Turning Loans into Lemonade: A Tough Squeeze

Turning Loans into Lemonade: A Tough Squeeze

May 18, 2020

Client Alert

Brownstein Client Alert, May 18, 2020

On May 15, 2020, the Small Business Administration (SBA) released much-anticipated guidance for the Paycheck Protection Program (PPP) loan forgiveness provisions. Until May 15, many borrowers were relying solely on the language within the Coronavirus Aid, Relief, and Economic Security (CARES) Act and brief guidance found in an interim final rule issued on April 2, 2020 (85 Fed. Reg. 20811). The new forgiveness guidance came in the form of an 11-page application. Borrowers from the nearly $659 billion pot of PPP funds will need to review the application carefully to maximize their forgiveness amounts. This article highlights critical updates to the PPP program following the release of the application.

The application provides new information on how forgiveness calculations will work. A borrower’s application for forgiveness should be submitted to the borrower’s lender and conform to the requirements of the application. The application provides new calculations for when the forgiveness period starts and ends. It also provides information on what costs may be considered for forgiveness. Unfortunately, the application only provides narrow flexibility in calculating the forgiveness period based on the statutory 8-week payroll forgiveness period. The application also attempts to provide employers safe harbor – albeit limited – when they rehire employees or when unable to rehire the employee despite offering the employee work. With regard to allowable costs, the application still applies the 75/25 rule to the percentage of payroll/nonpayroll costs eligible for forgiveness. Additionally, borrowers will need to make several certifications for the forgiveness of these loans, including an especially critical certification for borrowers who took out loans in excess of $2 million.

Calculating the Forgiveness Period

The forgiveness application form provides a “covered period” and an “alternative covered period” during which payroll costs may be forgiven. The CARES Act provided that the covered period would be the 8-week timeframe following the “origination date” of the PPP loan. SBA later stated this 8-week period would begin once the funds are disbursed. The application retains the SBA definition of the 8-week period to define the “covered period” for forgiveness. The covered period is a 56-day period, and day one of that period begins on the date of loan disbursal. Therefore, if a borrower received PPP funds on April 22, 2020, then the covered period would end on June 16, 2020. 

The application also provides for an “alternative covered period” for employers who pay employees on a biweekly (or less frequent) basis. This alternative covered period begins on the first day of the first pay period following the disbursement of the loan proceeds. Therefore, if a borrower received loan funds on April 22, 2020, but elects to use the alternative covered period, and the borrower’s first pay period following disbursal was April 24, 2020, then the alternative covered period would end on June 18, 2020. 

The application’s provision of an alternative covered period provides a narrow window of flexibility for struggling businesses. While states are reopening slowly, the trajectory of economic recovery remains to be seen. As written, the CARES Act seems optimistic about a “V-shaped” economic recovery. That model assumes future stay-at-home orders will not be needed to address the pandemic. However, some of the most hard-hit areas of the United States are still operating under stay-at-home orders that won’t expire until after businesses’ forgiveness periods run out, raising concerns about how businesses are going to keep workers on the payroll past the PPP’s current end date of June 30, 2020. The return of many businesses will be delayed due to phased reopenings, and ongoing consumer fears about the pandemic will inhibit recovery at least through the summer. The House-passed HEROES Act attempts to address this issue by extending the life of the PPP program through the end of 2020. It also extends the forgiveness window from eight to 24 weeks of payroll in order to provide businesses with a longer and more sustainable time horizon to use the PPP funds as they reopen.

Forgiveness Reduction and Rehiring Employees

The CARES Act states that borrowers will have their forgiveness amount reduced if borrowers let employees go or reduce employees pay during the pandemic. However, the CARES Act also contains provisions to restore reduced forgiveness if certain circumstances are met. First, a borrower will not be subject to a reduction in forgiveness if its FTE employee count was reduced between Feb. 15, 2020 and April 26, 2020, but then restored by June 30, 2020 to “levels in the borrower’s pay period that included Feb. 15, 2020.” Second, if a borrower reduced but then later restored employee pay, the borrower may be eligible for elimination of its loan reduction.

Furthermore, a borrower that makes a “good-faith, written offer to rehire an employee” will not have that employee counted in the forgiveness reduction amount. To be eligible, a borrower’s offer to rehire the employee must have been made during the covered period or the alternative covered period. Additionally, employees who were fired for cause, resigned voluntarily, or voluntarily requested and received a reduction in hours do not count toward a borrower’s reduction. However, this credit toward a borrower’s loan forgiveness FTE count only applies if the position was not filled by a new employee.

