The Small Business Administration (“SBA”) guidance provides that PPP Loans will accrue interest at 1% and have a term of 2 years. Payments on PPP Loans are deferred for 6 months. PPP Loans are unsecured, may not be supported by guaranties, and the bank has no recourse against the owners of the borrower in the absence of fraud. At the outset, make sure the loan documents governing your PPP Loan have these terms. As of the date of this writing, the SBA has not developed loan documents for lenders to use. Consequently, the lenders will likely use their document preparation system loan documents that were not designed for PPP Loans. It is advisable to have experienced legal counsel familiar with PPP Loans review your loan documents to make sure the loan documents are consistent with the rules governing PPP Loans. In addition, make sure the loan documents reflect that all or a portion of the PPP Loan may be forgiven. We suggest making sure that there is no prepayment penalty in the loan documents as a bank may treat the forgiveness amount as a prepayment.
PPP Loans are required to be used for:
1. Payroll costs defined as (i) salary, wages, commissions, or similar compensation, with the compensation of an individual employee in excess of an annual salary of $100,000 excluded (prorated as necessary), (ii) payment for vacation, parental, family, medical, or sick leave, but not including any of the foregoing to the extent for which a credit is allowed under the Families First Coronavirus Response Act, (iii) allowance for separation or dismissal, (iv) payment of group health care benefits, including insurance premiums, (v) payment of any retirement benefit, and (vi) payment of state or local taxes assessed on the compensation of employees. PPP Loan proceeds may also be used to refinance an Economic Impact Disaster Loan (“EIDL”) obtained from the SBA between January 31, 2020, and April 3, 2020. If the EIDL was used for payroll costs, then the PPP Loan must be used to refinance the EIDL. Note that the $100,000 annual salary exclusion applies only to cash compensation and not to non-cash benefits including employer contributions to retirement plans, employer payments for group health care benefits, including insurance premiums, and employer’s payments of state and local taxes assessed on the employee’s compensation.
2. Payment of interest on mortgage obligations incurred before February 15, 2020. Mortgage obligations means a loan secured by a mortgage on real or personal property.
3. Rent payments on leases dated prior to February 15, 2020.
4. Utility payments for services which began before February 15, 2020. The CARES Act defines utility payments as electricity, gas, water, transportation, telephone, or internet access.
At least 75% of the PPP Loan proceeds must be used for payroll costs. Proceeds used to refinance an EIDL count towards this 75% requirement.
PPP Loans are also subject to forgiveness. The borrower will have to apply to its lender for loan forgiveness. The amount of loan forgiveness can be up to the full principal amount of the PPP Loan and any accrued interest. The amount of loan forgiveness will depend on the amount of payroll costs (determined as described above), interest on mortgage loans incurred before February 15, 2020, rent payments on leases dated prior to February 15, 2020, and utility payments, all made during an 8 week period commencing on the date of the first disbursement of proceeds of the PPP Loan to the borrower. However, the SBA rules provide that not more than 25% of the loan forgiveness amount may be attributable to non-payroll costs. Consequently, the borrower should use as much of the PPP Loan proceeds as possible to pay payroll costs. While the SBA has issued guidance to lenders that PPP Loans should be funded within 10 days after application, it may be possible to work with your lender to “time” the first disbursement of the PPP Loan within this 10 day window to maximize the number of pay periods included in the 8 week forgiveness period.
The PPP Loan Forgiveness amount may be reduced by a reduction in the number of full-time equivalent employees or a reduction in wages by more than 25% of any employee who makes less than $100,000 in a year. The borrower can reduce, or negate entirely, the impact of a reduction in the number of eligible full-time equivalent employees by re-hiring or replacing furloughed or laid off employees by June 30, 2020. In addition, a borrower can negate the impact of the wage reduction prong by only reducing the wages of employees making in excess of $100,000 per year or reducing the wages of other employees by less than 25%.
The important take away from all this is that borrowers should use PPP Loan proceeds for payroll costs first, and then to the other allowable uses set forth above. Because the proceeds of PPP Loans are to be used for specific purposes, the Borrower must document those uses to maximize the forgiveness amount. The lender may allow the borrower to treat the PPP Loan as a non-revolving line of credit. In this case, the borrower will only take advances when the funds are needed. We suggest borrowers deposit the PPP Loan proceeds as disbursed into a separate, segregated account and not commingle them with the borrower’s general funds. This way, the borrower will have bank records, such as statements and cancelled checks, which can be used to trace each use of the funds for the required purposes and to evidence the uses that will maximize the loan forgiveness amount. It may also be wise to keep a log or other record that shows the date, amount, and use of each expenditure of PPP Loan proceeds. For example, a borrower may take a PPP Loan advance on the day before a payroll date and transfer the PPP Loan funds from the segregated account to the borrower’s payroll account. The bank would have a record of the disbursement and transfer and a log would help the borrower know exactly how each advance on the PPP Loan was used. The borrower could include copies of payroll records, invoices (i.e. rent or utility statements), and bank records in the log so that all the supporting documentation is in one place and ready to be submitted to the lender when the application for loan forgiveness is made.
The SBA indicates that it will issue additional guidance on loan forgiveness, so these rules could change. Borrowers should keep in close contact with counsel and their bank to make sure they understand any changes that could impact the amount of loan forgiveness they receive. The additional guidance may include what documentation a borrower will have to submit to the lender to justify its calculation of the loan forgiveness amount for which the borrower applies. The CARES Act itself provides that in an application for loan forgiveness, the borrower will have to submit documentation:
1. Verifying the number of full-time equivalent employees on payroll and pay rates for the 8 week forgiveness period and for the period, at the borrower’s election, of either starting on February 15, 2019, and ending June 30, 2019, or starting on January 1, 2020, ending February 29, 2020. This documentation would include payroll tax filing reports to the IRS and state and local income, payroll, and unemployment insurance filings.
2. Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on mortgage obligations, leases, and utilities.
3. A certification from the borrower that the information presented is true and correct and that the forgiveness amount was used to retain employees, make interest payments on mortgage obligations, make rent payments, or make utility payments.
The Banking and Finance attorneys at Dvorak Law Group have the knowledge and experience to efficiently assist our clients with financing needs. Please contact Dvorak Law Group for specific questions and recommendations regarding how PPP Loans may assist your business and with help in the use and loan forgiveness application process.
Read other articles related to COVID-19 here.