On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) became law in the United States. Among other things, the CARES Act provides relief to certain businesses in the form of “paycheck protection loans” through what the Act calls the Paycheck Protection Program (the “Program”). These loans are to be administered under Section 7(a) of the Small Business Act through the network of Small Business Administration (“SBA”) qualified lending institutions.
Paycheck Protection loans are available to small businesses already eligible for SBA 7(a) loans, in addition to businesses (including sole proprietors, independent contractors, and gig economy workers) that have 500 or fewer employees. The loans are also available to certain companies that employ more than 500 employees if an existing SBA employee-based size standard applies. Accommodation and food service businesses with multiple locations of less than 500 employees may also be eligible. Eligible participants may borrow up to 250 percent of their average monthly payroll costs, up to $10 million, for the period of February 15, 2020 through June 30, 2020 (the “Covered Period”) under the Program.
Average monthly payroll costs are calculated by taking the average of the borrower’s monthly payroll costs over the 12 months prior to the date the loan is made, except that wages paid to an employee in excess of $100,000 are excluded from the calculation. Each loan may be used by the borrower to cover many kinds of payroll costs, mortgage interest expense, rent expense, and/or utilities expenses through June 30, 2020. If an eligible borrower uses the loan for qualifying expenses without reducing its average monthly amount of full-time employees and without reducing any employee’s salary by more than 25 percent as compared to the last full calendar quarter the employee worked prior to February 15, 2020, some or all of the loan amount can be forgiven without tax consequences.
Much has already been written for the would-be borrower under the Program. But what should lending institutions know now and consider with respect to the lending program, the decision to lend, and their obligations thereunder?
Which lenders may participate in the Program and make Paycheck Protection loans?
To participate in the Program, a lending institution must be either:
- a current SBA Qualified Lender under Section 7(a); or
- an “Additional Lender” deemed qualified by the SBA and the Secretary of Treasury.
In order to service more prospective borrowers during the Covered Period, the SBA is authorized to identify and approve additional insured depository institutions, credit unions, and other lenders to participate in the Program. Additional Lenders must have the “necessary qualifications to process, close, disburse and service loans” administered by the SBA under the Program. Specific criteria for Additional Lenders is not set out in the Act, but it is to be established by the Department of the Treasury, the SBA and the Chairman of the Farm Credit Administration.
For perspective on the scale of this Program, it is estimated that all SBA qualified lenders originated $20 billion in loans in 2019. As the Program has authorized $349 billion in loans during the Covered Period, it will be crucial that additional lenders participate in the Program.
What are the differences in making a Paycheck Protection loan for a lender, as compared to a conventional SBA 7(a) loan?
- The SBA will guarantee 100 percent of any covered Paycheck Protection loan made during the Covered Period through deferred participation. This is an increase from the 75 percent guarantee of traditional 7(a) SBA loans.
- The SBA will reimburse the lender for 100 percent of eligible loan amounts forgiven within 90 days, plus interest accrued on such forgiven amounts.
- The SBA will not charge any administrative fees for Paycheck Protection loans. Additionally, within five days of disbursement of loan funds, lenders are to be reimbursed by the SBA for loan processing fees as follows:
- 5% for covered loans up to $350,000;
- 3% for covered loans between $350,000 and $2 million; and
- 1% for covered loans of $2 million or greater.
- Paycheck Protection loans will be risk rated on the lender’s balance sheet as 0%, eliminating any requirement to hold additional capital.
- The CARES Act indicates that the SBA will coordinate with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and state bank regulators to “encourage those entities not to require lenders to increase their reserves” on account of payments from the SBA related to covered loans.
- If a Paycheck Protection loan must be modified due to COVID-19 related difficulties, the lender will not be required to report the modification as a troubled debt restructuring. (Note that federal banking agencies have also issued separate guidance related to modification of preexisting loans due to coronavirus-related distress or defaults).
What are the terms and conditions of Paycheck Protection loans?
