenants, the lender, loan terms, loan performance, the borrower, borrower fundamentals, collateral, and other characteristics. The information will be used to verify that the lender, loan, and borrower meet eligibility requirements and to support ongoing accounting and credit risk monitoring needs with respect to the purchased loan participations.

The SPV will cease purchasing participations in Eligible Loans on September 30, 2020 and the Program will terminate, unless extended by the Federal Reserve and Treasury Department.

A Few Unanswered Questions

Although the April 30 Term Sheets and FAQ addressed many issues raised by potential participants in the Program, the revised guidance left certain questions unanswered, and raised some new ones.

Use of proceeds. The April 9 Term Sheets required that the Eligible Borrower use reasonable efforts to maintain payroll and retain employees “using the proceeds of the” Program loan. The April 30 Term Sheets do not include this use of proceeds language. Will there be restrictions on the use of proceeds, beyond the various restrictions on repayment of other debt and other restricted payments? Will the Eligible Borrower be permitted to use the proceeds for mandatory or other permitted debt payments, capital expenditures, permitted acquisitions, or other unrestricted payments?

Documentation. Will there be standard documentation for loans under the New Loan Facility and Priority Loan Facility? For upsized loans under the Expanded Loan Facility, will all terms applicable to existing loans apply to the upsized tranche, apart from the specific terms for the Expanded Loan Facility? Will the SPV use standard documentation to evidence its participating interest? Due to the requirements for lender verification, including verification of EBITDA methodology, the process of implementing Program loans will require detailed documentation and could be time intensive.

Restrictions on Share Buybacks and Distributions. The CARES Act restrictions on share repurchases are limited to shares listed on a national securities exchange, and the restrictions on dividends are limited to common stock. Does this mean that share repurchases of unlisted shares, or distributions in respect of preferred shares, may be permitted?

Revolving Credit Facility Considerations.

• Would the voluntary prepayment and reborrowing under a revolving credit facility qualify as “repaying a line of credit (including a credit card) in accordance with the Eligible Borrower’s normal course of business usage for such line of credit?”
• In calculating “existing outstanding and undrawn available debt,” is undrawn availability under an asset-based revolving credit facility included? Or is it (potentially) excluded as an “undrawn commitment that is used to finance receivables (including seasonal financing of inventory)?”

Intercreditor Terms. In the case of a secured Program facility, what will the intercreditor terms look like, especially in terms of the exercise of remedies and bankruptcy matters?

When Will the Program Begin? In its April 30 press release, the Federal Reserve indicated that a start date for the Program “will be announced soon.”

There will undoubtedly be more questions and uncertainties to address as potential participants consider their eligibility and their options under the Main Street Lending Program. We will continue to monitor the Federal Reserve and Treasury Department announcements for additional information and guidance.

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