UPDATE: President Signs Law Adding $320 Billion to Small Business Loan Programs
Congress passed and the President signed into law the Paycheck Protection Program and Healthcare Enhancement Act, which provides additional funding for the Small Business Administration’s (“SBA’s”) Paycheck Protection Program (“PPP”) loan program under Section 7(a) of the Small Business Act. The PPP loan program was established in March 2020 by section 1102 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).
Treasury and SBA Issue Guidance
The Treasury Department and SBA have issued a series of guidance documents and four interim final rules to assist firms seeking to apply for PPP loans. Among other things, Treasury and SBA have clarified that:
- Small businesses can apply for PPP loans through any participating SBA Section 7(a) lender or through any federally insured depository institution, federally insured credit union, and Farm Credit System institution using a simplified application form. Lenders stopped processing loans when the original appropriation of $349 billion was depleted. The new funding will allow lenders to re-start the program, with $310 billion targeted for the PPP program and another $10 billion added to the SBA’s Economic Injury Disaster Loan program.
- Treasury and SBA have emphasized that all borrowers must certify their economic need for a PPP loan. This new guidance may cause some borrowers to reconsider their applications. Although the CARES Act suspends the ordinary SBA requirement that borrowers must be unable to obtain credit, applicants for PPP loans must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” According to SBA, borrowers must make this certification in “good faith,” taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. If a borrower that applied for a PPP loan before April 23 does not believe it can make that certification in good faith, it can repay the loan in full by May 7 and SBA will consider the certification to have been made in good faith.
- Forgiveness of a part of the PPP loan is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Employers must use at least 75% of the loan for payroll. Forgiveness will be reduced if full-time-equivalent headcount declines, or if salaries and wages are reduced by more than 25%. The unforgiven part of the loan has a maturity of 2 years and an interest rate of 1%.
- If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the applicant or the owner of the applicant becomes a debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant’s obligation to notify the lender and request cancellation of the application.
- The SBA’s affiliation rules continue to apply in most circumstances, except as described below, which usually results in majority-owned private equity portfolio companies being ineligible. Private equity firms and hedge funds themselves are not eligible for PPP loans under existing SBA regulations.
Lessons from the First Batch of PPP Loans
In the rollout of the PPP loan program, we have seen some inconsistency in how applications are being treated. In some instances, we have seen banks process and approve applications promptly. In other instances, we have seen banks be slower to approve applications, or banks delay or decline applications due to compliance with Know Your Customer regulations. It is therefore important to reach out to your key contact in any banking relationship, and it may be prudent to consider several different banks as part of the process. The initial $349 billion ran out in less than two weeks, and the second allocation of $310 billion is likely to be depleted in even less time, so time is of the essence.
CARES Act PPP Loans
The Payroll Protection Program loan program established by the CARES Act allows qualifying small businesses to obtain low-interest loans up to $10 million. The government steps in to guarantee the loan, so no collateral or personal guarantee by the owner is required. Fees also are waived. Most importantly, the law allows lenders to defer payments for up to 6 months, and the indebtedness can be forgiven for the amounts used by the small business for qualifying payroll, benefits, rent, mortgage payments, and utilities during the covered period.
The CARES Act expands the availability of SBA Section 7(a) loans in several ways.
- The law increases the size standard to 500 employees for any small business subject to a size standard lower than 500 employees.
- The law also expands access to loans for 501(c)(3) nonprofit organizations, self-employed individuals, independent contractors, and veterans organizations.
- The new law waives applicability of the SBA’s affiliation rules for small businesses in NAICS industry sector 72, which is “Accommodation and Food Services” (i.e., restaurants, bars, caterers, hotels, casino hotels, B&Bs, RV parks, campgrounds). For these businesses, the affiliation rules are waived for loans issued before June 30, 2020. In addition, for accommodations and food service businesses only, the law counts separate locations of the same business as not being affiliated if each location has fewer than 500 employees.
- The new law also exempts from the affiliation rules bona fide franchises and companies funded by licensed Small Business Investment Companies (“SBICs”) (the latter of which are already subject to different affiliation rules). The SBA issued an interim final rule clarifying that in certain circumstances, the affiliation rules are waived for faith-based nonprofits.
- For all other industries, the SBA affiliation regulations continue to apply.
The maximum loan amount is the lesser of:
(A) 2.5 times average total monthly payroll costs incurred in the one-year period before the loan is made (or for seasonal employers the average monthly payroll costs for the 12 weeks beginning on February 15, 2019, or from March 1, 2019 to June 30, 2019) (or for businesses that were not in existence during the period from February 15, 2019 to June 30, 2019, 2.5 times the average total monthly payroll payments from January 1, 2020 to February 29, 2020);
PLUS the outstanding amount of any loan made under the SBA’s Disaster Loan Program between January 31, 2020 and the date on which such loan may be refinanced as part of this new program;
(B) $10 million.
Congress directed the SBA to issue direct emergency regulations implementing the enhanced loan program within 15 days, and to issue regulations and guidance for loan forgiveness procedures within 30 days.
SBA Affiliation Rules a Potential Barrier for Some
The Payroll Protection Program likely will not be useful for most private equity majority-owned businesses other than those in the hospitality industry (NAICS Code 72) because of the SBA’s affiliation rules. By way of background, SBA has size standards to determine whether a company is a “small business concern” eligible to participate in various SBA programs.
