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COVID-19 - Emergency forgivable loans for small U.S. businesses

Author(s): Paul Seraganian, Jason Comerford, Jennifer Lee, Marc Kushner, Alix Morse, Jie Chai, Chloe Nanfara

Apr 5, 2020

Last updated on April 24, 2020

For further information on the changes below, please contact one of the authors above or any member of our U.S. Cross-Border Legal Services Group.

On April 24, 2020, the Paycheck Protection Program and Health Care Enhancement Act was signed into law. The new law, among other things, increases the authorized level of funding for the U.S. government Paycheck Protection Program (PPP) from US$349 billion to $659 billion. Borrowers whose applications have been put on hold due to the exhaustion of PPP funding should immediately reach out to their lenders to move forward with their applications. Those who are considering applying for a PPP loan should reach out to a lending bank as soon as possible before the funding for PPP runs out for a second time.

On April 5, 2020, we published an Update describing the newly established Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security Act for the purpose of aiding U.S. businesses adversely impacted by the COVID-19 pandemic. On the evening of April 6, 2020, the U.S. government issued additional guidance regarding the PPP. Of particular note to Canadian companies in the context of the April 6, 2020 guidance is that only employees whose principal place of residence is in the United States are counted towards the 500-employee eligibility threshold described further below.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) was signed into law. Under the CARES Act, the U.S. government has established a Paycheck Protection Program (PPP) to provide up to US$349 billion in emergency forgivable loans for small businesses operating in the United States to stabilize their U.S. payroll and certain other business costs.

On April 2 and April 6, 2020, additional details on the scope and eligibility criteria for the PPP were released. This Update is designed to help those with U.S. businesses (including U.S. subsidiaries of Canadian companies) determine whether they may be eligible for this much-needed support.

This program is being applied on a “first-come-first-served basis” and will terminate once the funds made available for the PPP are exhausted — so affected businesses should do their best to proceed quickly.

The Paycheck Protection Program

Under the PPP, small businesses can apply to receive two-year, 1% interest rate loans for the lesser of US$10 million and 2.5 times their average monthly U.S. payroll costs in 2019 (subject to a US$100,000 annual salary cap per employee).

The CARES Act provides that up to the full principal amount and any accrued interest of the loan can be forgiven if:

  • the loan is used for payroll costs for employees whose principal place of residence is in the United States and payments for mortgage interest, rent and utilities for the eight-week period after the loan is made; and
  • the employee and compensation levels are maintained.

The PPP is administered by the U.S. Small Business Administration (SBA) and the first day on which loans were available was April 3, 2020. Funding is provided directly by participating private sector lenders, each of which will have its own form of PPP loan application, and is 100% guaranteed by the SBA.

Who is eligible?

Generally, a business is eligible for a PPP loan if it:

  • has 500[1] or fewer employees (including full-time, part-time and temporary employees) whose principal place of residence is in the United States;
  • has a place of business in the United States; and
  • operates primarily in the United States or makes a significant contribution to the U.S. economy through tax, labor or use of products.

Based on the latest guidance issued by the SBA, U.S. subsidiaries and U.S. branches of non-U.S. companies are eligible to apply to the PPP provided they meet the above criteria. Given the exceptional speed at which this program is being rolled out and regulatory guidance is being issued, it is possible that some lenders may take a contrary view. 

Early reports from the first several days of PPP loan applications (as of April 7, 2020) indicate there is not only unprecedented demand for PPP loans by small businesses but also some confusion and inconsistency among banks with regard to intake and eligibility requirements.

Are employees residing outside the U.S. counted towards the 500-employee threshold under the eligibility criteria of PPP?

Based on the latest guidance issued by the SBA, only employees whose principal place of residence is in the United States are counted towards the 500-employee threshold. We note, however, that there are some inconsistencies on this point in the rules and regulations being issued by the U.S. government and further guidance on this point may be forthcoming.

What about a business that has only been recently established?

