COVID-19 - The CARES Act: SBA Sec. 7(a) Paycheck Protection Program Loans and Loan Forgiveness

Thursday, April 9, 2020
This article is updating the April 1, 2020 Client Alert.

By Sanjay Mody and Delton Vandever (both are Partners in the New York office)

The new Coronavirus Aid, Relief, and Economic Security Act (CARES Act), signed into law on March 27, 2020, amends Sec. 7(a) of the Small Business Act to provide for a new loan program, available through June 30, 2020, entitled the Paycheck Protection Program (PPP). A wide array of businesses and nonprofits negatively affected by COVID-19 are eligible for PPP loans, consistent with the program’s intended goal of protecting jobs and wages. Aside from other favorable terms, PPP Loans will be forgiven under certain circumstances.

The SBA and the Treasury Department have now issued substantial guidance for implementing the PPP, including: (a) Interim Final Rules (IFR), effective April 2, 2020, (b) Interim Final Rules on Affiliation, effective April 3, 2020, (c) a Fact Sheet on Applicable Affiliation Rules, issued April 3, 2020, (d) FAQs, updated April 8, 2020, (e) a Borrower Fact Sheet and a Borrower Application, updated April 2, 2020, and (f) a Lender Fact Sheet and a Lender Application. The SBA is expected to issue additional guidance regarding loan forgiveness, and possibly other matters. Notwithstanding these informational materials, many of the technical specifics of the program remain uncertain and subject to lender discretion.

Lenders are currently accepting applications from businesses (including sole proprietorships) and non-profits, and they are authorized to accept applications from independent contractors and self-employed individuals starting April 10, 2020. Given the high demand and limited funding cap (currently $349 billion),[1] eligible borrowers are encouraged to apply as quickly as they can. The PPP is “first come, first served.”

Eligibility for PPP Loans and Application of “Affiliation Rules”

Traditional “small business concerns,” as determined either by (a) existing SBA size standards expressed in number of employees or annual receipts depending on industry classification, or (b) existing SBA “alternative size standards” based on a net worth of not more than $15 million with an average net income of not more than $5 million, are eligible for PPP Loans.

Other eligible PPP borrowers include businesses (including sole proprietorships, independent contractors, and self-employed persons), nonprofit organizations, veterans organizations, and Tribal business concerns, with 500 or fewer full and part-time employees whose principal place of residence is in the U.S. To the extent SBA size standards for a particular industry prescribe a higher limit for number of employees, the higher limit would apply. Businesses in the hotel and food services industry with more than one physical location will be eligible even if they have more than 500 employees total, so long as the business does not employ more than 500 employees per physical location.

Employees include persons employed on a full-time, part-time, or other basis. To determine number of employees, borrowers may use average employment over the same time periods used to calculate payroll costs (i.e., either the 12 months before the loan’s origination date or the calendar year 2019). Further, existing SBA “affiliation rules” require the counting of employees of any company (domestic or foreign) controlled by or under common control with the borrower. (Although existing SBA rules provide for counting employees of both domestic and foreign affiliates, a reference in the IFR to 500 or fewer employees “whose principal place of residence is in the United States” creates some ambiguity as to whether employees of foreign affiliates who do not reside in the U.S. should be included or excluded from the employee count.)

The four applicable tests for control-based affiliation are:

  • Affiliation based on ownership (own or control greater than 50% of voting equity or, if none, control management; minority shareholder that can block company action);
  • Affiliation arising under stock options, convertible securities, and agreements to merge (considered to have a present effect on the power to control and as though rights have been exercised);
  • Affiliation based on management (control management of borrower and another concern; control management through a management agreement); and
  • Affiliation based on identity of interest (identity of interest of close relatives with substantially identical interests such as where close relatives operate concerns in similar industries in the same geographic area).

To help borrowers identify businesses with which they may be affiliated, the application form requires borrowers to list other businesses with which they have common management. The affiliation rules are waived for businesses in the hotel and food services industry, franchises in the SBA’s Franchise Directory, and SBIC-funded entities. An exemption is applicable for faith-based organizations.

To be eligible for a PPP loan, a borrower must also have been in operation on February 15, 2020 and, if a business, had employees for whom it paid salaries and payroll taxes.

