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Treasury Issues Updated Guidance on CARES Act’s Paycheck Protection Program

Client Updates

On Thursday, April 2, 2020, the Treasury Department and the Small Business Administration (the “SBA”) issued an updated version of the Paycheck Protection Program (the “PPP”) application and issued an interim final rule (the “Initial Rule”) referencing its “Business Loan Program Temporary Changes; Paycheck Protection Program,” which provides formal guidance on key provisions of the SBA’s implementation of sections 1102 and 1106 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and requests public comment. The updated PPP application is available here. The full text of the interim final rule is available here.

On Friday, April 3, 2020, the Treasury Department and the SBA issued another interim final rule (the “Affiliation Rule”) clarifying that less restrictive affiliation rules apply to the PPP and exempting religious organizations from PPP affiliation rules. This interim final rule supplements the Initial Rule with additional guidance and requests public comment. Both interim final rules are immediately effective without advance notice and public comment. The full text of the Affiliation Rule is available here.

The PPP authorizes loans to businesses for payroll costs and other approved expenses. Subject to certain restrictions, the funds available under the PPP are forgivable. See our prior client alert on the CARES Act (which includes an overview of the PPP) here and our client alert on previous Treasury Department implementation guidance regarding the PPP and the PPP application here.

Summarized below are the Affiliation Rule, amendments to the PPP application, and new issues found in the Initial Rule.

PPP Affiliation Rules:

The Affiliation Rule clarified that the standard SBA determination of affiliation is not applicable to the PPP, rather that a narrower set of affiliations principles are applicable because the PPP is considered a “financial assistance program.” To be eligible for a PPP loan, an applicant, combined with its affiliates, must have 500 or fewer employees whose principal place of residence is in the United States or must be a business that operates in a certain industry and meets applicable SBA employee-based size standards for that industry, among other requirements. For purposes of determining the number of employees of an applicant, the employees of the applicant are considered together with the employees of its affiliates. Therefore, affiliation rules are critical for many applicants intending to participate in the PPP. Treasury Department guidance providing greater detail about affiliation rules applicable to the PPP is outlined below.

Affiliation is determined by control. Concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or multiple third parties control or have the power to control both. Whether control is exercised is inconsequential, so long as the power to control exists. Four tests for affiliation apply to applicants of the PPP; a finding of affiliation under any of the four tests is sufficient to establish affiliation for the PPP.

1) Affiliation Based on Ownership

  • Generally – For determining affiliation based on equity ownership, a concern is an affiliate of an individual, concern, or entity that owns or has the power to control more than 50% of the concern’s voting equity.

  • Managers – If no individual, concern, or entity is found to control, the board of directors, president, CEO, or other officers, managing members, or partners who control the management of the concern will be deemed by the SBA to be in control.

  • Minority Shareholders – A minority shareholder will be deemed by the SBA to be in control if it has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.1

2) Affiliation Arising Under Stock Options, Convertible Securities, and Agreements to Merge

  • Generally – Stock options, convertible securities, and agreements to merge (including agreements in principle) are considered to have a present effect on the power to control a concern. In other words, such options, convertible securities, and agreements are treated as if the rights granted by those instruments have been exercised.

  • Preliminary Agreements – Agreements to open or continue negotiations towards the possibility of a merger or sale of stock at some later date are not considered “agreements in principle” and are not given present effect.

  • Conditions Precedent and Probability Considerations – Options, convertible securities, and agreements that are subject to conditions precedent, which are incapable of fulfillment, speculative, conjectural, or unenforceable under state or federal law, or where the probability of the transaction or exercise of rights occurring is shown to be extremely remote, are also not given present effect.

  • Divestiture of Ownership Interest – An individual, concern, or other entity that controls one or more other concerns cannot use options, convertible securities, or agreements to appear to terminate such control before actually doing so. Present effect will not be given to individuals’, concerns’, or other entities’ ability to divest all or part of their ownership interest in order to avoid a finding of affiliation.

3) Affiliation Based on Management

  • Generally – Affiliation is found if the CEO, president, or other officers, managing members, or partners who control the management of the applicant also control the management of one or more other concerns.

  • Control of Managers – Affiliation arises if a single individual, concern, or entity that controls the board of directors or management of one concern also controls the board of directors or management of one or more other concerns.

  • Management Agreement – Affiliation is also found if a single individual, concern, or entity controls the management of a concern through a management agreement.

4) Affiliation Based on Identity of Interest

  • Generally – Affiliation exists if there is an identity of interest between close relatives2 with identical or substantially identical business or economic interests, such as where the close relatives operate concerns in the same or similar industry in the same geographic area.

  • Rebuttal – If the SBA determines that interests should be aggregated, applicants may rebut that determination by providing evidence showing that the interests deemed to be one are in fact separate.

5) Religious Exemption

  • Generally – Affiliation rules do not apply to the relationship of any faith-based organization with any other person, group, organization, or entity that is based on a sincere religious teaching or belief or otherwise constitutes a part of the exercise of religion.