To be eligible for a PPP loan, a borrower must have been in operation on or prior to February 15, 2020 and have employees for which the business paid salaries and payroll taxes or paid independent contractors as reported on a Form 1099-MISC in the United States on or prior to that date.

Where can you find the lenders?

Borrowers can locate the financial institutions that are participating in the PPP here. The SBA is also working with other financial institutions to enroll them as lenders under the PPP. In the first instance, borrowers should consider reaching out to a lender with which they have a pre-existing relationship as lenders may deem an existing account a prerequisite to the application review process.

How long does the PPP last?

The PPP is open for application until June 30, 2020 or until the funds made available for PPP are exhausted. Given that the loans are on a “first-come-first-served basis” basis, borrowers should consider reaching out to a lending bank as soon as possible. Members of the U.S. government have indicated that they are considering increasing the funding available for the PPP by an additional US$250 billion.

According to an estimate by the SBA in 2018, there were more than 30.2 million small businesses in the United States.

How should you calculate the maximum loan amount?

Please see below a sample calculation for the maximum PPP loan amount, which is capped at US$10,000,000. Note that the calculation method is different for seasonal businesses.

 

Salary (Annual)

Benefits (Annual)

U.S.-Resident Employee #1

US$80,000

US$20,000

U.S.-Resident Employee #2

US$90,000

US$20,000

U.S.-Resident Employee #3

US$150,000

US$20,000

Total Payroll Costs

US$380,000

Subtract compensation amount in excess of annual salary of US$100,000 for employee #3

Subtract US$50,000

Qualifying Payroll Costs

US$330,000

Divide by 12

Average Monthly Qualifying Payroll Costs

US$27,500

Multiply by 2.5

Maximum PPP loan amount

US$68,750

 

Are employees of affiliates counted towards the 500-employee threshold?

Businesses applying to the PPP will be aggregated with their “affiliates” worldwide for purposes of determining whether they fit within the 500-employee eligibility limit. Based on the latest guidance issued by the SBA, however, non-U.S. employees of an affiliate would not count toward the 500-employee threshold.

Businesses will be affiliated where one has the power to control the other, or the entities are under the common control of a third party, whether by ownership, common management or contractual relationships. The SBA will look at the totality of the circumstances in determining if businesses are affiliated, including affiliation arising through ownership of equity, stock options or convertible securities, agreement to merge, overlapping management and identity of close business or economic interest.

Can a PE- or VC-backed start-up apply for a PPP loan?

If a PE- or VC-backed start-up satisfies the eligibility requirements discussed above, yes. A start-up should pay close attention to the 500-employee threshold by confirming if its PE or VC backer “controls” it or any other companies according to the factors laid out by the SBA discussed above. For example, if a PE or VC fund controls more than 50% of voting securities of start-up A and start-up B, start-up A will need to include the employees of start-up B when determining whether it exceeds the 500-employee threshold. In some cases, a minority investor may be deemed to “control” a company if it has veto rights over actions of the board of directors. Therefore, a careful review of a start-up’s capital structure, charter, shareholder agreement(s) and similar documents is necessary before submitting a PPP loan application.

When do you need to make payments under the PPP loan?

Once a loan is made, payments start after six months but interest will accrue during that period.

Do you need to pay any fees to apply for the loan?

Neither the U.S. Government nor the lenders will charge any fees to apply for a PPP loan.

Do you need to post any collateral or provide a personal guarantee?

No.

What can you use the loan for?

The PPP loan can be used for eligible payroll costs for employees whose principal place of residence is in the United States as well as (to a limited extent) payments for mortgage interest, rent and utilities. According to the latest guidance provided under the PPP, due to the likely high demand for the loans, no more than 25% of the forgiven amount may be for non-payroll costs. 

Payroll costs include salary (subject to the US$100,000 annual salary cap per employee), commission, employee benefits (including costs for parental, family, medical or sick leave and payments required for health care benefits) and state and local taxes assessed on compensation. 