Ineligible Businesses

Even if the above eligibility requirements are met, an applicant will nonetheless be ineligible (with some exceptions and qualifications) if:

  • It is engaged in illegal activity, including the marijuana business (due to its illegality under federal law);
  • It is a household employer;
  • An owner (20% or more) is incarcerated, on probation, on parole; presently subject to indictment, criminal information, arraignment; or has been convicted of a felony within the last 5 years;
  • It (or any business owned or controlled by its owners) is currently delinquent on an SBA loan, or defaulted within the last 7 years and caused a loss to the government;
  • It is a financial business primarily engaged in the business of lending, investments, financing, or factoring, such as banks, life insurance companies, finance companies, investment companies, factors, and other businesses whose stock in trade is money;
  • It is a passive business owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds;
  • It is located in a foreign country or owned by undocumented aliens;
  • It is engaged in a pyramid scheme;
  • It is engaged in legal gambling activities;
  • It restricts patronage for any reason other than capacity;
  • It is government owned;
  • It is engaged in promoting religion;
  • It is a consumer or marketing cooperative;
  • It is engaged in SBA loan packaging;
  • The lender owns an interest in the business;
  • It presents performances of a prurient sexual nature or derives revenue through the sale of products or services of a prurient sexual nature (note that this is presently being challenged in Michigan);
  • It is primarily engaged in political or lobbying activities; or
  • It is a speculative business, such as oil wildcatting; dealing in stocks, bonds, commodity futures, and other financial instruments; mining gold or silver in other than established fields; research and development; or building homes for future sale.

Further, although some ambiguity exists, there may be additional eligibility requirements under existing SBA 7(a) program rules for a foreign-owned business, including that U.S. management has operated the business for at least 1 year and is expected to continue in place indefinitely.

Maximum PPP Loan Amount and Determination of Payroll Costs

PPP Loans can be taken in the amount of up to 2.5 times a borrower’s average monthly payroll costs, as calculated using data for either the 1-year period before the loan’s origination date or for the calendar year 2019. (The period differs for seasonal employers.) That amount is subject to a $10 million cap.  

Payroll costs consist of compensation paid to employees (but not payments made to independent contractors) whose principal place of residence is the U.S., including:

  • Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
  • Employee benefits including costs for vacation, parental, family, medical or sick leave; allowance for separation or dismissal; payments required for the provision of group health care benefits including insurance premiums; and payment of any retirement benefit;
  • State and local taxes assessed on compensation; and
  • For a sole proprietor or independent contractor: wages, commissions, income or net earnings from self-employment, capped at $100,000 on an annualized basis for each employee.

Payroll costs for purposes of determining the maximum loan amount are calculated on a gross basis, i.e., payroll costs are not reduced by taxes imposed on an employee and required to be withheld by the employer such as the employee’s and employer’s share of FICA and income taxes required to be withheld from employees. However, employer-side federal payroll taxes on employee wages are excluded from payroll costs.  (There is some question whether withholding taxes for the period after February 15, 2020 must be withheld in determining payroll costs for purposes of the maximum loan amount, but it does not appear so under the most recent guidance.) 

Permitted Uses of PPP Loan Proceeds

PPP Loan proceeds are to be used for: (a) payroll costs, including benefits, but excluding withholding taxes, (b) interest on mortgage obligations, incurred before February 15, 2020, (c) rent, under lease agreements in force before February 15, 2020, (d) utilities, for which service began before February 15, 2020, (e) interest payments on any other debt obligation, incurred before February 15, 2020 (but such payments would not be eligible for forgiveness), and (f) refinancing an EIDL loan made between January 31 and April 3, 2020. (If an EIDL loan was not used for payroll costs, it does not affect eligibility for a PPP loan. If an EIDL loan was used for payroll costs, the PPP Loan must be used to refinance the EIDL loan.) At least 75% of the loan proceeds must be used for payroll costs.

Forgiveness of PPP Loan Amounts Used for Certain Purposes

A borrower is eligible for forgiveness of a PPP Loan in an amount equal to the sum of the following costs incurred and payments made during an 8-week covered period beginning with the loan disbursement date:

  • payroll costs (but not including federal withholding taxes, such as an employee’s and employer’s share of FICA and income taxes required to be withheld from employees);
  • payment of interest on any covered mortgage obligation, i.e., any indebtedness or debt instrument incurred in the ordinary course of business that is a liability of the borrower, is a mortgage on real or personal property, and that was incurred before February 15, 2020;
  • payment on any rent obligated under a lease agreement in force before February 15, 2020; and
  • any covered utility payment, i.e., payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

In short, a borrower will owe money when the loan is due if it uses the loan proceeds for anything other than payroll costs, mortgage interest, rent, and utilities payments over the 8 weeks after getting the loan or if it fails to use at least 75% solely for payroll costs.

