“Paycheck Protection” Loans: SBA Advises on How to Ask for Forgiveness
Business Law Alert 06/18/20 Melissa McCord
Editor’s Note: Our original client alert dated May 18, 2020 has been updated to address new guidance on loan forgiveness.
Small businesses that received Paycheck Protection Program loans in the wake of the COVID-19 pandemic now have additional time and flexibility in their loan terms after Congress approved the Paycheck Protection Program Flexibility Act of 2020 (the “PPP Flexibility Act”), which the President signed into law on June 5, 2020. The SBA is implementing changes to previously issued forms and rules to reflect the changes mandated by the PPP Flexibility Act, which changes include:
- an updated Borrower Application Form (found here) (the “Loan Application”);
- an updated Loan Forgiveness Application form (found here);
- a new Loan Forgiveness Application Form “EZ” (found here, with instructions found here) (the “EZ Forgiveness Application”); and
- updates to previously issued rules (found here, here, and here)
The PPP Flexibility Act gives businesses more flexibility to use funds received under the Paycheck Protection Program (“PPP”), which currently makes available low-interest and potentially forgivable loans to businesses that employ fewer than 500 people (generally). Businesses will also have more time to apply for PPP loans. A bill passed by the House and Senate will extend the application window from June 30, 2020 to August 8, 2020.
PPP loans are meant to help small businesses pay for certain overhead costs and to encourage small businesses to keep their workers employed through the COVID-19 crisis. The U.S. Small Business Administration (“SBA”) administers the PPP, which was created in March under the Coronavirus Aid, Recovery, and Economic Security Act (“CARES Act”) and expanded in April by the Paycheck Protection Program and Health Care Enhancement Act (the “PPP Enhancement Act”). Find our prior alerts about the program here.
If a borrower would like to apply for loan forgiveness, the borrower must spend the PPP loan proceeds on payroll costs (with some exclusions), mortgage interest, rent, and utilities during the Forgiveness Measurement Period (defined below), and at least 60% of the amount forgiven must consist of payroll costs.
Alternative Measurement Period for Payroll. Under the original CARES Act, the forgiveness measurement period for payroll costs was defined as the eight weeks starting on the day the PPP loan is disbursed to the borrower. The PPP Flexibility Act expands the forgiveness measurement period to up to 24 weeks after loan origination, not to extend beyond December 31, 2020. Borrowers that received a loan prior to June 5, 2020, may choose to retain the original eight-week forgiveness measurement period (in either case, the “Forgiveness Measurement Period”).
For convenience, a borrower with a biweekly or more frequent payroll schedule can choose as its measurement period the eight weeks (or twenty four weeks, as applicable) that start on the first day of the borrower’s first pay period following loan disbursement. The alternate measurement period is only for tracking payroll costs, and not for tracking payments on rent, mortgage interest, or utilities. For these other forgivable costs, the forgiveness period will still begin on the date that the loan is disbursed.
If a borrower pays employees twice per month, instead of biweekly, the borrower cannot take advantage of the alternative measurement period for payroll costs.
Accrual or Cash Accounting? Companies have wondered if they must incur the forgivable costs during the Forgiveness Measurement Period, or if it is simply enough that the companies pay the costs during the Forgiveness Measurement Period. The standards set forth in the Forgiveness Application and the SBA rules are as follows:
- Payroll Costs: In general, payroll costs are eligible for forgiveness if they are paid or incurred during the Forgiveness Measurement Period.
- Payroll costs are “paid” when paychecks are distributed or ACH credit transactions are initiated.
- Payroll costs are “incurred” when employees’ pay is earned (in most cases, when employees put in their time).
Borrowers have voiced concern that at the end of the Forgiveness Measurement Period, they may have incurred some payroll costs (their employees have earned the wages) but have not paid them (they have not yet sent paychecks because payday will occur sometime after the Forgiveness Measurement Period). The Forgiveness Application and SBA rules indicate that such payroll costs are eligible for forgiveness so long as the payroll costs are actually paid on or before the next regular payroll date.
