Client Alert: The CARES Act – New Financial Resources for Small Businesses and Nonprofits
Date: March 27, 2020
At a High Level
The CARES Act is a $2 trillion relief package in response to the economic and health crisis caused by the coronavirus pandemic. The package includes a combination of loans, tax breaks and direct payments for major corporations and individual taxpayers to help the U.S. economy survive an abrupt shutdown in the face of social distancing and business closures or substantial curtailments required by state orders to slow the spread of the coronavirus.
The CARES Act provides about $500 billion in loans and assistance for big companies (airlines in particular), as well as states and cities. The package also provides direct payments to lower- and middle-income Americans of $1,200 for each adult and $500 for each child. Unemployment insurance would be vastly expanded. The CARES Act also provides money for hospitals, which experts predict are on the verge of being overwhelmed. These aspects of the CARES Act are beyond the scope of this alert.
The CARES Act provides a separate pot of about $350 billion in assistance for small businesses, the use of which is the focus of this article. Specifically, we address Title I of the CARES Act, known as the Keeping American Workers Paid and Employed Act, and other sections of interest to owners of small businesses and managers of non-profit organizations.
The New Loan Program in General
The CARES Act creates a new business loan program called the Paycheck Protection Program (the “PPP”). For the period from February 15, 2020, to June 30, 2020 (the “covered period”), the CARES Act allows the Small Business Administration (the “SBA”) to provide 100% federal guarantees of loans equal to 2.5 times the applicant business’s average monthly payrolls cost before the pandemic (up to a maximum of $10 million) to eligible businesses, including entities exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code. The funds are to be used solely to pay operational costs like payroll, rent, mortgage, health benefits, insurance premiums and utilities. Subject to certain conditions, PPP loans are forgivable, and if the business meets the conditions, the loan will essentially be converted into a grant.
PPP loans are administered under the SBA’s current business loan program; i.e., Section 7(a) loans. This means that any federally insured (FDIC) bank can make the loan. Unlike the current programs, however, banks are not permitted to require collateral or personal guarantee for a PPP loan. The maximum permitted interest rate on PPP loans is 4%. Additionally, the Administrator of the SBA (the “Administrator”) has no recourse against any individual, shareholder, member, or partner of an eligible loan recipient for non-payment, unless the individual uses the loan proceeds for unauthorized purposes. To incentivize banks to make these loans, the PPP provides for percentage fee payments to the bank originating each loan, as well as a mechanism for banks to easily sell the loans to the SBA.
A loan made under the SBA’s Economic Injury Disaster Loan program (“EIDLs”; see our March 20, 2020 Client Alert for more information) may be refinanced as part of a covered loan under the PPP as soon as these new loans are made available, even if the use of the EIDL is not a permitted user for a PPP loan.
The CARES Act also includes a “sense of the Senate” provision suggesting that the Administrator issue guidance to lenders and agents to ensure that the processing and disbursement of PPP loans prioritizes small businesses and entities in underserved and rural markets, including veterans and members of the military community, small businesses owned and controlled by socially and economically disadvantaged individuals, and businesses in operation for less than two years.
Eligibility Generally and a Special Rule for Hospitality and Dining Businesses
In addition to “small business concerns” as currently defined by the SBA, eligible businesses for PPP loans include any business concern, Section 501(c)(3) nonprofit organizations, veterans’ organization, or Tribal business that employs not more than the greater of: (a) 500 employees (including full-time, part-time, and those employed on other bases); or (b) the size standard in number of employees established by the SBA for the industry in which the entity operates.
There is also a special eligibility rule for businesses in the hospitality and dining industries. For any such business with more than one physical location, if it employs 500 or fewer employees per location and is assigned to the “accommodation and food services” sector (Sector 72) under the North American Industry Classification System (“NAICS”), the business is eligible to receive a PPP loan.
More generally, SBA regulations on entity affiliations (under 13 CFR 121.103) for eligibility are waived for the covered period for business concerns that are:
- Businesses in Sector 72 under the NAICS with 500 or fewer employees;
- Franchise businesses with SBA franchise identifier codes; and
- Any business that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act, known as Small Business Investment Company organizations.
This means that, for example, an organization that owns 15 franchised restaurants that each employ 40 full-time equivalent employees will qualify for the loans.
Sole proprietors, independent contractors, and eligible self-employed individuals (as defined in Congress’s prior COVID-19 bill, the Families First Coronavirus Response Act (the “Families First Act”)) are eligible loan recipients, subject to some documentation requirements to substantiate eligibility.
Maximum Loan Amount, Eligibility Requirements, and Permissible Uses
The maximum loan amount per applicant (capped at $10 million) is the lowest of:
(A): 2.5 times the average total monthly payroll costs incurred in the one-year period before the loan is made (or, for seasonal employers, the average monthly payroll costs for the 12 weeks beginning on February 15, 2019, or, if elected by the applicant, from March 1, 2019 to June 30, 2019);
PLUS the outstanding amount of a loan made under the SBA’s Disaster Loan Program between January 31, 2020 and the date on which such loan may be refinanced as part of this new program;
OR
(B): Upon request, for businesses that were not in existence during the period from February 15, 2019 to June 30, 2019:
2.5 times the average total monthly payroll payments from January 1, 2020 to February 29, 2020;
PLUS the outstanding amount of a loan made under the SBA’s Disaster Loan Program between January 31, 2020 and the date on which such loan may be refinanced as part of this new program;
OR
(C) $10 million.