  • Reliance – A faith-based organization may rely on a reasonable, good faith interpretation in determining whether its relationship to any other person, group, organization, or entity is exempt from affiliation rules. The SBA will not assess and will not require participating lenders to assess the reasonableness of the faith-based organization’s determination.

6) Waiver of Affiliation Rules

  • Generally – Affiliation rules are waived for any business concern (i) operating in the hotel and food services industries, (ii) operating as a franchise listed in the SBA’s Franchise Directory, and (iii) receiving financial assistance from small business investment companies licensed by the SBA.

Amendments to the PPP Application:

Many amendments to the PPP application are relatively minor and provide for greater precision and clarity. Certain more substantive and procedural changes are as follows:

  • Signatories – Owners of 20% or more of the equity of the applicant no longer need to certify or sign the application. An authorized representative is sufficient but will have to answer questions and certify statements on behalf of the applicant and owners.

  • Loan Calculation Formula – The loan calculation formula now includes Economic Injury Disaster Loan (“EIDL”) amounts, net EIDL advances, in addition to the 2.5 x average monthly payroll.

  • Criminal History Disqualification – Grounds for disqualification based on criminal history of the applicant or any owner of the applicant have been changed from any felony or misdemeanor for a crime against a minor within the last seven years to any felony within the last five years.

  • Additional Eligibility Certifications – The applicant is required to certify four additional statements regarding its eligibility to receive a PPP loan:

    • That the applicant is eligible to receive the loan under the rules of the PPP in effect at the time the application is submitted;

    • That the applicant is (i) an independent contractor, eligible self-employed individual, or sole proprietor or (ii) employs no more than the greater of 500 employees or, if applicable, the size standard in number of employees established by the SBA for the applicant’s industry;

    • That any EIDL loan received by the applicant between January 31, 2020 and April 3, 2020 was for a purpose other than paying payroll costs and other allowable uses under the PPP Rule.

      • Note: This certification may be revised in the future as it conflicts with the guidelines regarding the interaction between EIDL loans and PPP loans set forth in the interim final rule.

    • That the applicant was in operation on February 15, 2020 and had employees for whom it paid salaries and payroll taxes or paid independent contractors.

  • Illegality of Unauthorized Uses of Funds – The certification requiring the applicant to acknowledge the illegality of unauthorized uses of funds now has a knowledge qualifier and refers to legal liability rather than just criminal fraud in particular. It now states, “I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable.”

  • Accuracy of Information – The certification that all information provided is true and accurate now has a materiality qualifier and requires that all information provided is true and accurate in all material respects.

  • Questions – The citizenship status question has been removed, and two questions have been added regarding whether the United States is the principal place of residence for all employees of the applicant included in the payroll calculation and whether the applicant is a franchise listed in the SBA’s Franchise Directory.

  • Form Instructions – Details as to what constitutes payroll costs have been added to the instructions to the form.

The Initial Rule:

The Initial Rule provides additional implementation guidelines and requirements for the PPP. Additional guidance to, and modifications of, prior Treasury Department implementation guidelines and sections 1102 and 1106 of the CARES Act are summarized below.

  • Ineligibility Standards – Applicants are ineligible for a PPP loan if:

    • The applicant is engaged in any activity that is illegal under federal, state, or local law.

    • The applicant is a household employer (individuals who employ household employees, such as nannies or housekeepers).

    • An owner of 20% or more of the equity of the applicant is incarcerated, on probation, or on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years.

    • The applicant, or any business owned or controlled by the applicant or any of its owners, has ever obtained a direct or guaranteed loan from the SBA or any other federal agency that is currently delinquent or has defaulted within the last seven years, causing a loss to the government.

  • Independent Contractors Exclusions – Independent contractors do not count as employees for purposes of a borrower’s PPP loan calculation and loan forgiveness.

  • Interest Rate – The interest rate is now fixed at 1% for all PPP loans.

  • EIDL Loan Interaction – If an applicant received an SBA EIDL loan from January 31, 2020 through April 3, 2020, the applicant can still apply for a PPP loan. If the EIDL loan was not used for payroll costs, it does not affect eligibility for a PPP loan. If the EIDL loan was used for payroll costs, the PPP loan must be used to refinance the EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.

  • Payroll v. Non-Payroll Loan Uses and Forgiveness – Not more than 25% of loan proceeds may be used for non-payroll costs, and not more than 25% of the loan forgiveness amount may be attributed to non-payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included.

  • Maximum Forgiveness Amount – The amount of loan forgiveness can be up to the full principal amount of the loan and any accrued interest.

  • Misuse of PPP Loan Funds – If the applicant uses PPP funds for unauthorized purposes, it will be required to repay those amounts. If the applicant knowingly uses funds for unauthorized purposes, it will be subject to additional liability, such as charges for fraud. If one of the applicant’s shareholders, members, or partners uses PPP funds for unauthorized purposes, the SBA will have recourse against the shareholder, member, or partner for the unauthorized use.

1Note that the standard for determining affiliation for majority voting stockholders is an “irrebuttable presumption”, which differs from the “rebuttable presumption” for management and minority interest holders.
2
A close relative is a spouse, parent, child, sibling, or the spouse of any such person.

 

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