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Paycheck Protection Program Reforms Give Borrowers More Time to Use Funds and Make it Easier to Have Loans Forgiven

Client Updates

On June 5, 2020, President Trump signed into law House Resolution 7010, known as the “Paycheck Protection Flexibility Act of 2020,” which was previously passed by the U.S. Senate and the U.S. House of Representatives.

Congress created the Paycheck Protection Program (the “PPP”) under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) through the Small Business Administration (the “SBA”) to provide forgivable loans to eligible small businesses facing economic hardship to retain U.S. employees on their payroll during the COVID-19 pandemic.This alert summarizes the changes to the PPP, and supplements prior guidance regarding the PPP, which we discussed in prior alerts, and which can be found on our COVID-19 crisis response group website here.

The new law makes significant changes to the PPP, in response to developments in the business climate during the COVID-19 crisis after the CARES Act was originally signed into law: (i) negative economic effects of the COVID-19 crisis on businesses will extend beyond June 30, 2020, the original expiration date of the PPP, (ii) businesses have been subject to government restrictions such as shelter-in-place orders that have forced them to close, kept them from opening or operating at full capacity and fully staffing employees for a longer period than originally anticipated, and (iii) many businesses have not be able to return operations and business activity to pre-crisis levels, but still have fixed expenses including rent, mortgages, and utility payments that have contributed to a cash drain on business owners, resulting in their continuing need for government support and delaying opportunities to restore job opportunities for former employees.

With these factors as background, the new law changes the PPP in the following ways:

  • Extends the PPP to December 31, 2020 from June 30,2020;

  • Extends the covered period during which the borrower must spend the PPP loan funds to qualify for forgiveness to 24 weeks from eight weeks;

  • Raises the cap on uses of forgivable PPP funds for non-payroll costs to 40% from 25% and adds a minimum threshold for payroll costs, requiring borrowers to spend at least 60% of the forgiveness amount on payroll costs;

  • Extends the deadline for borrowers to restore levels of employee headcount and compensation to December 31, 2020 from June 30, 2020;

  • Adds a forgiveness exemption for borrowers who reduced full-time equivalent employees if the borrower was unable to rehire or return to the same level of business activity as before the COVID-19 crisis;

  • Extends the payment deferral period from 6 months to the date the SBA remits the forgiveness amount to the lender;

  • Allows PPP borrowers with forgiven loans to also defer payroll taxes; and

  • Extends the maturity date of new PPP loans that are not forgiven to 5 years from 2 years.

Paycheck Protection Program is extended through December 31, 2020

Prior to the new law, under the CARES Act, the PPP was originally set to run through June 30, 2020. In an acknowledgment that the negative economic effects of the COVID-19 crisis will continue beyond that original time period, the PPP is now extended until the end of 2020, effectively allowing businesses to take out a loan under the program until that time.

Covered period during which the borrower is required to spend the loan funds and have the loan eligible for forgiveness is extended to 24 weeks

Prior to the new law, PPP loan recipients could have their loans forgiven if the funds were used for eligible expenses over the eight-week covered period commencing when the loan was originally disbursed. However, many businesses have needed more time to incur forgivable expenses as operations are restored and business activity gradually returns. Accordingly, the covered period during which PPP funds must be spent to qualify for forgiveness has increased from eight weeks to 24 weeks or December 31, 2020, whichever is earlier. Existing borrowers can elect an eight-week covered period, which may preserve their plans for spending the PPP loan funds and seeking forgiveness on the earlier time frame.

