Novel Forgivable Loan Program May Provide Therapy to Ailing Businesses

Alerts / March 31, 2020

On March 25, 2020, the Senate approved legislation known as the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act or the Act), which is designed to provide financial assistance to individuals, businesses, nonprofits, and state and local governments impacted by the COVID-19 crisis. Section 1102 of the Act creates the Paycheck Protection Program (the Program) pursuant to which the Small Business Administration (SBA) has authority to commit to $350 billion in forgivable business loans (referred to herein as “covered loans”) under Section 7(a) of the Small Business Act. As the name implies, the Program is intended to encourage small businesses to retain employees through the COVID-19 crisis. The following is a brief summary of the Program:

  • Eligible Recipient – any “business concern” or 501(c)(3) that employs not more than the greater of (x) 500 employees (including individuals employed on a full-time, part-time or other basis) or (y) the size standard in number of employees established by the SBA for the industry in which the business operates. The generally applicable “unable to obtain credit elsewhere” requirement does not apply to covered loans.
    • Affiliation Rules – Under complicated SBA rules, the employees of “affiliates” of an applicant must also be included in the determination of whether the aforementioned size standard is satisfied. Affiliation is determined based on common control, considering all the facts and circumstances.
      • A special rule waives the affiliation rules for any business in the “accommodation and food services” sector and for certain businesses operating as franchises.
      • Another special rule waives the affiliation rules for any business that receives financial assistance from a small-business investment company.
    • Another special rule permits businesses in the “accommodation and food services sector” that employ not more than 500 employees per physical location to be eligible to receive a covered loan.
    • Individuals who operate as sole proprietorships and self-employed individuals are generally eligible for covered loans.
  • Loan Amount – The maximum loan amount for a covered loan is generally equal to the product of (x) 2.5, multiplied by (y) the average monthly “payroll costs” of the applicant for the one-year period before the date on which the loan is made.
    • In any event, the maximum loan amount cannot exceed $10 million.
    • In computing “payroll costs,” compensation to an individual employee (or sole proprietor or self-employed person) in excess of $100,000 on an annualized basis is not included.
    • New Businesses – For new businesses (i.e., those not in business during the period from 2/15/2019 to 6/30/2019), the computation is based on average monthly “payroll costs” for the period from 1/1/2020 to 2/29/2020.
  • Deferral – Borrowers are generally entitled to complete payment deferment relief for a period of not less than six months and not more than one year.
  • Forgiveness – Borrowers are eligible for forgiveness of debt on a covered loan (up to the full principal amount of the loan) in an amount equal to the sum of the following costs incurred during the eight-week period beginning on the date of origination of a covered loan: “payroll costs,” interest on “covered mortgage obligations,” payments on “covered rent obligations” and “covered utility payments.” Per Treasury Press Release dated March 31, 2020 (the Release), borrowers are advised that due to high subscription it is anticipated that not more than 25 percent of the forgiven amount may be for non-payroll costs. Any amount that would otherwise be includible in gross income of a borrower by reason of forgiveness of a covered loan is excluded from gross income.
    • Reduction in Employees – The loan forgiveness amount is reduced in proportion to the ratio of (A) the average number of full-time equivalent (FTE) employees per month during the covered period; to (B) at the election of the borrower, either (1) the average number of FTEs per month for the period from 2/15/2019 to 6/30/2019, or (2) the average number of FTEs per month for the period from 1/1/2020 to 2/29/2020.
      • Exemption for Rehires – If during the period from 2/15/2020 to 4/27/2020 there is a reduction in the number of FTEs (as compared to on 2/15/2020) and, not later than 6/30/2020, borrower has eliminated such reduction (i.e., rehired), then such reduction does not trigger a reduction in the forgiveness amount.
    • Reduction Related to Salary/Wages – The forgiveness amount is also reduced by any reduction in the salary/wages of an employee during the covered period in excess of 25 percent of the total salary/wages of that employee during the quarter preceding the covered period. Note: Employees who received, during any pay period in 2019, wages/salary at an annualized rate more than $100,000 are not included in the foregoing reduction calculation.
      • Exemption for Elimination of Reduction – If during the period from 2/15/2020 to 6/30/2020 there is a reduction in the salary/wages of an employee (as compared to on 2/15/2020) and, not later than 6/30/2020, such reduction is eliminated, then such reduction does not trigger a reduction in the forgiveness amount.
  • No Collateral Required – During the covered period, no collateral is required for a covered loan.
  • No Guaranty Required – During the covered period, no personal guaranty is required for a covered loan.
  • Interest Rate – During the covered period, the interest rate on a covered loan cannot exceed 4 percent. However, per the Release, the interest rate on a covered loan will be 0.5 percent.
  • Maturity – Any balance remaining on a covered loan after the reduction based on loan forgiveness shall have a maximum maturity of 10 years from the application date. However, per the Release, the remaining balance of a covered loan will have a maturity date of two years.
  • Fees
    • Guaranty Fees/Annual Fees – The guaranty fee and the yearly fees authorized for guaranteed loans under Section 7(a) are waived.
    • Processing Fees – Lenders are entitled to receive from the SBA (and not from borrowers) a prescribed processing fee for making covered loans.
    • Agents – Per the Release, agent fees must be paid out of lender fees. Agents cannot collect fees from an applicant.
  • Considerations Regarding Existing Loans – Prior to applying for a covered loan, prospective borrowers should review all existing loan agreements to determine whether incurring additional debt will cause a default or otherwise violate the terms of those agreements. Financial covenants, permitted debt definitions and other terms of loan documents may need modifications to allow borrowers to access covered loans without triggering technical defaults. Businesses with existing debt should consult with their legal counsel and lenders now about any necessary amendments or waivers to allow these loans.

Authorship Credit: Nathan F. Ware

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