On April 2, 2020, the Small Business Administration (SBA) published an interim final rule, “Business Loan Program Temporary Changes; Paycheck Protection Program,” which provides guidance and interpretation on the implementation of the “Paycheck Protection Program” (PPP) created by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). On April 3, the SBA published an additional rule to supplement the interim final rule with further guidance regarding the application of certain affiliate rules to the PPP. An understanding of the interpretive guidance provided by these interim final rules is critical to any small business looking to take advantage of SBA’s new $349 billion loan program.
The most critical piece of this interim rule to understand is that SBA has taken the position that a company’s payments to independent contractors should not be included in the definition of “payroll costs,” such definition being used to determine the size of a loan for which a small business may be eligible. This position seems to be at odds with the language of the CARES Act, which under a plain reading includes payments to independent contractors in the definition of “payroll costs.” It seems that SBA has recognized that the statute’s plain meaning would potentially allow independent contractors to double dip as the could be paid by the companies for which they are working and then also obtain loans on their own as independent small businesses. Perhaps SBA has taken upon itself to close this possible loophole in the statute. However, many small businesses rely extensively on independent contractors for their business operations and were counting on being able to obtain loans to pay these independent contractors. If SBA’s interim rule becomes final, these companies will have to make significant re-calculations to their operations.
The SBA’s interim rule also makes significant changes to the lending criteria. Rather than require lenders to comply with § 120.150 of the statute (lending criteria), the agency will instead “allow lenders to rely on certifications of the borrower in order to determine eligibility of the borrower and use of loan proceeds and to rely on specified documents provided by the borrower to determine qualifying loan amount and eligibility for loan forgiveness.” Part of this certification involves the borrower certifying that it is eligible to receive a loan under the PPP. To review what we highlighted last week, eligible organization are those qualifying as a “small business concern” under the Small Business Act, or any business concern, nonprofit organization, veterans organization, or tribal businesses with 500 or fewer employees whose principal place of residence is in the United States, or are a business that operates in a certain industry and meet the applicable SBA employee-based size standards for that industry.
An eligible entity must have also been in operation on February 15, 2020 and either had employees for whom it paid salaries and payroll taxes, or paid independent contractors as reported on a Form 1099-MISC. Subject to some additional restrictions and requirements, eligibility also extends to individuals who operate under a sole proprietorship, as an independent contractor, or certain self-employed individuals.
Even entities that meet the aforementioned eligibility requirements may be ineligible for a PPP loan if:
- The applicant is engaged in any activity that is illegal under federal, state, or local law;
- The applicant is a household employer (e.g., individuals who employ household employees such as nannies or housekeepers);
- An owner of 20% or more of the equity of the applicant is incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years; or
- The applicant has obtained a direct or guaranteed loan from the SBA or any other federal agency, and is either delinquent on such loan at the time of application for PPP, or has defaulted within the last 7 years and caused a loss to the government.
The CARES Act established that the maximum loan a small business may obtain under the PPP is either $10,000,000, or a calculation involving payroll costs (whichever is the lesser of the two). In its rule, SBA provided a step-by-step process for calculating these payroll costs:
- Aggregate the total payroll costs from the last 12 months for employees whose principal place of residence is the United States.
- Subtract any compensation paid to an employee in excess of an annual compensation (including salary, wages and tips) of $100,000.
- Calculate the average monthly payroll costs (divide the amount from Step 2 by 12).
- Multiply the average monthly payroll costs from Step 3 by 2.5.
- Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, after deducting the amount of any advance under an EIDL COVID-19 loan (since it does not have to be repaid).
By way of a very simplistic example, a small business with no individual compensation above $100,000, no outstanding EIDL loans, and whose annual payroll is $1,200,000 would qualify for a $250,000 loan. ((1,200,000 / 12) x 2.5).
Small businesses should be aware of additional guidance provided in the Interim Rule, including that:
- The fixed interest rate on loans made under the PPP will be 1%, not .5%.
- The maturity date on a PPP loan will be two years.
- A small business is only eligible to receive one PPP loan and may not apply for a second.
- The $349 billion program is first-come, first-served.
- At least 75% of PPP loan proceeds must be spent on payroll costs (a broad category of expenses also discussed in our article last week).
- Borrowers will not have to make any interest payments for six months following the date of disbursement of the loan, although interest will accrue on PPP loans during this six-month deferment.
Borrowers seeking a PPP loan should consult with counsel regarding both the requirements of the CARES Act as well as the guidelines provided by SBA’s Interim Final Rule. Eligible businesses should move quickly – banks have reportedly processed $70 billion in PPP loan applications since Friday, and the Treasury Department has indicated to Congress that the program funds need to be replenished.