COVID-19: Understanding the Paycheck Protection Loan Program and Expansion of the Emergency Economic Injury Disaster Loan Programs Under the CARES Act

• Mick Bain
• 3.30.2020

On Friday, March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) became law. The CARES Act is an emergency stimulus package intended to provide financial and other assistance and relief to individuals, businesses and certain industries particularly affected by the ongoing COVID-19 pandemic. For small businesses and certain other eligible recipients, the CARES Act will make available, through the Keeping American Workers Paid and Employed Act, $349 billion in Paycheck Protection Loans and an additional $10 billion for relief under an expanded version of the economic injury disaster loan program (EIDL Program).

Paycheck Protection Loan Program

Through an expansion of the existing Small Business Administration’s (SBA) 7(a) small business loan guaranty program (7(a) Program), Paycheck Protection Loans will be made available to small businesses and other eligible recipients for the purpose of paying payroll costs, utilities, rents and certain existing debt service payments and will be 100% guaranteed by the US government. A portion of the Paycheck Protection Loan may be forgiven. Businesses that wish to obtain a Paycheck Protection Loan will need to confirm that they are a small business or other eligible recipient, use the proceeds for only authorized purposes and, assuming they wish to take advantage of loan forgiveness, determine how much of the Paycheck Protection Loan will be forgivable. Paycheck Protection Loans will be made by participating lending institutions approved by the SBA.

Paycheck Protection Loan Amount. The actual amount of any Paycheck Protection Loan (subject to a $10 million cap) will be determined by a formula based on the business’s average monthly Payroll Costs (defined below) during the 12-month period before the loan is made (adjusted for seasonal employees) multiplied by 2.5, plus the amount of any EIDL Loan (defined below) made after January 31, 2020 that is refinanced with the Paycheck Protection Loan. For businesses formed between February 1 and June 30, 2019, there is an alternative formula. Notably, these calculations are made after excluding any compensation paid to any individual in excess of an annual salary of $100,000, as prorated for the covered period.

Use of Paycheck Protection Loan Proceeds. Paycheck Protection Loan proceeds are to be used for Payroll Costs (as defined below), mortgage interest (but not principal) payments and rent payments, utility payments, and interest (but not principal) payments on debt obligations incurred before February 15, 2020, as well as other uses currently allowed under the 7(a) Program.¹

Payroll Costs: The loan proceeds can be used for employee compensation, consisting of the following (Payroll Costs):

• salary, wage, commission or similar compensation (subject to a limit of $100,000 in wages paid per year (prorated for the covered period) for wages and salary paid to any employee and for payments to any independent contractor),
• a cash tip or equivalent,
• payment for vacation or parental, family, medical or sick leave,
• allowance for dismissal or separation, and
• payments for group healthcare benefits (including insurance premiums), retirement benefits, and state and local taxes assessed on employee compensation (prorated for the covered period) consisting of permitted wages, commissions, income, and net earnings from self-employment of sole proprietors or independent contractors.

In addition to the $100,000 limit referenced above, Payroll Costs do not include income tax withholding for wages, any compensation to any employee whose principal residence is not in the United States, and qualified sick leave wages or qualified family leave wages for which a credit is allowed under the Families First Coronavirus Response Act.

Paycheck Protection Loan Eligibility. Under the Paycheck Protection Loan program, eligible recipients include:

• any business that meets the applicable small business size standard for the North American Industry Classification System (NAICS) industry code in which it operates,²
• individuals who operate under a sole proprietorship or as an independent contractor, or eligible self-employed individuals,
• any other business, nonprofit organization, veteran organization or tribal business with 500 employees or fewer, or a higher employee head count for the industry as based on the entity’s NAICS code, if applicable, and
• accommodation and food service businesses with more than 500 employees, but no more than 500 employees per physical location.

For recipients where eligibility is based on employee head count, the employee number includes any individual employed on a full-time, part-time or other basis. Under the SBA’s affiliation rules, when assessing eligibility, the employee head count or average annual receipts must include all of the entity’s foreign and domestic affiliates that have control or the power to control the business (including negative control, such as the ability to prevent a quorum or otherwise block action by the board of directors or shareholders) or that are under or potentially under common control with the business, with exceptions for investor rights that are customary minority shareholder protections. Notably, the CARES Act waives the affiliation rules for accommodation and food service businesses in NAICS sector 72, franchises that are approved on the SBA’s Franchise Directory and small businesses that receive financing through the Small Business Investment Company (SBIC) program.

Implication of Affiliation Rules on Venture Capital and Private Equity-Backed Companies. For venture-backed and private equity-backed companies, the affiliate attribution rules may include as affiliates the venture capital or private equity fund, as well as the other portfolio companies controlled by the fund. Whether a venture capital or private equity-backed company is affiliated with a fund or a fund’s other portfolio companies will depend on the particular facts and circumstances of the entities involved, including the company’s equity ownership structure; composition of its board of directors; contractual, voting and other rights of the investors; and any ownership and control rights the company, its investors or management may have in other companies. The existing affiliation attribution rules are described here. Because the existing affiliation rules may result in a significant number of otherwise eligible businesses being unable to access Paycheck Protection Loans, lawmakers and trade associations are currently requesting that the Trump Administration reinterpret or change these rules as they relate to venture- and private equity-backed companies.

