The CARES Act, signed into law on March 27, established the Paycheck Protection Program, a loan program that makes approximately $350 billion available to small businesses using the SBA’s existing 7(a) loan program. The Paycheck Protection Program (PPP) has generated tremendous interest from companies and their investors. It has also raised a number of questions. We are expanding the FAQs we published March 28, 2020 to address recent developments and to answer additional questions that we’ve addressed for clients.
- What are PPP Loans?
PPP loans are an extension of the SBA’s loan guarantee program, also known as the 7(a) program. PPP loans will be made by approved SBA certified lenders and are 100% guaranteed by the federal government. They will be available through June 30, 2020.
- What certifications and representations must a borrower and its investors make in order to obtain a PPP Loan?
On March 31, 2020, the SBA released a sample application form for PPP loans. The application requires an applicant company and each person or entity that owns 20% or more of the company’s equity to make certain representations and certifications, some of which go beyond what is required under the CARES Act and may be difficult to make for companies with a significant number of investors or institutional investors.
The sample loan application requires
- An applicant company to confirm that:
- neither the company nor any of its owners is presently suspended, debarred, proposed for debarment, declared ineligible, voluntarily excluded from participation in the loan transaction by any Federal department or agency, or involved in any bankruptcy; and
- neither the company nor any of its owners nor any business owned or controlled by any of them has ever obtained a direct or guaranteed loan from SBA or any other Federal agency that is currently delinquent or has defaulted in the last 7 years and caused a loss to the government.
NOTE: If a company cannot confirm both No. 1 and No. 2, then, according to the sample loan application, it will not be approved for a loan.
- An applicant that is an individual and each owner of 20% or more of an applicant company’s equity to confirm that:
- it is not presently subject to an indictment, criminal information, arraignment or other means by which formal criminal charges are brought in any jurisdiction, or presently incarcerated, on probation or parole;
- it has not, within the last 7 years, (i) been convicted; (ii) pleaded guilty; (iii) pleaded nolo contendere; (iv) been placed on pretrial diversion; or (v) been placed on any form of parole or probation (including probation before judgment) for any felony or misdemeanor for a crime against a minor; and
- it is a U.S. Citizen or has Lawful Permanent Resident status.
- An applicant that is an individual and each owner of 20% or more of an applicant company’s equity to confirm that:
NOTE: If an applicant that is an individual and each owner of 20% or more of an applicant company’s equity cannot confirm each of No. 1, No. 2 and No. 3, then, according to the sample loan application, the applicant will not be approved for a loan.
The application also requires an applicant company and each owner of 20% or more of its equity to certify in good faith that, among other things:
- current economic uncertainty makes the loan request necessary to support the ongoing operations of the applicant;
- the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments (with an acknowledgement that if the funds are used for unauthorized purposes, the federal government may pursue criminal fraud charges);
- documentation 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 payments and covered utilities for the eight-week period following this loan will be provided to the lender; and
- during the period beginning on February 15, 2020 and ending on December 31, 2020, the Applicant has not and will not receive another loan under the program.
The application also requires an applicant company to represent that:
- to the extent feasible, it will purchase only American-made equipment and products; and
- the applicant company is not engaged in any activity that is illegal under federal, state or local law.
In addition, the application requires disclosure as to whether (i) the applicant company or any owner of the applicant company is the owner of any other business or has common management with any other business, and (ii) the applicant company received an SBA Economic Injury Disaster Loan between January 31, 2020 and April 3, 2020. The application does not exempt any applicants from providing such disclosure regarding ownership or common management with other businesses and calls for the applicant to provide a complete listing of all “Affiliates” and a description of its relationship with such “Affiliates.”
- When will applications for PPP Loans be available?
According to the SBA, applications for small businesses and sole proprietors will be available beginning April 3, 2020 and applications for independent contractors and self-employed individuals will be available beginning April 10, 2020. Whether or not applications will actually be accepted on April 3, 2020 will depend on how quickly lenders are able to receive any remaining guidance they may need from the SBA and prepare their systems to intake and process loan applications.
- What terms will PPP Loans have?