Can the loan be forgiven?

Up to the full principal amount and any accrued interest of a loan can be forgiven if:

  • the loan proceeds are used to cover eligible payroll costs and payments for mortgage interest, rent and utilities over the eight-week period after the loan is made; and
  • the employee and compensation levels are maintained.

Specifically, the amount of loan forgiveness will be reduced if (i) the average number of full-time equivalent employees per month during the eight-week period following the loan is less than the number of full-time equivalent employees per month from February 15, 2019 to June 30, 2019 or the average number of full time employees per month from January 1, 2020 to February 29, 2020 (assuming it is not a seasonal business, the borrower can elect which of the two periods to apply) and (ii) total salary or wages of any employee during the eight-week period is reduced in excess of 25% of total salary or wages of the employee during the most recent full quarter during which the employee was employed. If there have been reductions in employees or salaries and wages during this time period, the business has until June 30, 2020 to reverse the reductions to compliant levels. Please note that the foregoing salary reductions only apply to employees who received less than US$100,000 in salary or wages in any pay period in 2019.

Importantly, there is a ceiling on loan forgiveness for amounts used to cover eligible non-payroll costs (e.g., rent) equal to 25% of the borrowed amount.

To apply for loan forgiveness, a borrower must send a request to its lender and provide the relevant documents to verify compliance of the conditions discussed above.

What is the application process for the loan?

The latest sample application form provided by the U.S. Treasury Department can be found here. Lending banks will generally have their own application forms based on this sample. At a minimum, lending banks will require payroll-related documents such as payroll processor records, payroll tax filings or Form 1099-MISC as support to the application.

Each applicant for a PPP loan must also certify, among other things, that:

  • the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the applicant;
  • the funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments and utility payments; and
  • during the period beginning on February 15, 2020 and ending on December 31, 2020,  the applicant has not received and will not receive another PPP loan.

What about the other relief programs under the CARES Act?

Borrowers may apply for other SBA financial assistance, including Economic Injury Disaster Loans, provided there is no duplication in the uses of funds. For example, if a borrower uses its PPP loan to pay the salary of certain employees in the eight-week period, it cannot use a different SBA loan to cover those same costs.

However, obtaining a loan under the PPP makes a business ineligible for certain other relief, such as the payroll tax relief that is otherwise available under the CARES Act.

What is next for the PPP?

The U.S. Department of Treasury and the SBA are still issuing rules and guidance on the PPP on a real-time basis. The specific areas that the SBA is required to, or has indicated that it will, provide further guidance include loan forgiveness and deferment of loan payment. Some important details regarding PPP loans are underdeveloped. For example, it is unclear if the interest rate of 1% is compounded annually.

To encourage submission of loan applications by businesses in this environment of uncertainty, the SBA has assured applicants that they can rely on rules and guidance available at the time of submission when preparing the applications. An applicant will only need to revise its already submitted application if a new guidance requires such revision and the application has not yet been processed by a lender.

Where can you find more information about PPP?

See PPP-related resources at the website of the U.S. Department of the Treasury: https://home.treasury.gov/policy-issues/top-priorities/cares-act/assistance-for-small-businesses and at the website of the SBA: https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program-ppp. Please also reach out to an eligible lender with which you have a pre-existing relationship.

How to get help moving forward

If you have further questions about your eligibility for a PPP loan or require support in advancing your application, please feel free to contact any of the authors of this Update to discuss further.

 

[1] Even if an applicant has more than 500 employees whose principal place of residence is in the United States, the applicant may still be eligible for a PPP loan if it meets one of the following alternative standards:

  • the SBA’s employee-based or revenue-based size standard corresponding to the applicant’s primary industry. See www.sba.gov/size; and
  • the SBA’s “alternative size standard” as of March 27, 2020: (1) maximum tangible net worth of the business is not more than US$15 million; and (2) the average net income after federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than US$5 million.

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