Certification and Forgiveness
With an additional $310 billion in funding committed by Congress for Paycheck Protection Program (PPP) loans, the government has turned its focus to the self-certifications businesses attested to on the PPP loan application. We offer a few matters businesses should consider as they evaluate (or reevaluate) their eligibility for the program. Once the second round of PPP loans is funded, we expect the focus of attention to logically shift to the process for loan forgiveness. There are at least a few potential misconceptions regarding PPP loan forgiveness of which borrowers should be aware.
PPP Loan Application Self-Certification as to “Necessity”
Treasury Department guidance and additions to the SBA’s Paycheck Protection Program Loans Frequently Asked Questions (SBA FAQs) have served to focus more attention on applicants’ eligibility based on their access to liquidity through other means and particular industries. The Treasury Department issued guidance directed at publicly traded companies, hedge funds and private equity funds and their portfolio companies that have received funding. The guidance suggests that such entities should considering repaying the loans by May 7, 2020 if they cannot satisfy the PPP loan application certification requirement that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Further, SBA FAQs Question 39 provides that the SBA will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.
SBA FAQs Questions 31 and 37 provide some general guidance regarding the “necessary to support the ongoing operations of the Applicant” certification contained in the PPP loan application. In particular, the SBA reminds applicants the certification must be made in good faith, taking into account not only their current business activity, but also their ability to access other sources of liquidity on reasonable terms. Question 31 also states that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and that such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.
This new guidance appears to respond, at least in part, to reports that many small businesses were unable to obtain PPP loans in the first wave of funding under the CARES Act, even as a number of public companies and other large businesses promptly received PPP loans. The impact of the new guidance on smaller privately owned businesses is less straightforward. Presumably, most such businesses took the “necessary to support business operations” certification seriously when applying for PPP loans. SBA FAQs Question 31 expressly refers to “businesses owned by large companies with adequate sources of liquidity” and discusses a public company with substantial market value and access to capital markets. On the other hand, the SBA FAQs are the most expansive guidance to date as to the scope of the “necessary to support” certification and emphasize that thoughtful consideration of the certification should be undertaken by all borrowers. As such, the Treasury guidance and the SBA FAQs may prompt some PPP borrowers that may not yet be in financial distress to reconsider their positions and seek to repay PPP loans by May 7 to take advantage of the SBA’s safe harbor.
Part of the issue has to do with the fact that not all businesses faced imminent closure or layoffs at the time of the PPP application, but the “uncertainty” caused by the pandemic would lead a reasonable business to expect a severe downturn in their revenues due to their customers going out of business, large projects being put on indefinite hold or outright cancelled, or a reasonable expectation that receivables would become bad or, at the least, significantly delayed.
What should an applicant to do to demonstrate that the PPP loan was determined in good faith to be “necessary to support the ongoing operations of the Applicant”? Businesses and non-profits should document the decision making process they followed in making the election to pursue a PPP loan. The PPP is a payroll-centric program – the amount of funding and forgiveness is primarily based on historical and current (during the term of the loan) payroll and headcount. Accordingly, if the applicant was considering layoffs and staffing reductions absent PPP loan funding, the applicant’s Board meeting minutes or resolution by written consent approving the application for the PPP loan should reflect such facts. Similarly if the applicant’s cash flow to support operations was suffering, or was in danger of suffering, at the time of the application, the applicant should reflect such facts in its records and Board resolution. Other relevant facts, such as the inability of the applicant to draw on existing credit facilities or obtain new or additional debt financing on terms not significantly detrimental to the business, also should be reflected in the applicant’s records. Businesses and non-profits may want to consult with legal counsel to memorialize the process followed and information available at the time of applying for the PPP loan.
PPP Loan Forgiveness
We expect the SBA will soon turn to providing further guidance as to PPP loan forgiveness. We highlight below a few current misconceptions about this process.
1. For purposes of determining my loan amount and the subsequent loan forgiveness, I only need to maintain my current employee headcount but can reduce compensation.
