Paycheck Protection Forgiveness and Compliance—10 Frequently Asked Questions

Forgiveness Mechanics

1.  Which time period does the forgiveness period cover, and when should we apply for forgiveness?

For loans made on or after June 5, 2020, the date of the PPP Flexibility Act, the “loan forgiveness covered period,” is the 24-week period beginning on the date a borrower’s PPP loan was disbursed. For loans made before June 5, 2020, a borrower can elect to use a 24-week covered period or the eight-week period beginning on the date the borrower’s PPP loan was disbursed.

SBA’s June 26, 2020, Interim Final Rule makes it clear that borrowers can apply for forgiveness “at any time on or before the maturity date of the loan—including before the end of the covered period—if the borrower has used all of the loan proceeds for which the borrower is requesting forgiveness.” A borrower can apply for forgiveness as soon as it has expended the PPP loan, assuming the lender permits the business to submit an application. (Several banks have yet to accept forgiveness applications).

Of course, the question of “can” may be different from the question of “should.” Some borrowers may have reasons not to apply for forgiveness right away, just as some may decide to apply for only partial forgiveness.

2.  Can you pay an individual employee more because the covered period was extended?

Yes, a borrower can pay an individual more in total by continuing to pay his or her salary for the longer, 24-week period. However, for the purposes of loan forgiveness, forgivable cash compensation (which also includes tips, commissions, bonuses and hazard pay) per employee remains limited to $100,000 on an annualized basis.

Under an eight-week covered period, an individual employee can be paid up to $15,385. Under a 24-week covered period, an individual employee can be paid up to $46,154.

3.  Are there forgiveness limits on “owner-employee” compensation? And what is an “owner-employee” under the PPP?

Yes, SBA’s June 26, 2020 Interim Final Rule imposed unexpected caps on the amount of forgiveness available to “owner-employees,” specifying that: (1) for an eight-week covered period, owner-employees’ forgivable compensation is capped at the lesser of eight weeks’ worth of 2019 compensation or $15,385 and (2) for a 24-week covered period, owner-employees’ forgivable compensation is capped at the lesser of 2.5 months’ worth of 2019 compensation or $20,833.

Moreover, the regulation does not define the term “owner-employee” or specify a certain percentage of ownership as giving rise to these caps. For example, S-corporations are limited to 100 employees, but C-corporations have no maximum number. Does SBA really mean that a de minimis shareholder of a C-corporation must be treated as an “owner-employee?” The current regulations do not address this odd result, specifying only:

In particular, C-corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health insurance contributions made on their behalf. S-corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement contributions made on their behalf, but employer health insurance contributions made on their behalf cannot be separately added because those payments are already included in their employee cash compensation. Schedule C or F filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit.

SBA hopefully will provide further guidance in this area.

4.  What are the key points to know about reductions in loan forgiveness based on layoffs or other reductions in employee headcount?

The answer to this question depends on when and for what reasons the borrower reduced its number of full-time equivalent employees (FTEs). The borrower may face reductions in the amount of its loan forgiveness, subject to certain exceptions and safe harbors created by the CARES Act, PPP Flexibility Act and SBA regulations. We discussed reductions on loan forgiveness in more detail in earlier client alerts on May 18, 2020, and May 26, 2020, and included updates based on the PPP Flexibility Act here.

To summarize, a borrower may exclude any reduction in FTEs from its forgiveness calculation if the borrower is able to document: (1) an inability to rehire individuals who were employees of the borrower on February 15, 2020, and (2) an inability to hire similarly qualified individuals for unfilled positions on or before December 31, 2020. The regulations require borrowers to inform the applicable state unemployment insurance office within 30 days of any employee’s rejection of a rehire offer.

In addition to these bases to exclude FTE reductions, two specific “FTE Reduction Safe Harbors” may apply, as well:

• The borrower is exempt from the reduction in loan forgiveness based on a reduction in FTEs if the borrower is able to document that it was unable to operate between February 15, 2020, and the end of the covered period at the same level of business activity as before February 15, 2020, due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.
• The borrower is exempt from the reduction in loan forgiveness based on a reduction in FTEs if both of the following conditions are met: (a) the borrower reduced its FTE levels in the period beginning February 15, 2020, and ending April 26, 2020; and (b) the borrower then restored its February 15, 2020 FTE levels by not later than December 31, 2020.