The cap requiring borrowers to limit eligible non-payroll costs to 25% of the amount forgiven is raised to 40%, and a minimum threshold requires borrowers to spend at least 60% of the forgiveness amount on payroll costs

The CARES Act provides that PPP funds are forgivable if used for payroll costs, interest on mortgage obligations, rent or utility payments. Prior to the new law, SBA and Treasury regulations further required PPP borrowers to spend no more than 25% of the forgivable amount of PPP loan funds on those non-payroll costs. Relatedly, at least 75% of the funds were required to be used for payroll costs to achieve 100% forgiveness of the loan. The amount of forgiveness was subject to proportional reduction if the percentage of eligible expenses attributed to non¬payroll expenses exceeded 25% of the loan. In light of continued expense drains while businesses have been closed or operating at limited capacity, the new law raises the limit of the forgiveness amount of the loan to be used for non-payroll costs to 40% from 25%, increasing flexibility for borrowers in maintaining employee levels and sustaining operations. Notably, the new law expressly provides that to receive loan forgiveness, the borrower must use at least 60% of the covered loan amount for payroll costs, which acts as a cliff. As a result, PPP borrowers are required to use at least 60% of the forgiveness amount of the PPP loan to pay for payroll costs, or none of the loan will be forgivable. Under the previous regulations, a borrower who did not meet the 75% threshold would still have a portion of its loan forgiven - forgiveness would be proportionally reduced in accordance with the 75%/25% rule. Co-sponsors of the bill in the House of Representatives have stated that the new law was intended to retain proportional reduction, and members of the Senate have indicated that changes should be made to restore proportional reduction and have asked the SBA to do so in its regulations. The Senate may also make technical corrections to the law through additional legislation to restore proportional reduction.

Deadline to restore levels of employee headcount and compensation extended to December 31, 2020

Under previous SBA and Treasury regulations, forgiveness of PPP loans was subject to reduction to the extent, during the covered period following the making of the loan, (i) employee headcount decreased compared to a base period or (ii) compensation decreased by more than 25% for each employee making less than $100,000 relative to the first quarter of 2020, unless the reduced headcount or compensation levels were restored by June 30, 2020. To give borrowers more time to return to more normal capacity and staffing, the new law extends the deadline to restore levels of employee headcount and compensation to December 31, 2020.

Borrowers are exempt from loss of forgiveness for reduction of full-time equivalent employees if borrower is unable to rehire or return to the same level of business activity as before the COVID-19 crisis

In a new part of forgiveness calculations, the amount of loan forgiveness will not be reduced when a borrower has had a reduction in the number of full-time equivalent employees if the borrower in good faith is able to document:

  • an inability to rehire individuals who were employees of the borrower on February 15th,

  • an inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020, or

  • an inability to return to pre-February 15th level of business activity due to compliance with requirements established or guidance issued 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 during the period beginning on March 1, 2020, and ending December 31, 2020, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID– 19.

The first two prongs of this exemption help businesses which are unable to rehire the same or similarly qualified individuals for an unfilled position (which could include employees not being able to return to work because of family care requirements). The final prong of the exemption notably provides that if borrowers are not able to reopen and return to their pre-crisis level of operations due to government restrictions or requirements, any corresponding reductions in full-time equivalents will not count against them.

The payment deferral period is extended to the date SBA remits the forgiveness amount to the lender

Prior to the new law, under the CARES Act, principal and interest payments on a PPP loan were deferred for at least six months and not more than a year. Later SBA and Treasury regulations set the deferral period at six months. In light of continued limits on businesses’ cash flow, the new law extends the payment deferral period to either (i) the date the SBA sends the forgiveness amount to the lender, which may well be longer than 6 months from the time the loan as made or (ii) if the borrower does not apply for forgiveness, the date that is 10 months after the end of the covered period (i.e., 10 months after the earlier of (A) 24 weeks after the loan is disbursed or (B) December 31, 2020). In effect, this relieves borrowers from making principal and interest payments for loans eligible for full forgiveness and further extends the requirement to make payments for those loans for which borrowers do not apply for forgiveness.