There are very few borrower requirements to obtain a loan under the PPP. Those requirements include a good-faith certification that:
- The loan is needed to continue operations during the COVID-19 emergency;
- The loan proceeds will be used to retain workers and maintain payroll or make mortgage, lease, and utility payments;
- The applicant does not have any other application pending under this program for the same purpose; and
- From February 15, 2020, until December 31, 2020, the applicant has not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan.
Notably, there is no requirement to evaluate the borrower’s ability to repay the covered loan or that the borrower not be able to find credit elsewhere, unlike the normal Section 7(a) requirements.
Businesses may, in addition to uses already permitted under current SBA business loan programs, use the PPP loans for:
- Payroll costs, which:
- Include compensation to employees; paid leave; severance payments; payment for group health benefits, including insurance premiums; retirement benefits; state and local payroll taxes; and compensation to sole proprietors or independent contractors up to $100,000 in 1 year, prorated for the covered period; and
- Exclude individual employee compensation above $100,000 per year, prorated for the covered period; certain federal taxes; compensation to employees whose principal place of residence is outside of the US; and sick and family leave wages for which credit is allowed under the Families First Act.
- Payments of interest on mortgage obligations;
- Rent/lease agreement payments;
- Utilities; and
- Interest on any other debt obligations incurred before the covered period.
Loan Forgiveness and Deferred Payment
Under the CARES Act, it is presumed that businesses that were operating on February 15, 2020 and who receive a PPP loan are “impacted borrowers” who qualify for complete payment deferment relief for at least six months and up to one year. The Administrator has 30 days from enactment of the CARES Act to provide guidance to lenders on this process.
PPP loans also qualify for the CARES Act’s loan forgiveness provisions. Specifically, indebtedness is forgiven in an amount (not to exceed the principal amount of the loan) equal to the amount of the following costs incurred and payments made during the eight-week period beginning on the loan origination date:
- payroll costs,
- interest payment on any mortgage incurred prior to February 15, 2020,
- payment of rent on any lease in force prior to February 15, 2020, and
- payment on any utility for which service began before February 15, 2020.
The amount forgiven is not included in the taxable income of the borrower.
The amount forgiven will be reduced proportionally by any reduction in employees retained compared to the prior year and reduced by the reduction in pay of any employee beyond 25% of their prior year compensation. To encourage employers to rehire any employees who have already been laid off due to the COVID-19 crisis, borrowers that re-hire workers previously laid off will not be penalized for having a reduced payroll at the beginning of the period.
Borrowers seeking forgiveness of amounts must submit to their lender documentation establishing their payments and other qualifying costs (e.g., rent and utilities).
Any loan amounts not forgiven at the end of one year are carried forward as an ongoing loan with terms of a maximum of 10 years, at maximum interest rate of 4%.
The Administrator has 30 days following enactment of the CARES Act to issue regulations on these forgiveness provisions.
Expansion of the EIDL Program
In addition to PPP loans described above, the CARES Act expands the EIDL program for the covered period from January 31, 2020 to December 31, 2020. In addition to current eligible entities under the EIDL program, which include all non-profit entities under Section 501(c) of the Internal Revenue Code, the following may receive EIDLs:
- A business with 500 or fewer employees, regardless of revenue;
- Sole proprietorships, with or without employees, and independent contractors;
- Cooperatives with 500 or fewer employees;
- ESOPs with 500 or fewer employees; and
- Tribal small business concerns.
The CARES Act requires that for any EIDLs made in response to COVID-19 before December 31, 2020, the SBA shall waive: (i) any personal guarantee on advances and loans below $200,000, (ii) the requirement that an applicant needs to have been in business for the 1-year period before the disaster, and (iii) the requirement that an applicant be unable to find credit elsewhere. As revised, EIDL lenders may approve an applicant based solely on credit scores and without requiring any tax returns be submitted.
The CARES Act also establishes an emergency grant under the EIDL program. Entities applying for an EIDL during the period from January 31, 2020 to December 31, 2020, may request an emergency advance of up to $10,000, which must be distributed within three days and which does not have to be repaid, even if the loan application is later denied. The Administrator is charged with verifying an applicant’s eligibility by accepting a certification under penalty of perjury by the applicant that they are eligible.
Business Provisions: Employee Retention, Delay of Payroll Taxes
Title II, Subtitle C of the CARES Act provides eligible employers, which includes tax exempt organizations under Section 501(c) of the Internal Revenue Code, a refundable credit against payroll tax liability equal to 50% of the first $10,000 in wages per employee, which includes the value of health plan benefits. Eligible employers must have carried on a trade or business during 2020 and satisfy one of two tests:
- Have business operations fully or partially suspended operations due to orders from a governmental entity limiting commerce, travel, or group meetings; or
- Experience a year-over-year (comparing calendar quarters) reduction in gross receipts of at least 50% – until gross receipts exceed 80% year-over-year.
For employers with more than 100 full-time employees, only employees who are currently not providing services for the employer due to COVID-19 causes are eligible for the credit. If the employer had 100 or fewer full-time employees, all employee wages paid by eligible employers are credit-eligible. The employee retention credit is effective for wages paid after March 12, 2020, and before January 1, 2021.
Employers who receive a PPP loan are not eligible for the employee retention tax credit.
The CARES Act also postpones the due date for depositing employer payroll taxes attributable to wages paid during 2020. The deferred amounts would be payable over the next two years – half due December 31, 2021, and half due December 31, 2022. Employers who receive loan forgiveness under the PPP, discussed above, are not entitled to this postponement.
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We are happy to answer any questions you may have about the applicability of these programs to your particular situation.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.