Borrower Beware: Unresolved PPP Loan Questions Could Trap the Unwary

Note: This post has been updated as of May 6, 2020 with additional information.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) went from a concept to a fully enacted law in a matter of days. When this happens with legislation, there can be any number of drafting errors that cause unintended results. In order to give the U.S. Treasury and the U.S. Small Business Administration (SBA) the ability to counter these unintended results, the CARES Act included language that allows the SBA and the Secretary of the Treasury to prescribe regulations granting de minimis exemptions from the requirements of the CARES Act.

This has allowed the SBA and the Secretary of the Treasury to add requirements that at times may appear contrary to the original language in the law. These added requirements have prompted PPP loan questions from many business owners who have or are applying for Paycheck Protection Program loans.

Using 75% of a PPP Loan for Payroll

The most glaring example of an added requirement is Section III(2)(r) of the Interim Final Rule I released by the SBA, which states “at least 75 percent of the PPP loan proceeds shall be used for payroll costs.” This is an added requirement that is not present anywhere in the CARES Act. This “simple” sentence has resulted in numerous questions, including:

• Does this 75% apply to the total PPP loan proceeds or just with respect to the amounts that may be forgiven?

If it applies to the total loan, then in theory all borrowers would use 75% of the proceeds for payroll and all would have at a minimum 75% of their loan, plus interest on that portion, forgiven. But if that’s the case, why do sections of the CARES Act provide for a reduction in loan forgiveness related to a reduction in headcount and/or salary and wages? A business owner would never have those issues if they used 75% of the loan proceeds for payroll costs alone. Theoretically, you could cut employee pay by 25% and hire additional workforce — but would that accomplish your business goals as well as keep people employed?

In addition to raising the above question, the Interim Final Rule includes conflicting guidance:

“Question: Can my PPP loan be forgiven in whole or in part?

Answer: Yes. The amount of loan forgiveness can be up to the full principal amount of the loan and any accrued interest. That is, the borrower will not be responsible for any loan payment if the borrower uses all of the loan proceeds for forgiveable purposes described below and employee and compensation levels are maintained. The actual amount of loan forgiveness will depend, in part, on the total amount of payroll costs, payments of interest on mortgage obligations incurred before February 15, 2020, rent payments on leases dated before February 15, 2020, and utility payments under service agreements dated before February 15, 2020, over the eight-week period following the date of the loan. However, not more than 25 percent of the loan forgiveness amount may be attributable to non-payroll costs. While the Act provides that borrowers are eligible for forgiveness in an amount equal to the sum of payroll costs and any payments of mortgage interest, rent, and utilities, the Administrator has determined that the non-payroll portion of the forgivable loan amount should be limited to effectuate the core purpose of the statute and ensure finite program resources are devoted primarily to payroll. The Administrator has determined in consultation with the Secretary that 75 percent is an appropriate percentage in light of the Act’s overarching focus on keeping workers paid and employed.”

If the amount of loan forgiveness has any correlation to the amount of payroll costs other than 75% of the loan value, then it appears that the payroll costs could be forgiven, limited by the salary and headcount reduction. The “other forgivable costs” would then be limited to one-third of the payroll costs.

The situation is confusing, and businesses are trying to understand the rules so they can properly plan to keep their employees paid while making good decisions to maintain the health of their businesses.

At this point, business owners should do their best to use 75% of their PPP loans for payroll costs if they are hoping for loan forgiveness.

Certifying that a PPP Loan is ‘Necessary’

The latest issue that’s giving borrowers second thoughts is new guidance from the Treasury. In the form of a Q&A, the guidance identifies entities that are not eligible for a PPP loan and the actions they must take if they have received funding of a loan. The guidance also adds language that puts additional weight on the certification that the business has been affected and the funds are necessary.

From the guidance:

“Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, 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 such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification. Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.”

It is critical that businesses understand and fully document the manner in which they are, or expect to be, impacted by COVID-19 and why they need the funds.

We expect to receive further guidance detailing how businesses should document the pandemic’s impact and why a PPP loan is necessary.

If you have any CARES Act or PPP loan questions, don’t hesitate to reach out to your Delap advisor.

Update: Extended Repayment Date

The Small Business Administration in consultation with the U.S. Treasury released a new FAQ #43 on May 5, 2020, extending the repayment date from May 7 to May 14, 2020. Additionally, the SBA identified that they will provide guidance before the May 14 date as to how they will review (audit) the certifications.

“Question: FAQ #31 reminded borrowers to review carefully the required certification on the Borrower Application Form that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA guidance and regulations provide that any borrower who applied for a PPP loan prior to April 24, 2020 and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith. Is it possible for a borrower to obtain an extension of the May 7, 2020 repayment date?

Answer: SBA is extending the repayment date for this safe harbor to May 14, 2020. Borrowers do not need to apply for this extension. This extension will be promptly implemented through a revision to the SBA’s interim final rule providing the safe harbor. SBA intends to provide additional guidance on how it will review the certification prior to May 14, 2020.”