PPP borrowers with forgiven loans may also defer payroll taxes

Employers generally are responsible for paying a 6.2% social security tax on employee wages, up to a specified wage cap ($137,700 of wages for 2020). Self-employed persons are subject to a corresponding Social Security component of self-employment tax. The CARES Act generally allows employers to defer payment of the employer’s share of social security tax which the employer otherwise is required to pay for the period beginning on March 27, 2020 and ending on December 31, 2020 and, instead, pay such deferred social security tax (without interest or penalty) over the following two years, with half of the amount required to be paid by December 31, 2021 and the other half by December 31, 2022. A similar deferral applies to 50% of the social security portion of the self-employment tax otherwise required to be paid by self-employed individuals for the period beginning on March 27, 2020 and ending on December 31, 2020. However, prior to the new law, the CARES Act provided that employers who have PPP loans forgiven would not qualify for this deferral. In response to the continued constriction on cash and the need to focus cash on restoring business activity levels and retaining or replacing employees, the new law changes the payroll tax deferral to allow borrowers who have PPP loans forgiven to also qualify for this deferral.

Borrowers with new PPP loans that are not forgiven have five years to repay

The CARES Act provides that PPP loans have a maximum maturity of 10 years. Later SBA and Treasury regulations specified that PPP loans that were not forgiven had a two-year term. In a significant move that provides credit relief for an extended period, the new law extends the term for new PPP loans to a minimum of five years. Existing PPP loans continue to have a two-year term, but borrowers and lenders may renegotiate the terms of any existing PPP loan to match the newly permitted five-year maturity.

Borrowers receive significant relief, but new questions arise

The reforms to the PPP provide borrowers significant relief. However, the new law raises new questions, including:

  • If a borrower does not use at least 60% of the forgiveness amount of the PPP loan to pay payroll, none of the loan will be forgiven. Under the previous regulations, a borrower who did not meet the 75% threshold would still have a portion of its loan forgiven - forgiveness would be proportionally reduced in accordance with the 75%/25% rule. Will additional regulations or legislation be passed to retain proportional reduction where borrowers do not meet the minimum threshold for payroll costs?

  • If the new law is changed to permit proportional reduction, will guidance be provided to determine how to calculate what proportion of a borrower’s payroll costs and non-payroll costs are forgivable based on the requirement that a borrower must use 60% of the covered loan for payroll and may use 40% of the covered loan for nonpayroll costs?

  • If the covered period has been extended to 24 weeks, when is the borrower eligible to apply for forgiveness? Can it apply as soon as it spends the funds or does it need to wait until the end of the entire extended period?

  • Currently, the limit of cash compensation per employee is $15,385 for the existing eight-week covered period to qualify for forgiveness. Given the increase in covered period to 24 weeks, will the individual employee cash compensation cap increase in proportion, to $46,153?

  • When documenting an inability to return to the same level of business activity as before February 15, 2020, how is “business activity” defined?

Certain Risks Remain

While the new law provides borrowers with welcome and needed flexibility, it is not a free pass when it comes to litigation and regulatory risk. Borrowers still must carefully ensure the accuracy of all statements and certifications made to the government in connection with the program. They must also ensure that PPP funds are used only as authorized—i.e., on payroll, group healthcare benefits, certain mortgage interest and other interest payments, rent, or utility payments.

The government has already been, and is expected to continue to be, aggressive in pursuing individuals and companies who make false statements or misuse PPP funds. In the past several weeks, the Department of Justice (“DOJ”) has brought at least six criminal cases against individuals alleged to have made false statements in the PPP loan application or misused such funds, all of which it publicly announced through press releases on DOJ’s main website. While some of these cases involve fairly egregious conduct, such as claiming fictious payroll expenses or spending PPP funds on luxury cars, the speed at which DOJ has moved indicates it is keeping a close watch on the PPP program. In addition, as we have previously discussed, private plaintiffs or the government may seek to bring civil False Claims Act actions based on alleged false statements in connection with the PPP. Finally, it has also been publicly reported that SEC has been making inquiries of PPP recipients, presumably investigating whether a company’s PPP application raises questions about the adequacy of company’s prior disclosures to investors regarding its financial condition. We do not expect any of this activity to materially recede with the new law.

Each of the amendments to the PPP are retroactive as if included in the original CARES Act. The only exception is the increase to the minimum term for loans from two years to five years, which applies only to new PPP loans (but does not prohibit lenders and borrowers from renegotiating existing loans).

 

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