CARES Act: Paycheck Protection Program and EIDL Loan Program
By Carr Staley
Updated: April 7, 2020
The Coronavirus Aid, Relief, and Economic Security Act or CARES Act was signed into law on March 27, 2020. The CARES Act was passed as a comprehensive $2T stimulus package put in place to combat the economic challenges created by the novel coronavirus (also referred to as COVID-19). In order to address the challenges faced by small businesses, self-employed individuals, and independent contractors, the CARES Act expands existing loan programs and creates additional loan programs offered through the Small Business Administration (or SBA). Vela Wood is happy to assist in determining whether your business is eligible for participation in these loan programs.
Paycheck Protection Program
The Paycheck Protection Program (or PPP) greatly expands eligibility under what is commonly referred to as a Section 7(a) SBA loan. The general purpose is to provide businesses, independent contractors, sole proprietorships, non-profits, and certain other organizations with low interest rate loans to cover eight weeks of payroll costs and certain other eligible costs. PPP loans are eligible for loan forgiveness up to the full amount of principal and accrued interest if the loan proceeds are spent on eligible costs. The application process for businesses and sole proprietors began on April 3, 2020. The application process for independent contractors and self-employed individuals will open on April 10, 2020. PPP loans will be available through June 30, 2020.
Who is Eligible to Apply?
Eligible borrowers include:
- Businesses with 500 or fewer employees whose principal place of residence is in the United States
- Businesses that operate in certain industries that meet the applicable SBA employee-based size standards for that industry
- Businesses that meet the definition of a “small business concern” as defined in the Small Business Act.
- 501(c)(3) non-profits (including faith-based and religious organizations)
- Tax exempt veteran organizations
- Tribal business concerns with 500 or fewer employees (or who meet SBA employee-based size standards for the industry in which the Tribal business concern operates)
- An Individual operating as a sole proprietorship or as an independent contractor or who is otherwise an eligible self-employed individual
SBA size standards can be found here.
Eligible borrowers must also provide evidence that they were in operation on February 15, 2020 and either had employees who received salary or paid independent contractors as reported on a Form 1099.
Borrowers otherwise meeting the criteria above may nevertheless be ineligible. Reasons for ineligibility include engaging in illegal activity; being a household employer (individuals who employee nannies, housekeepers, or other similar household employees); and having an owner who is a convicted felon or presently on probation, on parole, or subject to indictment or arraignment; being delinquent or in default. Businesses described in 13 CFE 120.110 are also ineligible unless expressly permitted under the CARES Act. Examples of ineligible businesses include financial institutions, real estate holding vehicles, life insurance companies, foreign businesses, pyramid sale distribution plans, businesses deriving more than one-third of gross annual revenue from legal gambling activities, private clubs, government owned businesses, loan packagers earning more than one third of their gross annual revenue from packaging SBA loans, businesses owned in part by an SBA lender or other SBA-approved financing provider, businesses of a sexual or prurient nature, businesses primarily engaged in political or lobbying activities, and speculative businesses.
How do I Determine Eligibility?
Applicants are required to apply the SBA affiliation rules when determining eligibility. An explanation of the affiliation rules and examples of how they might apply can be found here.
The SBA affiliation rules will generally aggregate businesses that control, are controlled by, or are under common control with other businesses or third parties. Control can be found in a number of ways, which may include ownership, investor protection rights, or other rights that allow a minority owner to prevent a quorum or otherwise block an action.
The application of the affiliation rules has created some uncertainty for businesses backed by venture capital or private equity. Many venture capital or private equity investments involve some degree of control granted to the investor. This may, in turn, cause a venture or private equity-backed business to be deemed an affiliate of the other businesses held by the venture capital or private equity investor. Other factors considered when determining affiliation are present rights granted in connection with stock options or convertible instruments, board control, and identity of interest (generally found in circumstances involving close family members).
The Treasury has waived the SBA affiliation rules for businesses assigned a NAICS code beginning with 72 (generally hotels, hospitality, restaurants, and other accommodation businesses), franchises, and businesses receiving financial assistances from SBICs. In addition, faith-based organizations will generally not be considered affiliates if the relationship between the organizations is based on religious teaching or belief or constitutes part of the exercise of religion (although affiliation may be found on other grounds).
How do I Apply?
Eligible businesses can apply for a PPP loan through an SBA-approved lender. The SBA has provided a search tool to assist in locating an eligible lender. The search tool can be found here.
The application for a PPP loan can be found here.
As part of the application process, applicant businesses and all owners of 20% or more of the equity of the applicant will need to make certain representations and certifications. Businesses and owners should carefully review the application to ensure that the business, the owners, and the authorized representative of the business signing the application can in fact make the required representations and certifications.