Note that a borrower taking advantage of the alternative measurement period described above would not face this issue because its pay periods and the forgiveness measurement period should align.
- Nonpayroll Costs: Payments of mortgage interest, rent, and utilities are eligible for forgiveness if they are paid during the Forgiveness Measurement Period or incurred during the Forgiveness Measurement Period and paid on or before the next regular billing date immediately after the Forgiveness Measurement Period.
Payments to Furloughed Employees. As many PPP borrowers anticipated, the SBA confirmed that payments of salary, wages, or commissions to furloughed employees not working during the Forgiveness Measurement Period are eligible for forgiveness. The SBA determined that this interpretation is consistent with the intent of the CARES Act to enable businesses to continue paying their employees even if those employees cannot perform their day-to-day duties, whether due to lack of economic demand or public-health considerations. For employees who are not actually working but still on payroll, payroll costs are incurred based on the schedule established by the borrower (typically, each day that the employee would have performed work).
Payments of Bonuses and Hazard Pay. If an employee receives hazard pay or other bonuses during the Forgiveness Measurement Period, such additional payments are eligible for loan forgiveness if, after accounting for such additional pay, the employee’s total compensation does not exceed $100,000 on an annualized basis. Based on current guidance, it does not appear that loan forgiveness for such additional hazard pay or bonuses is contingent on whether a recipient of additional pay actually faced increased risk or hazard at the workplace.
Pay Raises and Bonuses to Owner-Employees. The Forgiveness Application and SBA rules limit the availability of bonuses and hazard pay to owner-employees (such as partners of a partnership) and self-employed individuals. The amount of loan forgiveness requested for owner-employees and self-employed individuals’ payroll compensation can be no more than the lesser of:
If a 24-Week Forgiveness Measurement Period applies:
- 2.5 months of the owner-employee’s 2019 compensation, or
- $20,833 per individual in total across all businesses.
If an 8-Week Forgiveness Measurement Period applies:
- 8/52 (approximately 15.38%) of the owner-employee’s 2019 compensation, or
- $15,385 per individual in total across all businesses.
Additionally, the Forgiveness Application emphasizes that borrowers cannot include employer health insurance contributions made on behalf of owner-employees and employer retirement contributions made on behalf of owner-employees in the calculation of payroll costs because such payments are already included in the compensation of such owner-employees.
Rental Payments and Business Loan Interest Payments. Mortgage interest payments on any business mortgage obligation on real property or personal property and rent payments on leases of real property or personal property are eligible for forgiveness. To qualify, the underlying leases and mortgages must have been in effect on or before February 15, 2020. Prepayments of mortgage interest are not eligible for loan forgiveness.
Utilities Payments. Business utility payments are eligible for forgiveness for electricity, gas, water, transportation, telephone, or internet access, in each case so long as such service began before February 15, 2020.
Reductions of Loan Forgiveness. Borrowers are penalized on their forgivable loan amount if they have a reduction in their full-time equivalent (“FTE”) workforce or have large salary or wage reductions. The Forgiveness Application and SBA rules outline how to calculate these forgiveness penalties and provide more detail on applicable safe harbors and exemptions.
***Please note that borrowers eligible to use the EZ Forgiveness Application are not required to submit these detailed calculations when applying for forgiveness. Please see below to determine eligibility to use the EZ Forgiveness Application.
- FTE Reductions, Safe Harbors and Exemptions: The FTE reduction penalty applies if the borrower’s average weekly number of FTE employees during the Forgiveness Measurement Period is less than (i) the weekly average from February 15, 2019, to June 30, 2019, or (ii) the weekly average from January 1, 2020 to February 29, 2020. The borrower has discretion to choose either historical comparison period.