- Size standards are assigned by the company’s primary line of business in accordance with NAICS codes. Some size standards are determined by the maximum number of employees, and some by total revenue, and the ceiling varies by industry. Under the CARES Act, and in accordance with guidance from the Treasury Department and SBA, a company can qualify as small under any of three ways:
(a) the temporary simplified size standard of no more than 500 employees (calculated per location for hospitality businesses);
(b) the existing industry-specific size standard in the SBA rules, assuming it is higher than 500 employees or based on revenue; or
(c) if the borrower has more than 500 employees, it still may qualify under the SBA’s “alternative size standard” for borrowers who (with all affiliates) are below a threshold based on net tangible worth of no more than $15 million and average net income (after Federal income taxes, but excluding any carry-over losses) for the past two years of no more than $5 million.
- Under the SBA’s affiliation regulations, any time another entity holds 50% or more of the small business’s voting equity, the companies are deemed to be affiliated, and the SBA counts the total employees or aggregate revenue of all their affiliated companies. For private equity clients with majority investments, this results in all of their portfolio companies being included in the employee census or revenue calculation, which almost always results in the size standard being exceeded. As a result, most of the time portfolio companies are not eligible for SBA programs.
- Even minority interests can result in a finding of affiliation, which is very fact specific. SBA will deem a minority shareholder to be in control if that individual or entity has the ability, under the concern’s charter, bylaws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors. SBA has provided guidance that minority owners may relinquish their control rights if they do so irrevocably. SBA also has clarified that negative control rights over certain extraordinary actions may not result in a finding of affiliation assuming no other grounds for affiliation exist.
- SBA also can find affiliation based on: (a) common management; (b) under stock options, convertible securities, and agreements to merge; or (c) based on identity of interest between close relatives. For purposes of PPP loans, certain other bases in the SBA regulations for finding affiliation are disregarded.
- Different affiliation rules apply depending on which SBA program is at issue (government contracting, disaster relief loans, research and development, minority business development, etc.) as well as for certain classes of small businesses (women owned, service disabled veteran owned, Native American or Alaskan Native American owned, those owned by a licensed Small Business Investment Company, etc.). For present purposes, we are focused solely on the rules for eligibility for Section 7(a) business development loans because that is what is provided in the CARES Act.
- SBA confirmed that the affiliation rules apply to all potential borrowers other than hotels and restaurants, franchises, businesses receiving financial assistance from an SBIC, and certain faith-based nonprofit organizations.
- Because borrowers must self-certify that they are eligible for an SBA loan after evaluating the applicable affiliation rules, it is imperative that borrowers review their particular circumstances with qualified counsel before submitting a loan application.
Section 7(b) Economic Injury Disaster Loans
The first COVID-19 response law signed into law earlier in March provides enhanced funding for loans under a separate SBA program for disaster relief under Section 7(b) of the Small Business Act. That law contains no language concerning the affiliation rules. SBA is processing applications for those loans under its normal procedures, which means the affiliation rules apply to determine if an applicant is eligible. As a result, majority-owned portfolio companies would not be eligible in most cases for disaster relief loans under that program. The new law signed on March 24 adds $10 billion to this program.
CARES Act Mid-size Business Loan Program
A separate section of the new law provides for the Treasury Department to make funds available to banks for a loan program for companies between 500 and 10,000 employees that would postpone payments for 6 months and set a maximum interest rate at 2%. This provision does not provide for loan forgiveness even if the borrower continues to pay its employees. These loans also would come with significant strings attached, including that the borrower make a good faith certification that:
- the funds it receives will be used to retain at least 90% of the recipient’s workforce, at full compensation and benefits, until September 30, 2020;
- the recipient intends to restore not less than 90% of the workforce of the recipient that existed as of February 1, 2020, and to restore all compensation and benefits to the workers of the recipient no later than 4 months after the termination date of the public health emergency;
- the recipient is an entity or business that is created, organized or domiciled in the United States with significant operations and a majority of its employees located in the United States;
- the recipient is not a debtor in a bankruptcy proceeding;
- during the term of the loan and for 12 months following repayment of the loan, the recipient will not pay dividends with respect to the common stock of the eligible business, or repurchase an equity security that is listed on a national securities exchange of the recipient or any parent company of the recipient while the direct loan is outstanding, except to the extent required under a contractual obligation that is in effect as of the date of enactment;
- the recipient will not outsource or offshore jobs for the term of the loan and 2 years after completing repayment of the loan;
- the recipient will not abrogate existing collective bargaining agreements for the term of the loan and 2 years after completing repayment of the loan and will remain neutral in any union organizing effort for the term of the loan; and
- the eligible business must agree to both a limitation on compensation increases and severance benefits for certain officers and employees.
Unlike the SBA loan program that already exists, the Treasury program outlined above for medium-sized businesses may take some time to get up and running. Separately, the Federal Reserve also has announced that it intends to launch a “Main Street Lending Program” supporting lending to small and mid-sized businesses consistent with section 13(3) of the Federal Reserve Act. Some initial details of this program have recently been announced and will be subject to a separate alert, and this may provide an opportunity for financial assistance not burdened by the SBA’s complex affiliation rules and size standards but will have some of the restrictions imposed by the CARES Act.