Other Requirements to Obtain a Paycheck Protection Loan. For Paycheck Protection Loans, the CARES Act waives the collateral and personal guarantee requirements and the requirement that recipients be unable to obtain credit elsewhere. However, eligible businesses will be required to make the following good faith certifications:

• that the uncertainty of the current economic conditions makes the loan necessary to support ongoing operations,
• that the funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments or utility payments, and
• that it has not received a loan between February 15, 2020 and December 31, 2020 and does not have any other application pending for a loan for the same purpose.

Paycheck Protection Loan Terms. The key economic terms of Paycheck Protection Loans are:

Interest Rate: The maximum interest rate on Paycheck Protection Loans will be 4%, and there will be no prepayment fee.

Fees: Borrower and lender fees in connection with participation in the Paycheck Protection Loan Program will be waived. There will be a cap on fees to agents that assist borrowers in loan preparation.

Principal and Interest Payments: Payment of principal, interest and fees will be deferred for six months and may be further deferred for up to one year.

Repayment: The maximum term of a Paycheck Protection Loan will be 10 years from the date on which the borrower applied for the loan.

Loan Forgiveness. Borrowers may apply to their lender for forgiveness of Paycheck Protection Loans. The amount that may be forgiven will be equal to amounts from the loan used by the borrower during the eight-week period beginning on the date the loan is initially funded for the following:

• Payroll Costs,
• mortgage interest payments,
• rent payments, and
• utility payments.

The amount forgiven may not exceed the principal amount of the loan and will be reduced:

• proportionately for any reduction in employees (by full-time equivalent) during the eight-week period following initial funding of the loan as compared to the average number of employees per month during the period of either (i) February 15, 2019 to June 30, 2019, or (ii) January 1, 2020 to February 29, 2020 (with adjustments for seasonal employers), and/or
• by the amount of any reduction in total salary or total wages for employees who earned less than $100,000 in wages or salary during 2019 (with certain exceptions for rehired employees) during the eight-week period following initial funding of the loan, if such reduction is in excess of 25%.

Borrowers that rehire employees will not be penalized for having a reduced payroll. Specifically, the amount of loan forgiveness will not be reduced as a result of a reduction in employees or in wages and salaries that occurs between February 15, 2020 and 30 days after the enactment of the CARES Act, if the reduction is reversed by June 30, 2020.

Any amounts forgiven under a Paycheck Protection Loan will be excluded from income for tax purposes. However, taking advantage of forgiveness under the Paycheck Protection Loan Program may disqualify an employer from the payroll tax deferral benefit under the CARES Act, and receipt of a Paycheck Protection Loan is an alternative to the wage credit available under the CARES Act for businesses experiencing a closure related to COVID-19.

Economic Injury Disaster Loan Program Expansion

The CARES Act also expands the SBA’s existing EIDL Program by relaxing the eligibility requirements under the program and increasing the funding available through December 31, 2020. Under the EIDL Program, the SBA offers loans (EIDL Loans) of up to $2 million for small businesses to recover from temporary losses following a statewide economic injury declaration, including losses they are experiencing due to the COVID-19 outbreak. EIDL Loans are not forgivable and are available to pay fixed debts, payroll, accounts payable and other bills that cannot be otherwise paid. Until December 31, 2020, the key provisions of the EIDL Program will be changed in the following ways:

EIDL Eligibility. The eligibility requirements will be relaxed. Specifically, in addition to small businesses, entities eligible for an EIDL loan will be expanded to include:

• private nonprofit organizations,
• small agricultural cooperatives,
• sole proprietorships, with or without employees, and independent contractors, and
• any business, cooperative, employee stock ownership plan or tribal small business with not more than 500 employees.³

Eligible businesses will be permitted to apply for an EIDL Loan if the business was in existence on January 31, 2020 and has suffered substantial economic injury as a direct result of COVID-19.

The following requirements will be waived: (i) the personal guarantee for loans of not more than $200,000, (ii) that the business be in operation for at least a year prior to the COVID-19 outbreak and (iii) that the business or its affiliates be unable to obtain credit elsewhere.

Use of EIDL Loan Proceeds. EIDL Loan proceeds can only be used for certain purposes. Prior to the CARES Act, EIDL Loans could be used for working capital necessary until resumption of normal operations and expenditures necessary to alleviate economic injury, but not beyond that which the business could have provided had the injury not occurred. The CARES Act expands these uses to include paying sick leave to employees unable to work due to the direct effect of COVID-19; maintaining payroll to retain employees; meeting increased costs to obtain materials unavailable from the business’s original source because of supply chain issues, rent or mortgage payments; and repaying certain obligations that cannot be met due to revenue losses.