A “full-time equivalent” employee is an employee who works 40 hours or more on average each week. For employees who were paid for less than 40 hours per week, borrowers may choose to calculate the full-time equivalency by either (i) dividing the average number of hours a part-time employee was paid per week during the covered period by 40, or (ii) using a full-time equivalency of 0.5 for each part-time employee (used consistently for all part-time employees). For example, if an employee was paid for 30 hours per week on average, a borrower using the first approach could consider that employee an FTE employee of 0.75. Under the second approach, that employee could be considered 0.5 of an FTE employee.
In either case, the borrower must provide the aggregate total of FTE employees for both the Forgiveness Measurement Period and the selected comparison period by adding together all of the employee-level FTE employee calculations to determine the potential reduction amount.
FTE Reduction Safe Harbors: Two separate safe harbors exempt borrowers from any loan forgiveness reduction based on a reduction in FTE employee levels, the first, created by Congress as part of the PPP Flexibility Act, and the second, created by Congress in the original CARES Act:
- The FTE reduction penalty will not apply if a borrower, in good faith, can document that it was unable to operate between February 15, 2020, and the end of the Forgiveness Measurement 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. We anticipate more guidance will be issued by the SBA to assist borrowers in determining whether they qualify for this safe harbor, which was created under the PPP Flexibility Act.
- The FTE reduction penalty will not apply if a borrower reduces its FTE levels between February 15, 2020, and April 26, 2020, and subsequently restores its FTE levels by not later than December 31, 2020, to its FTE levels in the borrower’s pay period that included February 15, 2020. On its face, this safe harbor permits a borrower to substantially reduce its workforce during the Forgiveness Measurement Period without penalty. However, 60% of the amount forgiven must consist of a borrower’s actual payroll costs, so a borrower that fails to retain FTEs in a sufficient number during the Forgiveness Measurement Period may have difficulty obtaining forgiveness for a sizable portion of its loan.
FTE Reduction Exceptions: The Forgiveness Application and SBA rules contain several additional exceptions to the FTE reduction penalty that are helpful to borrowers attempting to qualify for forgiveness, as set forth below, in each case assuming the borrower did not hire a new replacement employee:
- Good Faith Offer to Rehire. A borrower will not face an FTE reduction penalty for reducing the FTE of an individual who was an employee on February 15, 2020, if:
- the borrower made a good-faith, written offer to rehire such employee (or, if applicable, restore the reduced hours of such employee);
- the offer was for the same salary or wages and number of hours;
- the employee rejected the offer;
- the borrower maintained records documenting the offer and its rejection; and
- the borrower informed the applicable state unemployment insurance office of the employee’s rejection within 30 days.
The SBA indicated that it will provide further information regarding how borrowers will report information concerning rejected offers to state unemployment insurance offices.
- Other FTE Reduction Exemptions. A borrower will not face an FTE reduction penalty for reducing the FTE of an employee if the employee was fired for cause, the employee voluntarily resigned, or the employee voluntarily requested and received a reduction of hours.
- Salary/Wage Reductions: The salary/wage reduction penalty applies if the borrower reduces the salary/wage of any employee by more than 25% during the Forgiveness Measurement Period as compared to the comparison period of January 1, 2020, through March 31, 2020. The borrower must reduce the total forgiveness amount by the total dollar amount of the salary or wage reductions that are in excess of 25 percent of base salary or wages during the comparison period.
For example, assume a borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the Forgiveness Measurement Period, and the employee continued to work on a full-time, 40 hour per week basis during the forgiveness period. In this case, the first $250 (25 percent of $1,000) of salary/wage reductions is exempted from the penalty. Borrowers seeking forgiveness would list $1,200 as the salary/hourly wage reduction penalty for that employee (the extra $50 weekly reduction multiplied by twenty four weeks).
To ensure that borrowers are not doubly penalized, the salary/wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction. For example, if an employer reduces an hourly wage employee’s hours from 40 hours per week to 20 hours per week during the Forgiveness Measurement Period, but does not reduce the employee’s hourly wage during such period, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction and the borrower is not required to conduct a salary/wage reduction calculation for that employee.