Legislative Changes

5.  Were the changes made by the PPP Flexibility Act retroactive?

Most of the changes from the Flexibility Act are retroactive; the exception is the term of a borrower’s PPP loan. Under the Flexibility Act, borrowers and lenders can mutually agree to change the term of the loan.

Our client alert, found here, includes a discussion of the Flexibility Act changes to the PPP program.

6.  Are there other legislative or regulatory changes possible for the PPP?

Yes. House Democrats and Senate Republicans both have proposed legislation that affects the PPP. The House Democrats’ HEROES Act, which passed in the House of Representatives on May 15, 2020, among other things, would expand the PPP to include all nonprofits.

The Senate Republicans’ HEALS Act, introduced to the Senate on May 22, 2020, would amend the documentation requirements and eligibility criteria, and allow for a second round of PPP loans for certain small businesses that already received PPP loans whose revenue fell by more than 50 percent in the first two quarters of 2020.

We discussed the proposed legislation in more detail here.

Compliance Issues

7.  What tips would you suggest to ready the company for an audit or exam?

In any audit it is critical to have documentation to support what you did and why you did it. Policies, procedures and documentation reflecting contemporaneous decision-making will be critical to explain to auditors what the borrower did to comply with all PPP requirements.

Companies should establish a compliance program, including a code of conduct, compliance policies and training to ensure that employees understand, follow and document the company’s operations to ensure attention to the PPP loan requirements. These include strong financial and payment controls, as well as procedures designed to address the risk of employee misconduct.

8.  Our PPP application included detailed disclosures regarding “affiliation” under the SBA rules. How will SBA view those disclosures?

SBA’s “affiliation” rules govern whether a company will be considered a “small business” for the purposes of the PPP. Specifically, unless one of the PPP affiliation exceptions applies—for example, with respect to borrowers in the hotel and restaurant industries—the employees of a potential borrower would have had to be aggregated with the employees of its affiliates to determine the total number of employees. We discussed the relevant affiliation rules in detail here. SBA’s view of these disclosures will depend on the reasonableness of the interpretation that the borrower adopted. Before applying for forgiveness, consult your legal representative.

9.  How will a corporate deal—a merger or acquisition involving my company—affect my PPP loan and plan to seek forgiveness?

First, a key question is when was the merger or acquisition contemplated? If the borrower had an agreement—including, for example, a letter of intent or memorandum of understanding—in place at the time of its PPP application to merge, acquire or be acquired, then SBA likely would give that agreement “present effect” and deem the buyer and seller to have been “affiliated” as the time of the PPP application. We discussed the “present effect” rule here, as part of our overview of affiliation rules applicable to the PPP.

If the merger or acquisition in question was not contemplated at the time of the PPP application, then the buyer and seller will not be deemed to be affiliated for PPP purposes on the basis of that later transaction. There are, however, other considerations that are important for borrowers to consider in connection with M&A activity. A key example of such a consideration is that most PPP loan documentation requires borrowers to notify—and in many cases receive prior consent from—their lending institutions before undertaking a “change of ownership or control.” In such cases, absent this consent, the borrower may be in default if it closes a merger or acquisition. This is another area where borrowers are best advised to seek specific legal guidance. In addition, parties to the M&A transaction must consider the effect, if any, the transaction will have on other benefits under the CARES Acts, such as Employee Retention Credits, that can be claimed or have been claimed by entities within the parties’ aggregated control groups.

10.  Will my company be audited, and when?

SBA has represented that it will automatically audit borrowers whose affiliate groups received $2 million or more in PPP loans. This guidance was included in an FAQ published on May 13, 2020, and is discussed further here. It remains unclear whether and how SBA will carry out these “automatic” audits. SBA retains the right to audit loans of any size at any time, and SBA’s regulations also require borrowers to retain PPP documentation for six years following loan repayment.

Generally, however, SBA’s regulations provide for a maximum period of 150 days of review following a borrower’s submission of its loan forgiveness application: the lender must review a borrower’s forgiveness application and submit its decision to SBA within 60 days of receipt, after which SBA has 90 days to conduct its own review and reach a final decision on forgiveness. SBA’s latest Interim Final Rule dated August 11, 2020 amends Part 134 of Title 13 of Code of Federal Regulations to establish specific appeals procedures relating to PPP forgiveness determinations.

For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.

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