How is my PPP Loan Amount Determined?
As part of the application process, each applicant will need to calculate its loan amount and provide documentation supporting that calculation. The maximum loan amount available is the average monthly payroll costs incurred by the applicant multiplied by 2.5, with a maximum loan amount of $10,000,000. Applicants in operation for the entirety of 2019 can use the average monthly payroll costs from either the last twelve months or the 2019 calendar year. Applicants not in business between February 15, 2019 and June 20, 2019 will use average monthly payroll costs between January 1, 2020 and February 29, 2020. Applicants who are seasonal businesses may elect to use average monthly payroll costs incurred for the period between February 15, 2019 or March 1, 2019 and June 30, 2019.
Payroll costs for purposes of calculating an available PPP loan amount include:
- Salary, wage, commission, or similar compensation to employees up to $100,000 per employee per year
- Payment of cash tip or equivalent
- Payment for vacation, parental, family, medical, or sick leave
- Group health care benefits, including insurance premiums
- Retirement benefits
- State and local payroll tax
Independent contractors and sole proprietors applying for a PPP loan can include wages, commission, income, net earnings from self-employment, or similar compensation up to $100,000 per year.
Only cash compensation is considered when determining whether an employee receives compensation in excess of $100,000. Employer contributions to retirement plans, payments for the provision of group health benefits, and payment of state and local payroll taxes are not considered when determining whether the $100,000 threshold is met.
Payroll costs do not include (i) compensation to employees who do not reside in the United States and (ii) sick leave and family leave wages paid under the Families First Coronavirus Response Act. The interim final rules also exclude Federal employment taxes and FICA taxes imposed or withheld between February 12, 2020 and June 30, 2020. Payroll costs also do not include payments an applicant made to an independent contractor.
Applicants should also be prepared to provide documentation supporting payroll cost numbers when applying for a PPP, such as Form W-3, Form W-2, Form 940, Form 941 and other state and local payroll tax documentation. Independent contractors and sole proprietors should be prepared to submit Form 1099s. Additional documentation will likely include organizational documents and documentation establishing that the applicant was in operation on February 15, 2020.
Lenders providing PPP loans will generally not be required to verify or make an independent determination that an applicant’s calculations are correct and may rely on certifications and representations made by the applicant.
How Can PPP Loan Proceeds Be Used?
PPP loan proceeds may be used to pay:
- Payroll costs
- Costs related to the continuation of group health care benefits
- Interest on mortgage obligations
- Interest payments on debt obligations incurred prior to February 15, 2020
PPP loans can also be used to refinance economic injury disaster loans made between January 31, 2020 and April 3, 2020.
At least 75% of a PPP loan must be used for payroll costs, with the remainder available for group health care continuation, rent, interest on mortgage obligations, utilities, and interest on other debt obligations. Borrowers using PPP loans for unauthorized purposes will be required to repay those amounts. Borrowers who knowingly and intentionally misuse PPP loans (as well as any shareholder, member, or partner who causes the borrower to misuse PPP loans) could face additional penalties, including liability for fraud.
What are the Other Loan Terms Applicable to PPP Loans?
PPP loans are intended to be easily accessible and borrower friendly. Each PPP Loan will be issued on the same terms as detailed below:
- No requirement for a guarantee
- No requirement for collateral
- Payments of interest and principal are deferred for six months from the date of disbursement
- Applicants are not required to demonstrate that they are unable to obtain credit elsewhere
- Applicants will not be required to pay lender or SBA fees
- The Interest rate is fixed at 1%
- No prepayment penalty
- Amounts not eligible for forgiveness will have a two-year maturity from the date of disbursement
Is my PPP Loan Eligible for Forgiveness?
The total principal balance and accrued interest under a PPP loan is eligible for loan forgiveness if the proceeds are spent on payroll costs, group health care continuation, rent, interest on mortgage obligations, utilities, and interest on other debt obligations during the eight-week period following the date of disbursement. The amount forgiven will not be considered income for tax purposes. As stated earlier, no more than 25% of a PPP loan can be used for non-payroll costs when determining amounts eligible for forgiveness.
The amount available for forgiveness reduces in the event the borrower reduces headcount or salaries following the date the loan is made. The amount of the reduction caused by reduced headcount will be calculated by dividing the average number of FTE employees per month during the eight-week forgiveness period by the average number of FTE employees per month during the period beginning February 15, 2019 and ending June 30, 2019 or, at the election of the borrower, the period beginning January 1, 2020 and ending February 29, 2020. Reductions relating to salaries and wages will apply if the borrower has reduced salary by more than 25% when compared to the same periods (reductions in salary of employees making over $100,000 are not considered).