The salary/wage reduction penalty does not apply to employees paid more than the annualized equivalent of $100,000 in any pay period in 2019, and will not apply if a borrower reduced an employee’s salary/wage levels between February 15, 2020, and April 26, 2020, and subsequently restores the applicable employee’s salary or wages by no later than December 31, 2020.
Again, on its face, this safe harbor permits a borrower to substantially reduce salaries/wages during the Forgiveness Measurement Period without penalty. However, practically speaking, borrowers that fail to maintain their pre-pandemic salaries/wages during the Forgiveness Measurement Period may have difficulty obtaining forgiveness for a sizable portion of their loan.
Streamlined EZ Forgiveness Application. The SBA released a streamlined EZ Forgiveness Application that significantly simplifies the calculations the borrower is required to submit when requesting loan forgiveness. In particular, borrowers using the EZ Forgiveness Application will not need to calculate the forgiveness penalties set forth above for FTE reductions or salary/wage reductions. In other respects, the EZ Forgiveness Application is largely consistent with the ordinary Forgiveness Application.
Borrowers that can satisfy one of the following three requirements are permitted to use the EZ Forgiveness Application:
1. No Employees: The borrower is a self-employed individual, independent contractor, or sole proprietor who had no employees at the time it applied for a PPP Loan and did not include any employee salaries in the computation of average monthly payroll in its Loan Application.
2. Stable Salaries/Wages, Headcount, FTEs: The borrower did not:
- reduce annual salary or hourly wages of any employee by more than 25% during the Forgiveness Measurement Period compared to the period between January 1, 2020, and March 31, 2020 (for purposes of this statement, “employees” means only those employees who did not receive, during any single period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000); and
- reduce the number of employees or the average paid hours of employees between January 1, 2020, and the end of the Forgiveness Measurement Period. (Ignore reductions that arose from an inability to rehire individuals who were employees on February 15, 2020, if the borrower was unable to hire similarly qualified employees for unfilled positions on or before December 31, 2020. Also ignore reductions in an employee’s hours that the borrower offered to restore and the employee refused.)
3. Stable Salaries/Wages and COVID-19 Disruption: The borrower:
- did not reduce annual salary or hourly wages of any employee by more than 25% during the Forgiveness Measurement Period compared to the period between January 1, 2020, and March 31, 2020 (for purposes of this statement, “employees” means only those employees who did not receive, during any single period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000); and
- was unable to operate during the Forgiveness Measurement 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 of sanitation, social distancing, or any other work or customer safety requirement related to COVID-19.
Borrowers must certify which of the three choices above they are relying on to establish eligibility for the EZ Forgiveness Application and must retain records and documentation supporting their determination that they satisfy the applicable eligibility requirement.
Documentation Requirements. The Forgiveness Application contains a detailed summary of the documents that each borrower must submit with its Forgiveness Application. The borrower will need to submit documentation supporting the costs for which it is requesting forgiveness (payroll, rent, mortgage interest, and utilities) and documentation showing how its wages/salaries and FTEs during the Forgiveness Measurement Period compare with the applicable historical periods.
Required documentation may include bank account statements, third-party payroll service provider reports, tax forms, payment receipts, invoices, and account statements. For six years after the date the loan is forgiven or repaid, the borrower must retain all records relating to the borrower’s PPP loan, including documentation supporting the borrower’s certifications as to the necessity of the loan request, its eligibility for a PPP loan, and (if applicable) the borrower’s certification that it could not operate normally due to federal requirements or guidance regarding the maintenance of standards of sanitation, social distancing, or any other work or customer safety requirements related to COVID-19. The borrower must make such records available to the SBA upon request.