- Maximum amount of PPP Loan equal to the lesser of (i) 2.5x average monthly Payroll Cost (as defined below) during the year prior to the making of the loan and (ii) $10 million. For companies that were not in business during the period beginning on February 15, 2019 and ending on June 30, 2019, this can be calculated by reference to the average monthly payroll for the period from January 1, 2020 to February 29, 2020. For seasonal businesses, the average monthly Payroll Cost can be calculated using a 12-week period beginning February 15, 2019, or March 1, 2019, whichever the seasonal employer chooses.
- According to guidance from the Department of Treasury published on March 31, 2020:
- to the extent the loan is not forgiven, the loan will have a two-year term (as compared to the maximum 10-year term specified in the CARES Act);
- the interest rate will be capped at 0.50% (as compared to the 4% maximum interest rate specified in the CARES Act) and loan fees waived; and
- all payments will be deferred for six months (though interest will continue to accrue)
- No collateral or personal guaranties will be required.
- What is included in “Payroll Cost”?
Payroll Cost includes the following:
- salary, wages, commissions or tips;
- employee benefits including costs for vacation, parental, family, medical or sick leave, and allowance for separation or dismissal;
- payments required for the provisions of group health care benefits including insurance premiums;
- payment of any retirement benefit; and
- state and local taxes assessed on compensation.
Payroll Cost excludes the following:
- compensation above $100,000 per annum for any person (pro rated for the applicable period);
- federal wage withholding taxes and certain federal employment taxes for the period;
- sick leave and family leave wages for which a credit is allowed under the Families First Coronavirus Response Act; and
- any compensation of an employee whose principal place of residence is outside of the United States.
- What may PPP Loans be used for?
Permitted uses of proceeds for PPP loans will be:
- Payroll Costs;
- interest payments on mortgage obligations;
- rent payments on leases in force before February 15, 2020;
- utility payments for services that began before February 15, 2020; and
- interest payments on other debt existing before February 15, 2020.
- Will PPP Loans be forgiven?
Yes, PPP Loans are to be forgiven to the extent they are used during the eight-week period after the loan is made for:
- Payroll Costs,
- interest payments on mortgage obligations,
- rent payments under leases in force before February 15, 2020, and
- utility payments for services that began before February 15, 2020.
The amount of PPP Loans that is forgiven will not be taxed as cancellation of indebtedness income. However, on March 31, 2020 the SBA published guidance that due to likely high subscription, it is anticipated that not more than 25% of the forgiven amount may be for non-payroll costs.
In addition, the amount of a PPP Loan that will be forgiven may be reduced in the following circumstances:
- if the borrower reduces its average number of monthly FTE employees during the eight-week period following the making of the loan as compared to (at borrower’s election) either (i) the period between February 15, 2019 and June 30, 2019, or (ii) the period between January 1, 2020 and February 29, 2020. For example, if a borrower averaged 80 employees during the eight-week period following the making of the loan but averaged 100 employees during the historical measurement period, then the amount forgiven would be reduced by 20%; and
- if the borrower reduces the salary of an employee by more than 25% during the eight-week period compared to the most recent full quarter during which the employee was employed, then the amount of loan forgiveness will be reduced by the amount of salary reduction in excess of 25%. This reduction does not apply in the case of employees that had an annualized compensation level of more than $100,000 during any pay period in 2019.
Significantly, however, if a borrower reduces headcount or salaries during the period in between February 15, 2020 and April 26, 2020 but subsequently re-hires or reverses the salary reductions of the affected employees prior to June 30, 2020, that reduction in headcount or salary will not result in any reduction in loan forgiveness.
- What businesses are eligible for PPP Loans?
PPP Loans will be available to businesses with not more than 500 employees (or larger businesses that are designated as small by virtue of the size test for its NAICS code). However, there is a very important caveat that may be applicable to PE- and VC-backed companies. Current SBA rules require a company to count the employees or revenue of all of its affiliates in determining whether it meets the applicable small-business size standard.
- How does a business determine who its affiliates are for purposes of eligibility for PPP Loans?
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. SBA’s regulations provide that it will consider the “totality of the circumstances,” and may find affiliation even though no single factor is sufficient to constitute affiliation. Control can be either affirmative or negative.
Examples of affirmative control include voting or board control, i.e., majority of voting shares or board seats. For example, a person that owns more than 50% of a company’s voting stock controls or has the power to control the company for SBA loan purposes. Affiliation can also arise from common management, i.e., if one or more officers, directors, managing members or partners who control the board/management of one entity also control the board/management of another entity.