For purposes of permissible uses of loan proceeds and loan forgiveness (as opposed to determining the maximum loan amount), payroll costs do not include federal withholding taxes, i.e., a borrower cannot use loan proceeds to pay federal withholding taxes.

Amounts forgiven are excluded from gross income for tax purposes.

Limitations on PPP Loan Forgiveness

The amount of loan forgiveness may not exceed the principal amount of the PPP Loan. In addition, loan forgiveness will be reduced if the borrower: (a) decreases its full-time employee headcount, or (b) decreases salaries and wages by more than 25% for any employee that made less than $100,000 annualized in 2019. A borrower has until June 30, 2020 to restore its full-time employment and salary levels for any changes made between February 15, 2020 and April 26, 2020.

More specifically, under the “Reduction Based on Reduction in Number of Employees” provision, the PPP Loan forgiveness amount is reduced in proportion to any reduction in the average number of full-time equivalent monthly employees during the 8-week period beginning on the loan origination date as compared to the average number of full-time equivalent monthly employees during the period February 15, 2019 to June 30, 2019 or, at the borrower’s option, the period January 1, 2020 to February 29, 2020. So, for instance, if there were 50 full time employees during the 8-week covered period but 100 employees during the selected prior comparison period, the loan forgiveness amount would be reduced by 50%. A borrower that has already reduced its payroll as a result of the coronavirus pandemic will remain eligible for loan forgiveness if it hires them back to pre-crisis levels before June 30, 2020.

Under the “Reduction Relating to Salary and Wages” provision, the amount of loan forgiveness is reduced by the amount of any reduction greater than 25% in total salary or wages of any employee during the 8-week period beginning on the loan origination date. But this only applies with respect to employees who did not receive (during any single pay period) more than $100,000 in annualized salary or wages in 2019. The applicable comparison period in determining whether the reduction is greater than 25% is the most recent quarter before the 8-week period. So, a business should be able to reduce the wages of employees earning over $100,000 by any amount and/or reduce the wages of employees earning less than $100,000 by less than 25% without suffering a reduction of the PPP Loan forgiveness amount under this provision. A borrower that has already reduced wages as a result of the coronavirus pandemic will remain eligible for loan forgiveness if it restores them back to pre-crisis levels before June 30, 2020.

Application for PPP Loan Forgiveness

An application for PPP Loan forgiveness should be made to the lender servicing the loan and must include:

  • Documentation verifying the number of full-time equivalent employees on payroll and pay rates for the relevant periods, including payroll tax filings reported to the IRS and state income, payroll, and unemployment insurance filings;
  • Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, lease obligations, and utility payments; and
  • A certification that the documentation is true and correct and that the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments.

The lender must make a decision on the forgiveness request within 60 days.

Lenders and Lender Considerations

Currently approved SBA lenders, as well as additional lenders authorized by the SBA, may make PPP Loans. A lender’s underwriting obligations are limited to: (a) confirming receipt of the borrower certifications contained in the borrower application, (b) confirming receipt of information showing that the borrower had employees for whom the borrower paid salaries and payroll taxes on or around February 15, 2020, (c) confirming the dollar amount of average monthly payroll costs for the preceding calendar year by reviewing the payroll documentation submitted with the borrower’s application, (d) reviewing the application form, and (e) following applicable Bank Secrecy Act requirements.

While lenders must comply with these obligations, they will be held harmless for a borrower’s failure to comply with PPP criteria and may rely on borrower certifications in order to determine eligibility and use of loan proceeds and may rely on specified borrower documents and a borrower attestation to determine the maximum loan amount and eligibility for loan forgiveness. Lenders are not required to comply with standard SBA lending criteria. PPP Loans will be 100% guaranteed by the SBA.

