Congress extended the PPP program last week, giving businesses that have not yet obtained loans another 5 weeks to do so. A new bill has been proposed in the Senate amending the PPP to provide second loans to smaller businesses that have spent their PPP monies and suffered business declines.
The SBA published its Interim Final Rule titled “Revisions to Loan Forgiveness and SBA Loan Review Procedures” (the “20th IFR”) at the end of last month providing PPP borrowers additional flexibility in gaining forgiveness of their loans and clarifying loan review procedures. The 20th IFR updates prior guidance to reflect the terms of the Flexibility Act and (i) provides that borrowers may apply for forgiveness before the end of their covered periods, (ii) clarifies forgiven as caps on payroll applicable to owner-employees and self-employed individuals: and (iii) gives helpful guidance on the FTE safe harbor available to borrowers whose business has declined because of COVID related compliance.
Last Saturday, President Trump signed into law a bill extending to August 8 the deadline to obtain loans for eligible small businesses which have not yet borrowed under the PPP. The program had been scheduled to expire on June 30. The extension bill moved forward in Congress with unanimous approval by both the House and Senate. The PPP contains $130 billion of remaining funds out of a total of $670 allotted by Congress.
The PPP entitles businesses with under 500 employees to obtain term loans of up to $10 million to finance their payroll, benefits, rent, utilities, and mortgage interest, with loans potentially forgivable to the extent spent on such items over a 24 week period (or 8 weeks at the election of the borrower if the loan was made on or before June 5). In recent weeks the flow of loans under the PPP had slowed in part because so many needy small businesses have already received PPP financing and are currently not permitted to obtain second loans. For more information about the PPP, see HERE.
PENDING PPP AMENDMENT:
Congress, by extending the PPP, paved the way for a further modification to the PPP program that is now under consideration along with many other aid proposals. Democratic Senators have proposed the Prioritized Paycheck Protection Program (“P4”) Act which provides for second loans under the PPP to smaller, ailing businesses.
Details of the P4 proposal include the following: (i) loans limited to borrowers with 100 or fewer employees including sole proprietorships, (ii) applicants must have spent or be scheduled to spend their PPP borrowings, (iii) borrowers must have sustained a decline of revenues by at least 50% resulting from Covid-19, (iv) borrowings available up to 250% of monthly payroll costs, not to exceed $2 million, and (v) applications would be permitted through end of 2020 and recipients may apply for forgiveness beginning as early as 8 weeks after funding.
20th IFR-GUIDANCE ON LOAN FORGIVENESS
The 20th IFR updated the SBA’s two prior rules issued on May 22 to incorporate the changes made to the PPP by Congress under the Flexibility Act as well as to reflect the terms of the SBA’s revised Loan Forgiveness Application published on June 16. Significant points raised in the 20th IFR include the following:
Borrowers May Apply For Forgiveness Early
The SBA confirmed that a borrower may apply for loan forgiveness before the end of its covered period. (The “covered period” is the 24 weeks (or if the applicant obtained its loan on or before June 5 and so elects, 8 weeks) immediately following the date of the loan during which the borrower may gain forgiveness for qualified expenditures.) The 20th IFR states 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.”
The rule goes on to provide that if the borrower applies for forgiveness before the end of its covered period and has reduced employee’s salaries in excess of 25 percent, “the borrower must account for the excess salary reduction for the full 8-week or 24-week period.” (Meaning: if the borrower is subject to reduction of forgiveness because one or more employee’s salaries have dropped by more than 25% relative to its pre-COVID level, the borrower must compute its reduction over the full 8 weeks or 24 weeks as the case may be, not merely through the date of the forgiveness application.) The rule provides an example as follows:
“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 then end of the covered period, it must account for the salary reduction for the full 24-week covered period (totaling $1,200).
This is good news. It had been uncertain prior to the 20th IFR whether a borrower could apply for forgiveness early, and the SBA confirmed that a borrower may.
Unanswered Question-FTE Computation:
There remains a question not answered by the SBA, however. How does a borrower that applies for forgiveness early compute its FTE reduction ratio?
The CARES Act requires a borrower whose employment has dropped, to reduce its forgiveness based on a formula: the borrower multiplies its eligible forgiveness (i.e. total of eligible expenditures during its covered period) and times a fraction equal to average FTE’s during the covered period divided by average FTE’s during base periods prior to COVID. The borrower cannot compute its FTE’s during its covered period-i.e., the numerator of this fraction-until the end of the covered period. How than can the borrower apply early? The SBA did not answer this question. Here is an example we created to illustrate the dilemma:
ABC Company obtains its PPP loan of $400,000 on May 1 and elects a 24 week covered period to end on October 15. Twelve weeks have elapsed since the funding date, and ABC has incurred $500,000 of forgivable expenses since obtaining its loan. ABC had employed 20 employees during its pre-COVID base periods, laid off 4 employees in March and has employed 16 since.
