Here’s what startups, small businesses need to know about SBA loans, Payroll Protection Program

Editor’s note: Dan Fuchs and Jeremy Freifeld are attorneys at Hutchison PLLC.

RALEIGH – On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) became law. We have already received many questions from clients about the Paycheck Protection Program (the “PPP”) introduced under the CARES Act. The PPP expands the Small Business Administration’s existing 7(a) loan program. This client alert is intended to address some of the more common questions about the PPP. We suggest that you also review the latest guidance and sample application released by the U.S. Treasury yesterday afternoon.

What businesses are eligible?

Generally, the business must be either (i) a small business concern under the SBA regulations, or (ii) a business concern, nonprofit organization, veterans’ organization or Tribal business concern that employs not more than 500 employees.

Other borrower requirements.

In addition, the business must have been in operation as of February 15, 2020 and as of such date, had employees for whom the business paid salaries and payroll taxes, or paid independent contractors. In addition, the borrower (and according to the sample loan application, each 20% owner) must certify, among other things, (1) that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient, (2) that the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments and (3) that the applicant does not already have an application pending and has not received a loan under the existing 7(a) program.

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Do the “SBA affiliation rules” apply in connection with the PPP?

Generally, yes. The CARES Act waived the affiliation rules with respect to a few categories of businesses, primarily franchises and businesses related to accommodations and food services, but many otherwise-eligible business remain subject to the affiliation rules by the language included in the CARES Act. Subsequent regulations and guidance expected from the Treasury Department may change or clarify this understanding. To the extent such regulations or guidance are issued, we will publish another update. The latest U.S. Treasury guidance linked above does not expand further, but does note that “additional guidance may be released as appropriate.”

Why are the affiliation rules important?

Among other things, the affiliation rules aggregate the number of employees of an eligible business with those of its affiliates. The SBA affiliation rules take a broad interpretation of affiliates and would even include minority investors with negative control rights over a business (for example, protective provisions that give investors a blocking right over certain company activities). The National Venture Capital Association has published a helpful article with a comprehensive analysis of the affiliation rules as they apply to venture-backed companies.

How much can I borrow?

The maximum amount available is equal to the lesser of: (1) $10 million, or (2) 2.5x the borrower’s average total monthly Payroll Costs (as defined below).

Other Notable Loan Terms

Payment deferral (of principal, interest and fees) for at least six months and up to one year.
The CARES Act waives the normal requirements under the 7(a) loan program of a personal guaranty and collateral.
The SBA will not have any recourse against the personal assets of any individual shareholder, member or partner except to the extent such person uses proceeds for an unauthorized use.
Interest rate not to exceed 4.00% (provided that the latest U.S. Treasury guidance refers to the 0.5% fixed rate).

How is “covered period” defined?

February 15^th through June 30^th, 2020.

What can I use the loan funds for?

Payroll costs (as defined below); health care benefits (including insurance premiums); employee compensation (subject to limitations within the definition of payroll costs); interest on mortgage obligations (incurred before February 15, 2020); rent under lease agreements (in force before February 15, 2020); utilities (for which service began before February 15, 2020); and interest on debt incurred prior to the loan.

How are “Payroll Costs” defined?

The sum of any compensation with respect to an employee that is:
1. salary, wages, commission or similar compensation, subject to limitations on employees with an annual salary over $100,000 as noted below;
2. payments of cash tips or the equivalent;
3. payment for vacation, parental, family, medical or sick leave;
4. allowance for dismissal or separation;
5. payments required for the provision of group health care benefits, including insurance premiums;
6. payment of any retirement benefit;
7. payment of any state or local tax assessed on the employee;
8. the sum of any compensation with respect to a sole proprietor or independent contractor that is a wage, commission or similar compensation and that is not more than $100,000 in 1 year, as prorated for the covered period.
Payroll costs may not include:
1. compensation of an individual employee in excess of an annual salary of $100,000 in one year, pro-rated for the covered period;
2. taxes imposed or withheld under chapters 21, 22 or 24 of the Internal Revenue Code during the covered period (FICA, railroad wages and federal income taxes);
3. any compensation of an employee whose principal place of residence is outside the United States; or
4. qualified sick leave wages or family leave wages for which a credit is allowed under Sections 7001 or 7003 of the Families First Coronavirus Response Act.

How does the loan forgiveness work?

A borrower is eligible for loan forgiveness equal to amounts spent on the following items during the 8-week period following the origination date (the “8-week period”):

Payroll costs
Rent
Mortgage interest*
Utilities
For borrowers with tipped employees, additional wages paid to those employees

This amount may be reduced by a percentage change in FTE headcount (comparing average monthly FTE headcount during the 8-week period against average FTE monthly headcount from either January and February of 2020 or February 15, 2019 to June 30, 2019). This amount may also be reduced by the amount of any reduction in salaries and wages paid to an employee earning less than $100,000 per year that is in excess of 25% of the total salary or wages of such employee during the most recent full calendar quarter prior to 8-week period.

The above reductions do not apply to the extent the borrower restores its FTE numbers and wages to the earlier levels by June 30, 2020.

The U.S. Treasury guidance states that “it is anticipated that not more than 25% of the forgiven amount may be for non-payroll costs.”

So what should I do now? We are encouraging all companies which wish to apply for a loan under the PPP to contact their primary banker and let them know they are interested in the PPP. We anticipate that banks will experience high demand for loans under the PPP and each lender may have slightly different documentation requirements for the application process. It is important to understand how you can best position your company to be accepted. Note also that we will be publishing additional client alerts on the employee retention credit and payroll tax deferral provisions of the Cares Act; employers who elect to get a PPP loan may not take advantage of the retention credit and payroll tax deferral (and vice versa).

In addition, if you have questions or would like additional information, please feel free to contact Dan Fuchs at dfuchs@hutchlaw.com or Jeremy Freifeld at jfreifeld@hutchlaw.com and they would be happy to assist you.

*We note that mortgage interest under the CARES Act includes interest on any “covered mortgage obligation” which is defined to include mortgages on real or personal property, among other criteria. Some commentators have interpreted this to include any secured loan obligation incurred prior to February 15, 2020. Additional guidance is required to confirm whether all secured loan obligations are includable under the term “covered mortgage obligations.”

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This Alert is provided for informational purposes only and is not intended to be, nor should it be construed as, legal advice on any specific matter, nor does it represent any undertaking to keep recipients advised of all relevant legal developments. This Alert does not create or constitute an invitation to create an attorney-client relationship, nor should it be construed as an advertisement or solicitation for legal services. This material may be considered Attorney Advertising in some states. Prior results do not guarantee a similar outcome.