EIDL Loan Interest Rate. The maximum interest rate for EIDL Loans is 4%. However, for small businesses impacted by COVID-19, the interest rate will be 3.75% and for nonprofit organizations impacted by COVID-19, the interest rate will be 2.75%.

EIDL Grants. The CARES Act appropriates $10 billion for emergency EIDL Grants (as defined below). While a business’s application for an EIDL Loan is pending, the applicant may apply for a grant of up to $10,000 (EIDL Grant), which shall be paid within three days of application. Awarded EIDL Grants will not need to be repaid, even if the business’s application for an EIDL Loan is denied.

Interplay of EIDL with Paycheck Protection Program Loans. If a borrower has received an EIDL Loan unrelated to the COVID-19 outbreak, it may apply for a Paycheck Protection Loan due to COVID-19. Borrowers that have received an EIDL Loan in connection with the COVID-19 outbreak may not receive a Paycheck Protection Loan for the same purpose, but they may refinance their existing EIDL Loan with a Paycheck Protection Loan if they meet the eligibility requirements. EIDL Grants awarded under the EIDL Program would be subtracted from amounts ultimately forgiven under the Paycheck Protection Loan Program.

WHAT TO DO NOW

Any business that believes it could potentially benefit from the relief offered by the CARES Act should take steps now to prepare.

1. Determine eligibility. To determine eligibility, a potential applicant must first consider whether it falls within the definition of “small business concern” based on the head count or annual receipts thresholds for the entity’s NAICS code. If not eligible as a small business, an entity may still be eligible based on its employee head count. These eligibility assessments must include foreign and domestic affiliates except where waived for Paycheck Protection Loan applicants in the accommodation and food service industry, certain franchises, and recipients of SBIC financial assistance. In addition to determining whether your business falls within the eligibility criteria, confirm that you will be able to make the necessary certifications.
2. Select a lender. For purposes of the Paycheck Protection Loan Program, you will apply through an approved third-party lender. You should talk with your existing bank and/or lender to determine whether they are participating in the Paycheck Protection Loan Program. If not, you may find a participating lender by using the SBA’s online Lender Match tool available at https://www.sba.gov/funding-programs/loans/lender-match. For purposes of the EIDL Program, you will apply directly to the SBA.
3. Prepare information. Prepare the financial and other information you will need to submit your loan application, including documentation needed to determine the amount of your loan.
4. Determine what to apply for. Given the forgiveness feature of a Paycheck Protection Loan, any business that is seeking relief should consider applying for such a loan. While working through the possibility of applying for, and receiving, a Paycheck Protection Loan, also consider whether to apply for an EIDL Loan and/or EIDL Grant, which could be refinanced by a subsequent Paycheck Protection Loan.
5. Consider other programs. If your business does not qualify for these SBA programs or you are seeking different relief, you might consider:
   • The Main Street Business Lending Program. This is a separate program expected to be administered by the Federal Reserve that is aimed at helping small- and medium-sized business. The CARES Act mentions the program only to underscore that nothing in the CARES Act is meant to limit the discretion of the Federal Reserve to establish such a program, and that the Secretary of the Treasury may or may not use funds from the CARES Act to fund the program. More information is expected from the Federal Reserve soon. Depending on the details of this program, this could be one of the more important programs for small- and medium-sized businesses.
   • Tax Credit. Another alternative to the Paycheck Protection Loan Program is a refundable tax credit made available under the CARES Act for a portion of wages paid by a business that is experiencing a closure related to COVID-19. For more information on the wage credit, please click here: https://www.wilmerhale.com/en/insights/client-alerts/20200330-covid-19-latest-tax-law-developments. Please note that a business that receives a Paycheck Protection Loan (including by refinancing an existing EIDL Loan) will not be eligible for the wage credit.

HOW WILMERHALE CAN HELP: Please let us know if you would like our assistance in understanding whether and how to access these programs, including the following:

• determining loan eligibility, including under the affiliation rules,
• reviewing lenders’ SBA program loan documents and, if necessary, assisting with amendments to your existing credit facilities and loan documents,
• understanding the tax implications of program participation, 
• managing employment and HR matters and other landlord and vendor arrangements that might impact loan forgiveness, 
• receiving guidance from our public policy team, which has decades of experience helping clients access government programs, including through working with members of Congress and the Executive branch, and
• answering any other questions related to these programs.

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¹ The proceeds from 7(a) Program loans may be used in most instances only for “plant acquisition, construction, conversion, or expansion, including the acquisition of land, material, supplies, equipment, and working capital.”

² Size standards under the SBA rules vary based on the NAICS code for the business. In some cases, the test is based on employee head count, while in others, it is based on average annual receipts. For applicable size standards, click here. 

³ Notably, expansions to small business eligibility will not include relaxed eligibility rules for companies in the hospitality and restaurant industries with more than one location or affiliation waivers available to companies under the Paycheck Protection Loan program.