In the event a borrower rehires previously laid off employees or increases salaries to at or around previously levels (in each case prior to June 30, 2020), the reduction in the amount of available forgiveness will be removed.
Borrowers applying for loan forgiveness will need to provide documentation verifying the number of FTE employees and pay rates (including federal, state, and local payroll tax filings) and evidence that the PPP loan proceeds were used for forgivable purposes. Borrowers will also be required to certify that the amount requested for forgiveness was used to retain employees and to pay mortgage interest, utility payments, and interest on other qualifying debt obligations. The SBA may request any additional documentation it deems necessary.
The Treasury continues to provide ongoing guidance for applicants and lenders and we will continue to monitor the Paycheck Protection Program and provide updates as they become available. Applicants interested in learning more are encouraged to review the fact sheets, affiliation rules, FAQs, and other information made available by the Treasury and found here.
Emergency Economic Injury Disaster Loans
Emergency Economic Injury Disaster Loans (or EIDLs) are provided through the SBA to businesses who have experienced economic injury due to a disaster. Normally, this would include fires, hurricanes, drought, and other natural disasters that impact the ability of a business to operate. EIDLs provide up to $2,000,000 in loan proceeds with terms up to thirty years. Interest on an EIDL is currently 3.75%, with a cap of 4%. Businesses experiencing economic loss as a result of COVID-19 are eligible to apply for an EIDL.
The CARES Act expands accessibility to the EIDL Program to include any business with up to 500 employees, sole proprietorships, independent contractors, and any cooperative, ESOP or tribal small business concern with up to 500 employees. SBA affiliation rules apply when determining eligibility. Eligible businesses can be approved based solely on credit score and may request an emergency advance of up to $10,000 within three days after applying for an EIDL. The emergency advance may be used for any allowable purpose applicable to EIDLs and may include payment of sick leave, maintaining payroll, paying vendors, making rent and mortgage payments, and paying any other obligations that cannot be paid due to loss of revenue related. Importantly, this emergency advance is not required to be repaid even if the applicant is subsequently denied an EIDL.
The CARES Act waives certain restrictions and other requirements normally applicable to EIDLs. These waivers include the requirement for a personal guarantee for EIDLs up to $200,000, the requirement that the borrower be in business for at least a year (the CARES Act does, however, require that borrowers be in operation on January 31, 2020), and the requirement that the borrower be unable to obtain credit elsewhere.
EIDLs will require collateral to the extent the borrower has assets to pledge. A lack of collateral will not, however, disqualify a borrower from receiving an EIDL.
EIDL loan amounts are determined based on the projected loss of revenue a business will suffer as a result of a disaster. Although an EIDL may be approved based on the applicant’s credit score, the maximum loan amount will likely require additional supporting documentation and substantiation. As such, businesses planning to apply should be prepared to provide historic financial statements, tax returns, statements of fixed liabilities, and at minimum a 13-week cash flow projection in order to substantiate.
Can I apply for both a PPP and an EIDL?
Eligible businesses can apply for both a PPP and an EIDL, but must certify that the proceeds of each loan will not be used for duplicative purposes. In practice, an EIDL cannot be used for payroll costs or rent, lease, or mortgage payments if an eligible business also intends to apply for a PPP. In the event an eligible business requests an emergency advance in connection with an EIDL application and is subsequently approved for a PPP, the amount of the emergency advance will reduce the amount of the PPP available for forgiveness on a dollar for dollar basis.
Certain other SBA Loan Programs
The CARES Act provides a subsidy for other Section 7(a) loans, loans made under Title V of the Small Business Investment Act, and loans made by an intermediary using Section 7(m) loans and grants. The subsidy allows the SBA to pay principal, interest, and fees on eligible loans that were made prior to or after the enactment of the CARES Act for a period of 6 months. The commencement of the six-month period depends on whether the loan was in place prior to or after the enactment of the CARES Act and whether it is in deferment, with the general effect being that the six-month period begins on the due date of the next payment.
A Closing Note
Borrowers interested in any of the SBA programs described above should keep in mind that these programs are debt products and should be treated as such. Prospective borrowers will need to abide by debt restrictions contained in their current credit facilities and are encouraged to discuss any necessary amendments with their existing lenders. Currently the Treasury has not issued any guidance regarding subordination of PPP loans or EIDLs to current third-party credit facilities and a proactive approach will go a long way in preventing unforeseen hiccups during the application process.