Considerations for PPP borrowers as they apply for loan forgiveness
The Paycheck Protection Program (PPP) closed for new loans on August 8, 2020, though a renewal is currently being negotiated in Congress.1 Regardless of the future of new loans, as PPP borrowers continue through the lifecycle of the program by preparing to apply for loan forgiveness, the Small Business Administration (SBA) has continued to issue important new regulations and guidance that will impact their forgiveness analysis. We summarize below some of these important new developments.
Clarification of “Owner-Employee” Compensation Limitations
The SBA’s new Interim Final Rule dated August 24, 2020, clarifies the important issue of the percentage of equity ownership of a borrower that triggers the PPP’s limitations on “owner-employee” compensation. As we explained in a recent client alert, the SBA set strict limits on the amount of compensation paid to an “owner-employee” that would be eligible for forgiveness—but the SBA failed to define “owner-employee.” The new Interim Final Rule clarifies that “owner-employees with less than a 5 percent ownership stake in a C- or S-Corporation are not subject to the owner-employee compensation rule.” It should be noted that the new Interim Final Rule applies this exception only to C-Corp and S-Corp entities and does not provide an exception for partnerships or limited liability companies.
As we discussed in our earlier alert, the 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.
Yet the regulation did not define the term “owner-employee” or specify a certain percentage of ownership as giving rise to these caps. Did the SBA really mean that a de minimis shareholder of a C-corporation must be treated as an “owner-employee?” The August 24, 2020, Interim Final Rule resolves this question by announcing the five percent ownership threshold to trigger than “owner-employee compensation rule.”
Allowability of Rent Payments to Related Parties
The August 24 Interim Final Rule also states that rent payments to a “related party”—i.e., a tenant and landlord that have common ownership—are eligible for forgiveness if: (1) the amount of loan forgiveness requested for rent or lease payments to a related party is no more than the amount of mortgage interest owed on the property during the forgiveness covered period that is attributable to the space being rented by the business, and (2) the lease and the mortgage were entered into prior to February 15, 2020. By contrast, mortgage interest payments to a related party are not eligible for forgiveness.
Deferral Period and Forgiveness
The SBA’s June 26, 2020, Interim Final Rule provided that a borrower “may submit a loan forgiveness application 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.”
For loans made on or after June 5, 2020, the date of the PPP Flexibility Act, this 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.
The June 26, 2020, rule further provided that if a borrower “does not apply for loan forgiveness within 10 months after the last day of the covered period, or if the SBA determines that the loan is not eligible for forgiveness (in whole or in part), the PPP loan is no longer deferred and the borrower must begin paying principal and interest.”
Loan Forgiveness Reductions
The June 26, 2020, rule also included significant guidance regarding the reductions in forgiveness applicable to borrowers that reduced their head count or employee salaries during the covered period of the loan. We discussed loan forgiveness reductions 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.
A. Reduction in Number of Employees
To summarize, a borrower may exclude any reduction in Full-Time Equivalents (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.
B. Reduction in Salary
With respect to salary reductions in excess of 25 percent (based on a maximum annual salary of $100,000), a borrower is subject to one of the CARES Act (as amended by the PPP Flexibility Act) Safe Harbors if: (1) the borrower reduced the salaries between February 15 and April 26, 2020; and (2) restored the salaries on or before December 31, 2020. Importantly, the June 26, 2020, rule specifies that if a borrower applies for forgiveness before the end of the covered period and is in the midst of a salary reduction of greater than 25 percent, the borrower must apply that reduction across the full duration of the covered period, for example:
A borrower is using a 24-week covered period. This borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period, with an FTE of 1.0. In this case, the first $250 (25 percent of $1,000) is exempted from the loan forgiveness reduction. The borrower seeking forgiveness would list $1,200 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by 24 weeks). If the borrower applies for forgiveness before the end of the covered period, it must account for the salary reduction for the full 24-week covered period (totaling $1,200).
Appeals of SBA Loan Review Decisions
While not yet at the forefront of borrowers’ minds, the SBA also has taken early steps to establish an appeals process for borrower challenges to the SBA’s review of forgiveness decisions. Specifically, the SBA’s 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. These regulations provide that a borrower has the right to appeal the SBA’s loan review decision to the SBA’s Office of Hearings and Appeals and establishes the timeframes and substantive requirements of such appeals.
The appeals in question will occur after the review procedures set forth in prior SBA regulations. Those 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 the SBA within 60 days of receipt, after which the SBA has 90 days to conduct its own review and reach a final decision on forgiveness.
Mergers & Acquisitions Involving PPP Borrowers
As the economy begins to recover, an issue of growing importance to PPP borrowers that the SBA has not yet addressed is whether a PPP borrower that intends to seek forgiveness may be acquired by another company.
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 the 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.
For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.
Pillsbury is closely monitoring and analyzing the global legal, economic, policy and industry impacts of COVID-19. For our latest insights, visit our COVID-19 and Economic Impact Resource Center.
1. Legislation to extend the program, which we discussed here, has stalled in Congress. Approximately $130 billion in appropriations remains available, and Congress is expected eventually to extend the PPP.