Senate Passes CARES Act, Which Includes $349 Billion for SBA Guarantees of Forgivable Loans for Small and Medium Sized Businesses
Late on March 25, 2020, the Senate unanimously passed the Coronavirus Aid, Relief, and Economic Security Act or the “CARES Act”. As of this writing, the CARES Act still requires approval from the House and the President’s signature before becoming law. The CARES Act includes a “Paycheck Protection Program” which authorizes up to $349 billion of federally guaranteed loans to qualifying small and medium sized businesses. Loans can be up to $10 million per business and may be forgiven if the business maintains its payroll through June 30, 2020.
Below is a high level summary of the Senate’s version of the CARES Act. Please note that such provisions may be modified by the House and we expect the U.S. Department of Treasury (the “Treasury”) and the U.S. Small Business Administration (“SBA”) to release guidance in the coming weeks which will provide further detail on the program and may materially change the summary below. Please consult with a KMK attorney or other advisor prior to relying on the information below.
UPDATE: As noted above, the SBA and Treasury have released additional guidance which substantially modifies and clarifies some of the provisions in the CARES Act. Some changes are noted in line below, but lenders and borrowers need to ensure they are working with the most up to date guidance. Please contact a KMK attorney with any questions.
Modification of SBA 7(a) Loan Program
The Paycheck Protection Program is a modification of the SBA’s 7(a) loan program, in which the SBA partially guarantees loans made by banks to qualifying small businesses. The Paycheck Protection Program modifies the 7(a) loan program in four important ways: (1) expands the businesses that are eligible for loans, (2) modifies the loan terms, including eliminating guarantee and collateral requirements of the borrower, (3) allows all or a portion of the loan to be forgiven if the borrower maintains its payroll, and (4) modifies a number of provisions to incentivize banks to make such loans and make the loan process faster and more efficient.
- Businesses and Non-Profits Eligible for Paycheck Protection Loans
Generally, businesses and 501(c)(3) non-profits with not more than (i) 500 employees, including employees of affiliates, or (ii) the applicable size standard for the industry as provided by the SBA, if higher, are eligible for Paycheck Protection Program loans (“Paycheck Protection Loans”). “Employees” includes all persons employed on a full-time, part-time or other basis. Certain sole-proprietors, independent contractors, and other self-employed individuals are also eligible for loans. Businesses must also meet the SBA’s definition of a “business concern.”
The requirement to include employees of affiliates is waived for (1) accommodation and food service businesses, (2) businesses operating as certain franchisees on the SBA’s Franchise Directory, and (3) small businesses that receive financing through the Small Business Investment Company (SBIC) program. In addition, the 500 employee limit is waived for accommodation and food service businesses so long as they do not have 500 or more employees in any one physical location.
Importantly, the CARES Act waives the “credit available elsewhere” test normally applicable to SBA loans. This means that business are not required to seek other sources of capital, including equity or debt investments from owners with liquid assets prior to obtaining a Paycheck Protection Loan.
The CARES Act did not modify the types of businesses that are generally ineligible for SBA business loans. Therefore, the following businesses that are ordinarily not eligible for SBA Loans, such as financial businesses, passive business, foreign businesses, gambling businesses, and private clubs, among others, are generally ineligible for Paycheck Protection Loans:
Please note that the above is only a summary of the key eligibility requirements. Please contact a KMK Law attorney or other advisor before making a final determination if you are eligible for a Paycheck Protection Loan.
2. Paycheck Protection Loan Terms
Loan Amount. Qualifying businesses and non-profits are eligible for loans up to 2.5 times their monthly payroll costs, measured over the prior twelve months, or $10 million, whichever is smaller. Payroll costs is defined broadly and includes salaries, certain employee benefits, state and local taxes and certain types of compensation to sole proprietors or independent contractors up to $100,000. Payroll costs specifically exclude employee compensation in $100,000 annually, compensation of foreign employees, FICA and income tax withholdings (UPDATE: this provision was changed by subsequent guidance), and certain COVID-19 paid leave. Seasonal employers or businesses in operation for less than a year are subject to a different calculation.
Use of Proceeds. Paycheck Protection Loans may be used to pay payroll costs (as defined above), group healthcare benefits, insurance premiums, and interest on a mortgage or other debt incurred prior to February 15, 2020, and to make rent and utility payments. Loan proceeds may not be used to prepay debt. (UPDATE: Subsequent guidance requires borrowers to use at least 75% of loan proceeds on payroll costs.)
Collateral. Payment Protection Loans do not require collateral from either the business or its owners like other SBA loans.