Paycheck Protection loans are a type of SBA 7(a) loan, that must have, among other things, the following terms and conditions:
- No collateral requirement
- No personal guarantee requirement (but note: recourse possible against shareholder, member or partner of eligible recipient of a covered loan if loan not used for permitted purposes)
- Maximum interest rate of 4% per annum
- Maximum term of 10 years after the date borrower applies for forgiveness
- No prepayment penalty
- Deferral of all loan payments (including principal, interest and fees) for a minimum of six months and up to a maximum of one year. Guidance on deferment rules from SBA to be provided within 30 days of Act being signed into law.
The Secretary of Treasury is expected to issue additional guidance and regulations, including any other specific terms of covered loans.
What diligence must lenders require of the borrowers applying for and receiving Paycheck Protection loans and forgiveness of such loans?
A lender evaluating a Paycheck Protection loan application must verify that the potential borrower was in operation on February 15, 2020 and paid either employees (salary and payroll taxes) or independent contractors (as reported on a Form 1099-Misc). To properly calculate the amount of an available Paycheck Protection loan, lenders must also be able to verify the average number of monthly employees the borrower had during the 12 month period ending on the date of the loan, as well as the payroll costs incurred by the borrower in connection with those employees during such period. Payroll costs are defined as salary and wages to an employee up to $100,000 on an annualized basis; paid leave; retirement benefits; health insurance payments; and state and local payroll taxes. Lenders must also collect a good-faith certification from each borrower that loan funds are necessary to support ongoing operations given current economic conditions and that the borrower will use loan funds to retain workers, maintain payroll, or make mortgage, lease, or utility payments.
For a lender to properly forgive portions of loans used for covered purposes (and in order to be reimbursed by the SBA for amounts forgiven), a lender must ensure that the borrower submit an application and the following documentation:
- Verification of the number of full-time (or equivalent) employees on payroll and pay rates, for the period both prior to and after receipt of the covered loan;
- IRS payroll tax filings and state income, payroll and unemployment insurance filings;
- Proof of mortgage interest, lease and utility payments; and
- Certification from the borrower of the correctness of the documentation and that the requested forgiveness amount was used for qualified purposes.
Based on our reading of the Act, there does not appear to be clear criteria for lenders to follow when deciding whether to forgive a loan. There also does not appear to be a requirement that a lender must agree to forgive loans, even if a borrower meets all eligibility criteria. The criteria to determine forgiveness could be based on the forgiveness eligibility criteria or some other factors that the SBA explains in regulations it is to issue within 15 days, but as of the date of this writing, the answers to these questions are not entirely clear.
What if the potential borrower has already applied for or received an Emergency Economic Injury Disaster Loan through the SBA?
Over the past few weeks, businesses in all fifty states became eligible to apply for low interest 7(b) economic injury disaster loans directly through the SBA. Borrowers applying for or having already received a 7(b) disaster loan may also receive a Paycheck Protection loan, so long as the loans are not used for the same purposes. Additionally, borrowers that received a 7(b) disaster loan after January 31, 2020 may refinance the outstanding balance as a covered paycheck protection loan under the Program.
When will lenders have additional information?
The SBA must issue regulations within 15 days of enactment of the CARES Act. It is expected that the SBA will issue guidance in stages, and that the SBA will work to create a streamlined application process to be used by applying borrowers and lenders participating in the Program.
Who can we contact for additional information?
Bean Kinney & Korman’s lending attorneys, whose names and contact information are listed below, are available to answer any questions you may have about this new program, which is of extremely high interest among many of our clients at present. Please do not hesitate to contact us if we may be of assistance.
Joe Corish firstname.lastname@example.org
Andrea Davison email@example.com
Blake Frieman firstname.lastname@example.org
Zack Andrews email@example.com
This material is intended for general informational purposes only and does not constitute legal advice. The reader should consult legal counsel to determine how laws apply to specific facts and situations.