We have blogged extensively about the Paycheck Protection Program (PPP) established by the Coronavirus Aid, Relief and Economic Security (CARES) Act. The CARES Act appropriated $349 billion to the PPP to fund government-backed loans to qualifying businesses to cover payroll costs, rent, mortgage interest and utilities. The full amount of principal may be forgiven for borrowers who comply with the PPP’s terms and conditions.

Tonight, five days after the initial frenzied rollout, the Department of the Treasury (Treasury), issued a Frequently Asked Questions document (FAQs) which is expected to be updated periodically. This post summarizes some of the important takeaways.

Effect of the FAQs

The FAQs purport to be a document that borrowers and lenders can rely on as the Small Business Administration’s (SBA) interpretation of the CARES Act and the PPP Interim Final Rule (Rule), which we previously discussed here.

The FAQs go on to state that “the U.S. government will not challenge PPP lender actions that conform to this guidance, and to the PPP Interim Final Rule and any subsequent rulemaking in effect at the time.” However, borrowers and lenders should not be lulled into a false sense of security, as a footnote correctly reminds the reader that: “[t]his document does not carry the force and effect of law independent of the statute and regulations on which it is based.”

Eligible Borrowers: Size and Type

The FAQs clarify that “small business concerns” (as defined under Section 3 of the Small Business Act) need not have less than 500 employees to be eligible for a PPP loan, as long as they otherwise satisfy existing statutory and regulatory criteria. In short, whether a business with more than 500 employees may still be considered a small business concern depends on factors like the industry the business is in and the amount of revenue it generates. The FAQs point borrowers to the “Size Standards” section of SBA’s website for more information.

The FAQs also note that a business can qualify as a small business concern that is eligible for a PPP loan if it meets both tests in SBA’s “alternative size standard” as of March 27, 2020, i.e.: (1) maximum tangible net worth of the business is not more than $15 million; and (2) the average net income after Federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than $5 million.

Small business concerns are not the only types of entities eligible for PPP loans. Other qualifying entities include:

  • Businesses that have 500 or fewer employees whose principal place of residence is in the United States.
  • Businesses that operate in a certain industry and meet applicable SBA employee-based size standards for that industry.
  • Qualifying tax-exempt nonprofit organizations described in section 501(c)(3) of the Internal Revenue Code (IRC).
  • Tax-exempt veterans organization described in section 501(c)(19) of the IRC.
  • Tribal business concerns described in section 31(b)(2)(C) of the Small Business Act that have 500 or fewer employees whose principal place of residence is in the United States, or meet the SBA employee-based size standards for the industry in which they operate.

Affiliation Rules

Since the number of a business’ employees is relevant to whether it qualifies for a PPP loan, it must be sure to accurately count its employees. Ordinarily, when counting the number of employees for the purpose of determining eligibility for a SBA loan, a business must comply with “affiliation rules.” This means the business must count the employees of any of its affiliates in addition to its own direct employees. Traditionally, affiliates include, by way of example only, other entities that are commonly owned or controlled.

Last week, Treasury issued its Interim Final Rule regarding affiliation for purposes of the PPP (Affiliation Rule). The Affiliation Rule makes clear that non-profits (which were not entitled to SBA 7(a) loans prior to the passage of the CARES Act) and veterans organizations are subject to SBA’s affiliation rules. The particular affiliation rules that apply to these entities and small businesses are set forth at 13 C.F.R. 121.301(f). The Affiliation Rule also sets out an exemption from the affiliation rules for certain religious organizations, which will not be discussed at length here.

One affiliation rule issue that sometimes arises in the context of SBA 7(a) loans relates to the concept of “blocking rights.” Where the applicant is controlled by a person who is also a minority shareholder in another entity, that entity may be considered an affiliate if the minority shareholder has control of the potential affiliate by virtue of “blocking rights.” A minority shareholder will be deemed to have such rights if he or she is capable, as a matter of corporate governance, of preventing action by the board or the other shareholders. However, the FAQs explain that, if a minority shareholder irrevocably waives such blocking rights, he or she will no longer have “control” for purposes of the affiliation analysis (unless an independent basis for affiliation existed).

The FAQs further explain that a borrower must certify in its PPP loan application that it meets the eligibility requirements for receiving a PPP loan after applying the affiliation rules for purposes of counting employees, if applicable. Lenders are not responsible to make an independent determination of the applicability of affiliation rules, and are simply permitted to rely on the borrower’s certification.

Calculating Average Number of Employees and Amount of Payroll Costs

Under the CARES Act, a borrower’s maximum loan amount is 250% of their average monthly payroll costs in the preceding year. Previous guidance indicated that this calculation should be performed using data for the year preceding the loan’s application date. The FAQs clarify that a borrower may alternatively base this calculation on the entirety of the 2019 calendar year.

Alternatively, for seasonal businesses, the applicant may use the average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019. Additionally, an applicant that was not in business from February 15, 2019 to June 30, 2019 may use the average monthly payroll costs for the period January 1, 2020 through February 29, 2020.