False. There are three components to loan forgiveness. First, to be eligible for forgiveness, at least 75% of the amount borrowed must be spent on payroll-related expenses. Second, there is a reduction in forgiveness if the average monthly number of full time equivalent employees (FTEs) is less during the first eight weeks after the loan is funded than the average monthly number of FTEs from either (i) February 15, 2019 to June 30, 2019, or (ii) January 1, 2020 to February 29, 2020. The loan forgiveness amount is prorated. For example, assuming all loan proceeds are spent on eligible expenses, if the eight-week monthly average is 40 FTEs and the monthly average during the earlier period chosen by the applicant was 50 FTEs, only 80% of the loan can be forgiven. (Part-time employees can be aggregated on an FTE basis for purposes of the calculation, and employees laid off between February 15, 2020 and April 26, 2020 but rehired before June 30, 2020 will count in the calculation. What number of hours per week constitutes an “FTE” has yet to be specified.) The third test measures the level of compensation. For those employees making $100,000 or less on an annualized basis during 2019, a borrower cannot reduce individual compensation by more than 25% during the eight-week period as measured against the most recent full quarter of 2020 (in most cases the first quarter of 2020). Any reduction of individual compensation greater than 25% will reduce the loan forgiveness amount on a dollar-for-dollar basis. The details of these tests have yet to be defined. Further SBA guidance is expected in the coming weeks.
2. The loan forgiveness is self-executing and happens automatically.
FALSE. Loan forgiveness does not happen automatically. A PPP loan borrower has to apply to its lender to have its PPP loan totally or partially forgiven, and requires that (i) the borrower has used its PPP funds during the eight weeks after funding for permissible expenditures and in ratios acceptable to the SBA in accordance with program requirements; (ii) the borrower has submitted all necessary and requested paperwork to demonstrate that it has used PPP funds in a compliant manner; and (iii) its lender has made a determination that the borrower is eligible for loan forgiveness. Under the CARES Act, a lender has up to 60 days after a borrower applies for forgiveness to make a determination about whether a PPP loan can be forgiven. Since the testing period for PPP loan forgiveness is the initial eight weeks after the loan is funded to the borrower, there is a potential waiting period of 16.5 weeks where a borrower’s PPP loan is outstanding and unforgiven (assuming it applies for forgiveness as soon as it is able to do so). With respect to loan amounts that are not eligible to be forgiven, no payments are due for the first six months the PPP loan is outstanding, but the loan accrues interest at 1% per annum during this period.
Furthermore, as noted above, SBA FAQs Question 39 (posted by the SBA on April 29, 2020) provides that the SBA will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. It is unclear what effect this review will have on the 60 day period noted above that is prescribed in the CARES Act.
One word of caution – the documentation and other information requests from lenders for forgiveness purposes are likely to evolve as the SBA regulations are published. Accordingly, best practice is to keep meticulous records of how all PPP funds are used, and to contact your lender as soon as possible to verify exactly what documentation or other information will be required to ensure forgiveness of the PPP loan. Further, borrowers should ask their lenders what a formal request for loan forgiveness will look like, and request any required forgiveness paperwork as soon as possible. Ideally, the loan forgiveness request, together with all verification paperwork, will be ready for submission as soon as the initial eight-week period has passed.
3. An employer that has applied for and received a PPP loan that is not yet forgiven cannot defer deposit and payment of the employer’s share of Social Security tax without incurring failure to deposit and failure to pay penalties.
False. The IRS issued guidance to employers that have received PPP loans, but whose loans have not yet been forgiven. Such employers may defer deposit and payment of the employer’s share of Social Security tax that otherwise would be required to be made through the date the lender issues a decision to forgive the loan, without incurring failure to deposit and failure to pay penalties. Once an employer receives a decision from its lender that its PPP loan is forgiven, the employer is no longer eligible to defer deposit and payment of the employer’s share of Social Security tax due after that date. However, the amount of the deposit and payment of the employer’s share of Social Security tax that was deferred through the date that the PPP loan is forgiven continues to be deferred and will be due in two installments: 50% on December 31, 2021 and 50% on December 31, 2022. The deferral applies to deposits and payments of the employer’s share of Social Security tax that would otherwise be required to be made during the period beginning on March 27, 2020, and ending December 31, 2020.
Further SBA guidance regarding loan forgiveness is needed and expected. There remain questions, for example, about accounting (accrual versus cash) for expenses during the eight-week test period and a number of other issues that are likely to be addressed over the coming weeks.
Hirschler is here to assist. If you would like to discuss the potential impact of the Treasury guidance and SBA FAQs on your PPP loan or loan application or the loan forgiveness provisions discussed above or have any other questions about your business operations during this difficult period, please do not hesitate to contact us.
Luis F. Ruiz