Under SBA’s general affiliation rules, if two or more persons own or control less than 50% of a company’s voting stock, and such minority holdings are equal or approximately equal in size, and the aggregate of these minority holdings is large as compared with any other stock holding, SBA presumes that each such person controls or has the power to control the business. This rule, however, does not appear in SBA’s affiliation rules for its loan programs.
Negative control includes, but is not limited to, instances in which a minority shareholder “has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.” If a minority shareholder has such ability, then that minority shareholder is an affiliate of the company.
Other blocking rights held by minority shareholders can also lead to a finding of affiliation. For example, a company that is 40% owned by a VC fund can be deemed to be an affiliate of the fund (and other companies the fund controls) if the fund has the power to block certain actions by the company’s board or its executives.
The SBA’s Office of Hearing Appeals (OHA) has interpreted the affiliation rule to mean that negative control arises from a minority shareholder’s power to block ordinary actions essential to operating the company. See Size Appeal of: Southern Contracting Solutions, LLC, SBA No. SIZ-5956, 2018 (S.B.A.), 2018 WL 4492382. OHA has found that a minority shareholder’s ability to prevent ordinary corporate actions, thereby creating affiliation, can include the following:
- taking on new debt;
- issuing dividends;
- setting officers’ compensation;
- purchasing equipment;
- making changes to a budget;
- incurring expenses over $5,000; and
- amending or terminating leases.
In Southern Contracting, OHA explained that a company giving minority owners the ability to block certain extraordinary actions of the company does not provide negative control to the minority owners, if those supermajority provisions are crafted to protect the investment of the minority owners, and not to impede the majority’s ability to control the company’s operations or to conduct the company’s business as it chooses.
Further, OHA has identified numerous extraordinary actions that a minority owner may be given power to block without resulting in a finding of negative control, including:
- adding new members;
- dissolving the company;
- filing for bankruptcy;
- amending the bylaws;
- issuing additional capital stock;
- entering into a substantially new business;
- selling all or substantially all the company’s assets;
- mortgaging or encumbering all or substantially all of the company’s assets; and
- committing any act that could result in a change in the amount or character of the company’s contribution to capital
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 of the individual company.
- That sounds complicated. Do businesses really need to conduct an affiliation analysis to apply for these loans?
Generally, yes. The CARES Act waives the application of the SBA’s affiliation rules for (i) businesses with an NAICS Code beginning with 72 (food services and lodging) [link to list of NAICS codes], (ii) businesses operating as franchises, and (iii) businesses that receive financial assistance from a Small Business Investment Company. In the days leading up to final passage of the CARES Act, some observers expressed concern that companies backed by VC or PE funds may be left out of the PPP program without a broadly applicable waiver of the affiliation rules. The CARES Act did not provide such a waiver except to companies in the three categories mentioned above, so most companies will need to consider the SBA’s affiliation rules when determining their eligibility for PPP loans. A number of industry participants and government officials have encouraged the SBA and Treasury Department to provide greater clarity regarding the affiliation rules for companies that receive institutional investment, such as venture- and private equity-backed companies. The Treasury Department stated on March 31, 2020 that additional guidance may be released as appropriate, but as of today’s date (April 1, 2020) no additional guidance has been publicly announced.
- How should businesses assess whether any of their investors constitute “affiliates”?
Before applying for a loan, companies and their counsel should review their capitalization tables, shareholder agreements and other governing documents to evaluate whether provisions in those documents give minority owners either affirmative or negative control. As a general matter, provisions providing minority owners with the power to block a company’s ordinary actions are more likely to create negative control and result in affiliation. Each prospective loan applicant needs to determine, based on its own unique circumstances, whether it qualifies after analyzing affiliation and other eligibility requirements. Consideration should be given to whether it is possible to amend certain provisions of shareholder agreements or governing documents to provide a stronger basis for determining that an investor is not an affiliate. Companies must be prepared to identify all affiliates and be prepared to defend their eligibility and affiliation determinations, taking into account their individual business objectives. As a cautionary note, the False Claims Act has been used against companies that allegedly made false or misleading statements in their size status certifications.
- What about businesses that are too large to qualify for PPP Loans or Economic Injury Disaster Loans?