Borrowers may calculate their average number of employees over the same time periods. Alternatively, according to the FAQs, borrowers may elect to use SBA’s usual calculation: “the average number of employees per pay period in the 12 completed calendar months prior to the date of the loan application (or the average number of employees for each of the pay periods that the business has been operational, if it has not been operational for 12 months).”

Exclusions from Payroll Costs

The FAQs explain that payments made to independent contractors or sole proprietors may not be included within the calculation of a business’ payroll costs. However, persons falling into either category may apply for their own PPP loans.

Payroll costs are to be calculated using gross numbers, without deductions for federal income or FICA taxes withheld from the employee’s wages. However, the employer’s share of payroll taxes may not be counted among payroll costs. The FAQ’s provide the following example: “an employee who earned $4,000 per month in gross wages, from which $500 in federal taxes was withheld, would count as $4,000 in payroll costs. The employee would receive $3,500, and $500 would be paid to the federal government. However, the employer-side federal payroll taxes imposed on the $4,000 in wages are excluded from payroll costs under the statute.”

Additionally, the CARES Act makes clear that individual compensation in excess of $100,000 annually must be excluded from the determination of payroll costs. However, since other fringe benefits like retirement contributions and health insurance premiums are payroll costs, businesses have wondered whether only salary exceeding $100,000 must be excluded, or whether any compensation, including the value of fringe benefits, must be excluded to the extent it exceeds $100,000 per year.

The FAQs clarify that only salary exceeding $100,000 per year must be excluded from the calculation of payroll costs. It does not apply to “non-cash” fringe benefits, such as retirement contributions or the payment of health insurance premiums.

The FAQs also explain that the term “payroll costs” includes costs related to vacation and parental, family, medical and sick leave, except family and sick leaves under the  Families First Coronavirus Response Act (FFCRA). That is because employers are already entitled to reimbursement of the cost of paid leave under the FFCRA through refundable payroll tax credits, which we have also blogged about in our sister publication.

Lender Verification of Payroll Costs

The FAQs clarify that lenders are not required to replicate a borrower’s payroll calculations in order to verify them. This is consistent with the government’s public messaging: PPP loans should be easy to obtain and the proceeds should be disbursed quickly.

Lenders are entitled to rely on the borrower’s certification as to the accuracy of the payroll calculations, including with respect to amounts required to be excluded from payroll costs. However, the lender must also perform a “good faith review, in a reasonable time” of the borrower’s calculations and supporting documentation. The FAQs specifically state that “minimal review” of calculations based on a payroll report from a “recognized third-party payroll processor” would be considered reasonable. If the lender notes an error in the borrower’s calculations or a “material lack of substantiation” in the supporting documentation, the lender should work through these issues with the borrower rather than denying the loan outright.

Professional Employer Organizations

Some employers utilize the services of professional employer organizations (PEOs). In some states, this means that the PEO is technically the employer of its clients’ employees for payroll purposes (e.g., though the employees work from Company X, their pay stubs indicate that their wages are paid by ADP). In acknowledgment of this, the FAQs state that payroll information, such as a Form 941, provided by the PEO will be acceptable proof of the borrower’s payroll costs. If such information is not available, a statement of wages and payroll taxes from the PEO will suffice.

Signatories

The FAQs explain that one authorized individual may sign the PPP loan application on behalf of the business but, in doing so, the signer represents to the lender and the U.S. government that he or she is authorized to make all certifications contained in the loan application, including those that are made on behalf of all individual owners with an interest of 20% or more in the borrower. Lenders are entitled to rely on that representation without probing further.

Prior Crimes

A business will not, according to the FAQs, be disqualified from taking a PPP loan because one of its owners pleaded guilty to a felony in the distant past. The only types of criminal history that are disqualifying include the following circumstances, if applicable to any owner of 20% or more of the business’ equity:

  • Currently being incarcerated, on probation, on parole, subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or
  • Within the last five years, for any felony, being convicted, pleading guilty, pleading nolo contendere, being placed on pretrial diversion, or being placed on any form of parole or probation (including probation before judgment).

Lender Specific Forms

The FAQs state that lenders need not use the sample PPP loan forms available on Treasury’s website. They can use their own forms as long as they obtain the same information by using the same language. However, lenders are still required to send the data to SBA using SBA’s interface.

Lenders also have the option to use their own promissory notes, or the SBA form promissory note, as they see fit.

Previously Submitted Applications

According to the FAQs, loan applications that contain calculations or information that are at odds with the FAQs do not need to be withdrawn. However, a borrower may choose to revise its application based on the publication of the FAQs.

Loan Disbursement and Forgiveness

The FAQs state that lenders must make the first disbursement of PPP loan proceeds no later than ten calendar days after the date of loan approval. A loan will be forgiven to the extent it was used on qualifying expenditures in the eight-week period beginning on the date the lender makes the first disbursement of the PPP loan to the borrower.

Conclusion

According to Forbes, Phillip Taylor, the founder of FinCon, recently likened the rollout of the PPP to “building an airplane while you’re flying it.” This quote immediately came to mind as I reviewed and summarized these FAQs, knowing  that thousands of borrowers have already submitted applications without the benefit of these very important clarifications, particularly those concerning the calculation of payroll costs. One can only hope that, in practice, lenders and the SBA will show flexibility in the processes of both lending and forgiveness.