ABC wants to file for forgiveness now as it fears it may soon have to lay off 10 more employees because its revenues have fallen, and it has exhausted its PPP loan. It’s FTE fraction through the first 12 weeks is .8 (16 average FTE’s over the 12 weeks divided by 20 employees during pre-COVID base period equals .8). If ABC applies this .8 fraction to its eligible forgiveness its whole loan will be forgiven (.8 times $500,000 = $400,000). Is ABC permitted to compute its FTE ratio based on only these 12 weeks (even though the CARES Act would seem to require it wait and compute the FTE’s over the full 24-week period)?
The SBA’s example quoted above, suggests that the answer is yes. In its example, the SBE permits the borrower to compute its average weekly wage reductions through the date of its forgiveness application and assume that this figure ($25/week) will continue for the balance of the covered period (i.e., $25/week x 24 weeks= $1,200). This logic would suggest the borrower may do the same in computing its FTE ratio: i.e., compute the ratio through date of application and assume the same ratio will continue for the balance of its covered period. Further, it would seem that this assumption-that the ratio to date will continue for the balance of the covered period-must be made. Otherwise how can an applicant apply early for forgiveness?
- Consider Applying Early. Early filing is a welcome option for many borrowers as it potentially reduces reduce risks associated with waiting.
- Accumulate a Cushion. Borrowers may wish to amass an excess of forgiveness expenditures over their loan amount before applying for forgiveness. This will help protect against losing full forgiveness if their lender or the SBE contest their computations.
Clarification of Compensation Caps for Owner-Employees and Self-Employed Individuals
The SBA provided further guidance on the caps applicable to owner-employees, schedule C filers, and general partners. The 20th IFR apparently provides as follows for the purposes of computing the loan forgiveness caps applicable to payroll:
- Owner-Employees of S Corporations are capped in the aggregate of their cash compensation plus employer retirement contributions (but not health insurance contributions which are included in their cash compensation) in the amount of the lesser of (A) 2.5/12 (or 8/52 in the case of an 8 week covered period) times the sum of the forgoing two items (cash compensation and retirement contributions) in 2019 or (B) $20,833 ($15,385 for an 8-week covered period).
- Owner-Employees of C Corporations are capped in their aggregate of cash compensation, employer retirement and health insurance in the amount of the lesser of (i) 2.5/12 (or 8/52 in the case of an 8 week covered period) times the sum of the foregoing three items (cash compensation, and retirement and health insurance contributions) in 2019 or (ii) $20,833 ($15,385 for an 8-week covered period).
- Other Owner-Employees-Similar caps.
- General Partners are capped in their owner compensation replacement in the amount of the lesser of (i) 2.5/12 (or 8/52 in the case of an 8 week covered period) times their 2019 net profit or (ii) $20,833 ($15,385 for an 8-week covered period).
- Schedule C or F Filers are capped in their aggregate owner compensation replacement in the amount of the lesser of (i) 2.5/ (or 8/52 in the case of an 8 week covered period) times their 2019 net profit or (ii) $20,833 ($15,385 for an 8-week covered period).
While the SBA has not defined “owner-employees”, in its form PPP loan application it defines “owner” for purposes of the SBA 7(a) program (of which the PPP is a part) as: any sole proprietor, trustor of a trust, general partner or any limited partner holding 20% or more equity of a partnership, and member of an LLC or owner of a corporation, in each case holding more than 20% of such entity.
- Correction to Forgiveness Application. The SBA’s form forgiveness application is confusing in its presentation of the cap on owner-employees. PPP borrowers should ensure that they apply the cap correctly when they complete their application if they have any owner-employees.
- Caps. PPP borrowers which are subject to these caps, or have owner-employees subject to these caps, are likely to be able to obtain full forgiveness despite these limitations by taking advantage of the 24-month covered period.
Favorable Guidance on Business Reduction Safe Harbor
Congress in the Flexibility Act provided a new FTE reduction safe harbor available to borrowers which suffer a loss of business related to COVID compliance. To meet the safe harbor the borrower must document that its business declined relative to the level on February 15, 2020 “due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020 by the Secretary of [HHS], Director of the [CDC] or [OSHA] related to the maintenance of standards for sanitation, social distancing or any other worker or customer safety requirement related to COVID-19.”
The SBA clarified that borrowers can meet the requirement if they show that their business decline stems directly or indirectly” from compliance with such COVID requirements and provided an example as follows:
“Example: A PPP Borrower is in the business of selling beauty products both online and at its physical store. During the covered period, the local government where the borrower’s store is located orders all non-essential businesses, including the borrower’s business, to shut down their stores, based in part on COVID-19 guidance issued by the CDC in March 2020. Because the borrower’s business activity during the covered period was reduced compared to its activity before February 15, 2020, due to compliance with COVID requirement or Guidance, the borrower satisfies the Flexibility Act’s exemption and will not have its forgiveness amount reduced because of a reduction in FTE’s during the covered period. . . ”
The example captures a situation applicable to many borrowers-i.e., the immediate cause for the full or partial shutdown of their business arose from a state or local governmental mandate prompted by guidance from the CDC or other federal agency and not directly from the guidance itself.
Takeaway: As clarified, this safe harbor may be available to many more borrowers.
Houston Harbaugh attorneys are available to help with this and other business issues as you proceed through the pandemic. Contact the attorney with whom you regularly deal or the below author of this article: Harrison S. Lauer, Houston Harbaugh, [email protected]; (412) 288-2229.