Process for Forgiveness. The borrower must submit the Forgiveness Application to its lender. The lender will have 60 days following receipt of the Forgiveness Application to notify the SBA of its forgiveness decision. If a lender determines that a borrower is eligible for forgiveness, the lender will request payment from the SBA. If the lender determines that a borrower is not entitled to forgiveness, the borrower has 30 days to request the SBA to review the lender’s decision.
The SBA will have 90 days to review a lender’s determination, and the SBA must remit the forgiven amount to the lender within that 90-day period unless it determines that the borrower is not eligible for forgiveness. The borrower must repay all amounts ineligible for forgiveness in accordance with the original terms of the loan. A borrower may appeal the SBA’s determination that the borrower is ineligible for a PPP loan or ineligible for the loan amount or the loan forgiveness amount. The SBA indicated that it will issue a separate rule addressing the appeal process.
Lender Review. SBA rules narrow the scope of the lender’s responsibility to review the borrower’s Forgiveness Application. Specifically, the SBA rules indicate, in part:
Providing an accurate calculation of the loan forgiveness amount is the responsibility of the borrower, and the borrower attests to the accuracy of its reported information and calculations on the Loan Forgiveness Application. Lenders are expected to perform a good-faith review, in a reasonable time, of the borrower’s calculations and supporting documents concerning amounts eligible for loan forgiveness. For example, minimal review of calculations based on a payroll report by a recognized third-party payroll processor would be reasonable. By contrast, if payroll costs are not documented with such recognized sources, more extensive review of calculations and data would be appropriate. The borrower shall not receive forgiveness without submitting all required documentation to the lender.
The SBA rules indicate that “lenders may rely on borrower representations.” The SBA advises lenders to review a borrower’s certifications in the forgiveness application, to confirm receipt of documentation to verify payroll and nonpayroll costs, and to confirm the borrower’s loan forgiveness calculations.
However, borrowers should understand that the borrower is ultimately responsible for submitting accurate and complete documentation, and should not view a lender’s approval of a loan application or a Forgiveness Application as an absolute shield against further inquiries by the SBA, as discussed in greater detail below. If the SBA notifies a lender that the SBA is reviewing a loan, the lender must, within five business days, notify the borrower and transmit electronic copies of the loan documentation to the SBA. Lenders are not eligible for processing fees in connection with PPP loans if the SBA determines that the borrower is ineligible for such a loan or if the lender fails to meet its obligations under the PPP regulations.
SBA Review. The SBA reserves the right to review any PPP loan at any time as the SBA deems appropriate. Under the SBA rules, the SBA is specifically authorized to review loan files for the following items:
- Eligibility. The SBA may review whether the applicant is specifically ineligible to receive SBA loans under existing regulations (for example, businesses engaged in “any illegal activity” are not eligible to receive SBA loans under any circumstances), and affiliation rules, in each case, as modified by the CARES Act and subsequent guidance. Additionally, the SBA may review information, certifications, and representations on the borrower’s application form (SBA Form 2483) and the Forgiveness Application.
- Loan Amounts, Use of Proceeds. The SBA may review whether a borrower calculated the loan amount correctly, used loan proceeds for the allowable uses specified in the CARES Act, and is entitled to loan forgiveness in the amount claimed on the borrower’s Forgiveness Application.
The CARES Act indicated that if a PPP loan is not repaid, the SBA has no recourse against any individual shareholder, member, or partner of an eligible borrower. While acknowledging this nonrecourse provision in the statute, the SBA emphasizes in the SBA rules that this limitation applies only if the borrower was in fact an “eligible recipient.” Borrowers that fail to satisfy the eligibility requirements set forth in the CARES Act and related guidance face some risk that the SBA could seek remedies against individual shareholders, members or partners of a borrower.
Additional Information. We expect the SBA to issue more guidance on this topic in the future. The complete text of (i) the CARES Act is here, (ii) the PPP Enhancement Act is here, and (iii) the PPP Flexibility Act is here.
For more information, please contact your Quarles & Brady attorney or:
- Melissa McCord: (414) 277-3079 / [email protected]