PPP Economic Need and Loan Forgiveness

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Some of the provisions below have been modified by the Paycheck Protection Program Flexibility Act (PPPFA) which was signed into law on June 5, 2020. Click here for our article on PPPFA.

By Chris Anderson, Shareholder

UPDATE:  The Department of the Treasury and SBA posted an updated version of PPP Frequently Asked Questions on April 29, 2020.  The answer to Question 39 states the following:

“To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.  Additional guidance implementing this procedure will be forthcoming” (emphasis added).

The Department of the Treasury and SBA have been updating guidance on the Paycheck Protection Program (PPP) on almost a daily basis, and an update to a Frequently Asked Questions document on April 23, 2020, was quite alarming.  The answer to Question 31 of the FAQ’s states the following:

“… all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere… borrowers must still certify in good faith that their PPP loan request is necessary.  Specifically, before submitting a PPP application, all borrowers should review carefully the required certification [under CARES Act Section 1102(a)(1)(G)] that ‘(c)urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.’  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” (emphasis added).

The answer to Question 31 further states that “(a)ny borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by the SBA to have made the required certification in good faith.”

This additional information appears to suggest that borrowers will be subject to future scrutiny about their eligibility for a PPP loan.  We hope that the SBA and Treasury provide more guidance on this matter, but in the interim, borrowers should gather data now to support their position that they applied for the loan in good faith based on current and projected needs of their business.  Specifically, it seems reasonable for borrowers to gather the following data and records:

  1. Employee count and hours worked per employee, before and after operations were impacted by the pandemic;
  2. Potential traditional financing options including expansion of lines of credit and/or other loans, including loan limits, interest rates, and other fees;
  3. Budget projections that account for decreased or eliminated operations during stay-at-home orders and potential on-going effects of decreased demand, revenue, etc.;
  4. Monthly profit and loss information that shows the effects of closures or limited operations; and
  5. Cash and receivables on hand at the time of applying for the loan, including an assessment of the collectability of the receivables.

The above list is not exhaustive and should be tailored to each business to best support the contention that the business needed PPP funding.  Borrowers should also consider the safe harbor established in the FAQ document of paying back the PPP loan before 5/7/2020 if there are significant concerns about their economic need for the loan.

Borrowers are also turning their attention to the loan forgiveness aspects of PPP.  Borrowers may be able to have some or all of their PPP loan forgiven if they use the funds for the following expenses during the 8-week period following the disbursement of the loan (referred to as the “Covered Period”):

  1. Payroll costs, up to $100,000 per employee (pro-rated for the Covered Period);
  2. Group healthcare benefits including insurance premiums;
  3. Employer retirement plan benefit payments;
  4. State unemployment insurance contributions;
  5. Rent under lease agreements existing before 2/15/2020;
  6. Utilities under service agreements before 2/15/2020; and
  7. Interest on covered mortgage obligations on real or personal property incurred before 2/15/2020, NOT including any prepayment or payment of principal.

Note that the SBA declared in its Interim Final Rule that 75% of the proceeds from the PPP loan must be spent on payroll costs within the Covered Period.  Additionally, the amount of loan forgiveness will be reduced in two ways: (a) due to a decrease in full-time equivalent (FTE) employees; and (b) for the reduction in excess of 25% of the total salary and wages of any employee during the Covered Period as compared to a base period (described below).

Each of these potential reductions in forgiveness are challenging.  For the reduction in FTE employees, the borrower must determine the average monthly FTE employee count during the Covered Period against one of two base periods:  (a) the period from 2/15/2019 to 6/30/2019; or (2) the period from 1/1/2020 to 2/29/2020.  Of course, the borrower should choose the smaller count of these 2 base periods to minimize the reduction in the forgiveness.

Comparing FTE employees for the Covered Period against the selected base period generates a percentage that is then applied against the loan, representing the maximum amount that can be forgiven in this step. For example, if a borrower had 50 FTE employees during the selected base period and 45 FTE employees for the Covered Period, the maximum forgiveness amount is 90% (45/50) of the loan.

A reduction in employees that occurred in the borrower’s operations between 2/15/2020 and 4/26/2020 can be corrected by 6/30/2020, allowing for that reduction in FTE employees to be ignored for purposes of the loan forgiveness reduction discussed above.  Of course, correction means rehiring those employees (or others to take the furloughed employees’ place).

The second potential reduction in loan forgiveness requires the borrower to look at employees that have had their pay reduced.  If an employee’s wages/salary have been reduced in excess of 25% of the amount during the most recent quarter of employment before the Covered Period, the amount of the loan forgiven must be reduced dollar-for-dollar by that decrease.

Documentation of the count of employees, hours worked, FTE equivalent calculations, and comparisons of wages before and during the Covered Period is essential.  Again, with the possibility of future scrutiny by the SBA and perhaps other authorities, borrowers must have complete and contemporaneous records to support their assertions about the loan amount itself and the forgiveness amount.

Obviously, the above discussion is complex and is further complicated by a number of questions regarding the details of the determinations.  Here are some of those questions:

  1. The PPP loan forgiveness provisions of the CARES Act state that “costs incurred and payments made” during the Covered Period will count in the forgiveness calculation. Does that mean that the borrower can use the accrual basis or the cash basis for expenses during the Covered Period?
  2. Can a borrower count rent paid to a controlled entity in the forgiveness calculation? Many businesses set up separate legal entities to house operations and the real property in which each business operates.  Obviously, the borrower has the ability to postpone, accelerate, or otherwise change the rent paid to the related entity, which could lead to perceived abuses in the forgiveness calculation.
  3. Can a borrower increase its payroll costs during the Covered Period by bonuses which are paid merely to maximize the forgiveness amount?
  4. Similar to #3, can a borrower pay its employees more frequently during the Covered Period than normal to maximize the forgiveness amount, particularly if the answer to the “incurred and paid” question in #1 is that the borrower has to use the cash basis for the Covered Period?

These are just a sample of questions which we hope the SBA and/or Treasury will address.

Please contact your Maloney + Novotny team member with questions or use this online contact form.  We have established a CARES Act task force within the firm to assist clients with these matters.

Given that guidance from governmental agencies has been released frequently since passage of the CARES Act, the matters discussed above are constantly changing.  This article is for informational purposes only and should not be relied on by anyone without consulting an expert on these matters.

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