For businesses that are too large to qualify for either PPP Loans or Economic Injury Disaster Loans (EIDLs), whether due to their own size or on a combined basis with their affiliations, there may be additional government financing made available in the days to come. The portion of the CARES Act referred to as the Coronavirus Economic Stabilization Act of 2020 (CESA) includes approval for a $500 billion loan and subsidy program for loans, loan guarantees and other investments in larger businesses. This includes relief for certain specified industries, such as air carriers, as well as a loan program for mid-size businesses with 500-10,000 employees. The loan programs authorized under CESA are separate from the PPP Loans and EIDLs described in this update. For more information on these loan programs, see our publication “Government Financing Options for Mid-Size and Large Companies Impacted by COVID-19.”
- What should companies do next if they are interested in obtaining a PPP Loan?
- Perkins Coie can help answer questions about your eligibility for a PPP Loan, including how the affiliation rules may apply to your business.
- Contact an SBA lender in your area or with whom you may have an existing relationship (link to SBA lender match website: https://www.sba.gov/funding-programs/loans/lender-match). Lenders are expected to begin processing applications as early as April 3, 2020 and demand for these loans is expected to be significant. Accordingly, eligible applicants who wish to apply should move quickly to claim their place in line.
- Consider what consents will be required to obtain a PPP Loan, including from any existing lenders.
ECONOMIC INJURY DISASTER LOANS
- What are Economic Injury Disaster Loans?
Economic Injury Disaster Loans (EIDLS) are loans made directly by the SBA to business that have suffered substantial economic injury from COVID-19 such that they are unable to meet their obligations as they mature or to pay their ordinary and necessary operating expenses (loss of profits/sales alone insufficient).
- What terms will EIDLS have?
- EIDLs will be capped at $2 million with an interest rate capped at 3.75%.
- Long-term repayment will be permitted (up to 30 years).
- Loans over $200K will require collateral and may require personal guarantees from principals. However, the SBA will not decline a loan for lack of collateral but requires borrowers to pledge what is available.
- Applicants may request an emergency EIDL grant (up to $10,000), which the SBA is required to distribute within three days.
- What may EIDLs be used for?
Proceeds of EIDLs may be used for working capital, including fixed debts, payroll, accounts payable, sick leave and other obligations that can’t be met because of COVID-19’s impact.
- Will EIDLs be forgiven?
No, but businesses are not required to repay emergency EIDL grants, even if subsequently denied an EIDL by the SBA.
- What businesses are eligible for EIDL?
To be eligible for an EIDL, a business must qualify as a “small business concern” under existing SBA guidelines based on their NAICS code number (see link). The SBA affiliation rules discussed above in the context of PPP Loans also apply to EIDLs. The waiver of affiliation rules for certain businesses described above does not apply to EIDLs. Any business requesting an emergency EIDL grant must self-certify that it is otherwise eligible under applicable SBA guidelines.
- 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 the EIDL is used for purposes other than the permitted uses of a PPP Loan (such as trade payables, which are not a permitted use of PPP Loan proceeds). Borrowers can also refinance an EIDL that was made on or after January 31, 2020 and before the date PPP Loans were made available into a PPP loan in order to take advantage of the loan forgiveness aspects of the PPP program.
- 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 a PPP Loan, including how the affiliation rules may apply to your business.
- Applications for EIDLs can be made directly through the SBA’s website: https://disasterloan.sba.gov/ela/Information/EIDLLoans.
- 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.
 The sample application does not specify clearly which “owners” of the company are the subjects of Questions (1), (2), and (3) of the application. Plausible interpretations include owners of any amount of equity in the company or owners of at least 20%. The National Venture Capital Association has requested urgent clarification of this ambiguity and other immediate revisions to the application.
 The U.S. Government’s System for Award Management (www.sam.gov) allows for a search of entities that are suspended, debarred, or declared ineligible from contracting with the federal government. In addition to searching records in SAM.gov, applicants may wish to ask each of their shareholders for a written confirmation that they do not fit within the descriptions in Questions (1) and (2).
 The CARES Act provides that the average monthly Payroll Cost is determined based on the trailing twelve-month average for companies that were in business during the period beginning on February 15, 2019 and ending on June 30, 2019. However, the sample application form indicates that average monthly Payroll Cost is to be calculated based on average monthly payroll for 2019.