The forgiveness application, in practice, provides borrowers with a narrow window to rehire in the face of enhanced unemployment benefits. While rehiring employees may take place until June 30, 2020, borrowers must offer to rehire employees during their 8-week covered period or alternative covered period if they wish to receive loan forgiveness credit for employees who turned down an offer to rehire. Borrowers who laid off employees after April 26, 2020 are ineligible to claim such loan forgiveness credit. This may pose a challenge to borrowers with employees receiving more from enhanced unemployment than original wages, or where stay-at-home orders are in place for a period of time that extends beyond borrowers’ own 8-week covered period.

Allowable Costs; 75/25 Rule Still in Effect

In addition to payroll costs, other nonpayroll costs may be eligible for forgiveness under the CARES Act. These costs include mortgage interest, rent and utilities. The application expands on the definition of mortgage interest and rent by stating the allowable uses extend to mortgages and lease agreements on both real and personal property. The application still states that only 25% of PPP funds received may be used for nonpayroll costs. Therefore, 75% of funds must go towards payroll costs. This is consistent with the April 2, 2020 interim final rule (85 Fed. Reg. 20811). The 75/25 rule was recently called into question by the SBA inspector general, who determined this ratio exceeded SBA’s statutory authority under the CARES Act. The House-passed HEROES Act would overturn this rule, expand the allowable use of funds, and restrict the SBA administrator from promulgating a regulation that would institute another payroll-to-nonpayroll ratio for forgiveness. In sum, the application keeps allowable costs for forgiveness at the current regulatory status quo despite vocal objections.

Forgiveness Certifications, Loan Review, and Loans in Excess of $2 Million

The forgiveness application requires more extensive documentation than what was required by the PPP loan application. Borrowers will need to provide documentation of how the funds were used following their disbursal. Borrowers who received loans of over $2 million will need to be even more vigilant. SBA and Treasury issued joint guidance that stated loans over $2 million would be scrutinized closely following a forgiveness application, while loans that do not exceed $2 million will be presumed to meet the loan certification that the funds were necessary (See SBA FAQ 39 and 46, Paycheck Protection Program Loans Frequently Asked Questions (FAQs)). Notwithstanding the necessity certification safe harbor, smaller loans may be scrutinized on other grounds, but borrowers should expect large loans to receive a great deal of scrutiny. 

The application also asks borrowers to certify whether – when considered together with their affiliates – they received loans in excess of $2 million. Affiliation with a borrower is defined by SBA interim final rule on affiliates (See 85 Fed. Reg. 20817 (April 15, 2020)). A borrower, therefore, should be aware of whether any affiliate business took out a PPP loan and aggregate the total loan amount. This aggregation of affiliates’ loan amounts would not apply to businesses that received a waiver of the affiliation rule under 15 U.S.C. § 636(a)(36)(D)(iv). These exempted businesses under the CARES Act need not aggregate their affiliates and only have to check the box if their own loan amount exceeds $2 million. This waiver applies to businesses classified under the North American Industry Classification System code beginning with 72 (typically restaurants and hotels), franchises identified in the SBA Franchise Directory, and a business that received funds from a Small Business Investment Company (SBIC).

The application also takes another bite of the apple regarding a borrower’s original loan certification and eligibility. The forgiveness application provides a page-long list of certifications that require the borrower to certify that it used the loan funds as authorized, and that the information submitted was and is accurate and truthful. Borrowers seeking forgiveness should submit forgiveness applications to their lenders. It should be expected that any borrower, together with its affiliates, that received loans in excess of $2 million will be referred to SBA for a thorough review of the loan and forgiveness application. 

Lenders may also refer loan forgiveness applications to SBA that raise any red flags. Therefore, it is important to gather any and all documentation and be confident in your certifications before applying for forgiveness. SBA has yet to release any specifics on what such reviews will entail, but the application makes clear that a borrower – no matter the size of its loan – is required to retain all records relating to its loan “for six years after the date the loan is forgiven or repaid in full.” These records include all documentation submitted with the borrower’s loan application, supporting the borrower’s “certifications as to the necessity of the loan request and its eligibility” for the loan, supporting the borrower’s forgiveness application, and demonstrating the borrower’s compliance with the loan requirements. Borrowers must also permit SBA, “including representatives of its Office of Inspector General,” to access such files upon request.

 

For additional information or assistance, please contact a member of our Small Business Rapid Response Team

Click here to read more Brownstein alerts on the legal issues the coronavirus threat raises for businesses.

This document is intended to provide you with general information regarding economic updates related to the Paycheck Protection Program. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions.

Meet The Team

Reese Goldsmith Policy Advisor and Associate T 202.747.0505 rgoldsmith@bhfs.com
Mitchell J. Langberg Shareholder T 702.464.7098 mlangberg@bhfs.com
Sarah M. Mercer Shareholder T 303.223.1139 smercer@bhfs.com