Borrower Certifications

The borrower’s authorized representative must make the following certifications in the borrower application form:

  • I have read the statements included in this form, including the Statements Required by Law and Executive Orders, and I understand them.
  • The Applicant is eligible to receive a loan under the rules in effect at the time this application is submitted that have been issued by the Small Business Administration (SBA) implementing the Paycheck Protection Program under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (the Paycheck Protection Program Rule).
  • The Applicant (1) is an independent contractor, eligible self-employed individual, or sole proprietor or (2) employs no more than the greater of 500 employees or, if applicable, the size standard in number of employees established by the SBA in 13 C.F.R. 121.201 for the Applicant’s industry.
  • I will comply, whenever applicable, with the civil rights and other limitations in this form.
  • All SBA loan proceeds will be used only for business-related purposes as specified in the loan application and consistent with the Paycheck Protection Program Rule.
  • To the extent feasible, I will purchase only American-made equipment and products.
  • The Applicant is not engaged in any activity that is illegal under federal, state or local law.
  • Any loan received by the Applicant under Section 7(b)(2) of the Small Business Act between January 31, 2020 and April 3, 2020 was for a purpose other than paying payroll costs and other allowable uses loans under the Paycheck Protection Program Rule.

The authorized representative must also certify in good faith that:

  • The Applicant was in operation on February 15, 2020 and had employees for whom it paid salaries and payroll taxes.
  • Current economic uncertainty makes the loan necessary to support ongoing operations of the Applicant.
  • The funds will be used to retain workers and maintain payroll or to make mortgage, lease, and utility payments as specified under the PPP rule; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable such as for charges of fraud.
  • The Applicant will provide to the lender documentation verifying the number of full-time equivalent employees on its payroll as well as the dollar amounts of payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities for the eight-week period following this loan.
  • I understand that loan forgiveness will be provided for the sum of documented payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities, and not more than 25% of the forgiven amount may be for non-payroll costs.
  • During the period beginning on February 15, 2020 and ending on December 31, 2020, the Applicant has not and will not receive another loan under the PPP.
  • The information provided in the application and the information provided in all supporting documents and forms is true and accurate in all material respects; I understand that knowingly making a false statement to obtain a guaranteed loan from the SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.
  • I acknowledge that the lender will confirm the eligible loan amount using required documents submitted; I understand, acknowledge, and agree that the lenders can share any provided tax information with the SBA’s authorized representatives, including authorized representatives of the SBA Office of Inspector General, for the purpose of compliance with SBA Loan Program Requirements and all SBA reviews.

Key PPP Loan Terms and Provisions

Key loan terms and provisions for PPP Loans include:

  • Nonrecourse: PPP Loans are nonrecourse against any individual shareholder, member, or partner of the borrower, except to the extent that the person uses the covered loan proceeds for an unauthorized purpose.
  • Fee Waiver: Neither the government nor lenders will charge any fees for a PPP Loan.
  • Credit Elsewhere: The borrower of a PPP Loan does not have to show it is unable to obtain credit elsewhere.
  • Waiver of Personal Guarantee and Collateral Requirements: No personal guarantee or collateral is required for a PPP Loan.
  • Maturity and Interest Rate: A PPP Loan will have a maturity of 2 years and an interest rate of 1%.
  • Deferment: Lenders must defer repayment of PPP Loans for 6 months.
  • Waiver of Prepayment Penalty: PPP Loans are not subject to a prepayment penalty.

All PPP Loans will have the same terms regardless of lender or borrower.

Applying for a PPP Loan

Applications for a PPP Loan should be submitted to participating lenders and not directly to the SBA. Businesses are encouraged to apply as soon as they can and may want to immediately:

  • Check their eligibility for a PPP Loan based on having 500 or fewer employees (including employees of affiliates) or as a traditional “small business concern”;
  • Determine their maximum loan amount by calculating their average monthly payroll costs for the one-year period before the loan date or for the calendar year 2019;
  • Review the borrower application form, and contact their lender for specific application materials and guidance; and
  • Gather supporting documents.

In submitting an application, borrowers should consider seeking the maximum loan amount possible given the significant demand for the program and a one-loan-per-borrower rule.


[1] Congress is presently considering legislation that would appropriate an additional $250 billion for the PPP.

This Client Alert has been prepared for informational purposes only. It is not intended as legal or tax advice and should not be relied upon as legal or tax advice.