Guarantee. Payment Protection Loans do not require personal guarantees from owners like other SBA loans.
Interest Rate. Not to exceed four percent (4%). (UPDATE: Subsequent guidance set the interest rate at 1%.)
Maturity. Any portion of a Paycheck Protection Loan that is not forgiven as described below will have a term of up to 10 years and amortize the same as 7(a) loans, which are generally repaid with fixed monthly principal and interest payments over the remaining term. (UPDATE: Subsequent guidance set the loan term at 2 years.)
Deferment. The CARES Act allows automatic deferments of principal and interest payments for at least six months and not more than one year for all borrowers.
SBA Disaster Loans. After the date Paycheck Protection Loans are made available, businesses cannot obtain both an SBA Disaster Loan and a Paycheck Protection Loan for the same purpose.
3. Loan Forgiveness
Paycheck Protection Loans are eligible for loan forgiveness equal to the amount spent by the borrower during an 8-week period after the origination date of the loan on payroll costs, interest payment on any mortgage incurred prior to February 15, 2020, payment of rent on any lease in force prior to February 15, 2020, and payment on any utility for which service began before February 15, 2020. Payroll costs are subject to the same exclusions as noted above. (UPDATE: See note above. Subsequent guidance requires 75% of loan proceeds to be used for payroll costs.)
The loan amount eligible for forgiveness will be reduced proportionally by any reduction in employees during the covered period compared to certain prior periods. In addition, the loan amount eligible for forgiveness will be reduced by the reduction in pay of certain employee in excess of 25 percent. Tipped workers may receive forgiveness for additional wages paid to those employees.
To encourage employers to rehire any employees who have already been laid off due to the COVID-19 crisis, borrowers that re-hire workers previously laid off will not be penalized for having a reduced payroll at the beginning of the period and the payroll costs of any such employees are eligible for loan forgiveness.
In order to have any loan forgiven, Borrowers are required to submit certain documentation verifying their payroll and pay rates during the applicable periods and make certifications regarding the use of the loan.
Any loan amounts forgiven under the CARES Act will not be taxable income.
Given the importance of this novel aspect of the Paycheck Protection Program, we expect meaningful guidance from the Treasury and SBA on how businesses and lenders can better ensure their Paycheck Protection Loans are eligible for forgiveness.
4. Amendments to Incentive Loans and Speed Up Loan Processing Efficiency
In an attempt to incentivize banks to make such loans and speed up loan processing, the CARES Act increases the SBA guaranty of such loans to 100% for the remainder of 2020 and substantially modifies the procedures and requirements required of lending banks to have their loans guaranteed by the SBA.
For example, to assess eligibility lenders are only required to determine whether a business (1) was operational on February 15, 2020, and (2) had employees for whom it paid salaries and payroll taxes, or a paid independent contractor.
Borrowers are required to make certain certifications regarding the impact of COVID-19 on their business and intentions regarding use of a Paycheck Protection Loans.
The CARES Act grants wide authority to Treasury approve new lenders who do not make 7(a) loans to make Paycheck Protection Loans. The CARES Act also contains a number of additional provisions encouraging banks to make Paycheck Protection Loans, such as waiving certain fees, limiting lender liability if borrowers are ineligible for such loans, providing guidance on loans sold on the secondary market, providing regulatory risk of capital weight of such loans, and requiring SBA to pay lenders certain processing fees. There are also certain incentives banks to make Paycheck Protection Loans to borrowers with existing SBA existing 7(a) or 504 loans.
We are eager to see guidance from the Treasury and SBA on these matters. We expect lending banks to seek and require additional guidance from the Treasury and SBA on many of these provisions so they can have greater assurance that the loans they make will be guaranteed by the SBA.
If signed into law, the Paycheck Protection Program as part of the CARES Act will provide substantial relief to many small and medium sized businesses and allow them to retain and in many cases rehire previously laid off employees through the COVID-19 pandemic. Although the Paycheck Protection Program smartly builds upon the existing SBA 7(a) loan program for efficiency and simplicity, such modifications are themselves complex and companies should seek appropriate guidance to ensure (1) they are eligible for a Paycheck Protection Loan, (2) a Paycheck Protection Loan is permitted by any existing debt agreements of such company or appropriate consents are obtained, (3) they use the proceeds of any Paycheck Protection Loan as required, and (4) they obtain the maximum amount of loan forgiveness permitted.
KMK Law has commercial finance, tax and employment attorneys as well as a multi-disciplinary team ready and willing to advise on such matters. Please contact a KMK attorney for assistance, including those listed below.
Nicholas L. Simon