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4 Tips for Pursuing Principal Forgiveness of a PPP Loan
4 Tips for Pursuing Principal Forgiveness of a PPP Loan

The Paycheck Protection Program (“PPP”) has been a highly popular relief program for small businesses passed in response to the COVID-19 pandemic. The PPP allows small businesses to obtain government-backed loans from private lenders which, if spent properly on payroll, rent, utilities and/or mortgage interest, can be all or partially forgiven. Over the last month, small businesses have been hastily flocking to lenders to obtain loans from the limited pool of funding, and lenders have been diligently working to properly review, document, and fund the loan requests. Up to this point, there has been little instruction from the SBA regarding the mechanics of the loan forgiveness feature that is soon to become a critical phase at the “back end” of the program.

Per the CARES Act, small businesses have eight weeks from the date of loan funding to make expenditures that will be credited towards loan forgiveness. Many loans were funded in mid to late April. Borrowers must ensure now that they are spending loan funds properly in order to qualify for maximum loan forgiveness. Additionally, lenders need to prepare now for the large wave of debt forgiveness requests that will likely begin flowing in just a few short weeks and to determine the protocol for evaluating such requests. This article attempts to point out some tips relevant to both borrowers and lenders in navigating the debt forgiveness process.

Tip 1:  Be aware that not all of the PPP loan may be forgiven, even if it’s spent entirely on payroll costs.

The amount of a PPP loan forgiveness that a borrower qualifies for is based on its historical payroll costs. However, one feature of PPP loans that is easy to overlook is that payroll costs are only forgivable during a period of eight weeks commencing as of the date the loan is received by a borrower, even though a borrower is generally eligible for a PPP loan in an amount equal to two and one half months’ worth of payroll. In other words, assuming the borrower applies for the maximum available loan amount, the borrower will not be entitled to full debt forgiveness if it simply spends the loan proceeds on payroll and maintains its normal levels of payroll. We have found this fact is especially easy to overlook by borrowers who have relied on easy-to-use reports from their payroll companies to fill out the standard SBA application forms. Many payroll company calculations have simply provided the historical monthly average payroll figure, which many borrowers then multiplied by 2.5 to complete the standard SBA application form, as such form instructed. However, taking the historical payroll amount from the payroll company (or accountant) and multiplying it by 2.5 will often lead to a loan amount greater than the expected payroll costs over the eight week period that payroll is eligible for forgiveness. Borrowers can spend the loan funds on rent, utilities, or mortgage interest during the eight week period to qualify for forgiveness, but these expenses will only be forgivable up to a maximum amount of 25% of the loan amount. To qualify for full forgiveness, borrowers must therefore spend at least 75% of the loan on payroll during the eight week period and spend the other 25% on either rent, utilities, or mortgage interest or spend it on additional payroll costs (up to the maximum eligible amounts per employee, as discussed below).

Tip 2:  Payroll timing can have a major impact on amount to be forgiven.

The period during which expenses are eligible for forgiveness is tied to the date the loan is funded. The forgiveness period is not dependent on business’s payroll dates. Frequency and timing of payroll can have a significant impact on loan forgiveness amount. For example, businesses who pay employees bi-monthly (i.e. 24 pay periods per year) as opposed to bi-weekly (i.e. 26 pay periods per year) may miss inclusion of an extra payroll period towards forgiveness if they simply maintain their existing payroll schedule. Consider this example. A company runs payroll bi-monthly on the 15th and 30th/31st of each month. The company has a PPP loan funded on May 1, which means it has until June 26 (8 weeks, or 56 days) to make payments that qualify for forgiveness. This company, assuming it maintains its normal payroll schedule, will qualify for forgiveness (up to eligible amounts per employee) of the three payrolls it runs on May 15, May 31st, and June 15. This represents 12.5% of its annual payroll.  Now consider a company that also gets a loan funded on May 1, but it runs payroll bi-weekly every other Friday. Assume May 1 was a day on which it was scheduled to run payroll. This company will qualify for forgiveness (up to eligible amounts per employee) for the five payrolls it runs on May 1, May 15, May 29, June 12, and June 26. This represents 19.2% of its annual payroll. These numbers are provided for example purposes only and are not meant to suggest that a bi-monthly payroll is necessarily more advantageous than a bi-weekly payroll. However, the example is meant to illustrate the importance of payroll timing on the loan forgiveness calculations. Companies should consider, to the extent they can, adjusting the timing of their payrolls so that more payroll is paid during the eight week loan forgiveness period in order to maximize the forgiveness amount. Note that loans are forgiven based on actual payroll paid, not payroll amounts accrued but not yet paid. 

Tip 3:  Salary and wages are capped at an annualized amount of $100,000 per employee, but benefits and other compensation are not.

Businesses should be aware that they will only be eligible for forgiveness to the extent they pay employees an annualized salary of $100,000 prorated for the eight week forgiveness period. In other words, only $15,384 (rounded down to the nearest dollar) paid to an employee in salary or wages will be eligible for loan forgiveness. This amount represents $100,000 prorated to eight weeks. (Note once again the difference between monthly and weekly payroll. The $100,000 cap is prorated over eight weeks, not two months. Businesses and lenders should use caution in calculating the caps based on monthly payroll). This cap does not apply, however, to other kinds of “payroll costs” that are not salary or wages. For example, say a company pays an employee an annual base salary of $150,000. Assume also that the employer pays 50% of the employee’s health insurance premiums (valued at $1,200 per year) and makes an employer contribution to the employee’s 401k equal to 4% of the employee’s base salary ($4,800 per year). Even though this employee’s salary prorated over eight weeks would be $23,076.92, only $15,384.62 of salary will be eligible for forgiveness. However, the prorated amounts of health insurance premiums ($184.62) and 401k contributions ($738.46) would be eligible for forgiveness. Timing is again a key component of maximizing forgiveness. Businesses should also keep in mind that the employer side federal payroll taxes (such as FICA) are still payable and are not forgivable, even for payroll that is eligible for loan forgiveness.

Tip 4:  Make sure documentation of payments made, staffing levels, and prior compensation paid to employees is ready and available.

The SBA has not issued much guidance as to what specific documentation lenders are to rely on in order to calculate forgiveness amounts. However, based on the CARES Act language and the SBA PPP interim rule, lenders will need to verify that all forgivable payroll costs were actually made and all forgivable rent, utilities, or mortgage interest costs were actually incurred during the eight week forgiveness period. It will therefore be critical for businesses to have ready and available documentation that evidences the payments made and the recipients of such payments. Additionally, the payroll data needs to be broken down to the individual employee level and historical payroll data is also needed. This is because the loan forgiveness amount is dependent on maintaining staffing levels as compared to what they were during the period of February 15, 2019 to June 30, 2019 (or in some instances, upon election, from January 1, 2020 to February 29, 2020). Loan forgiveness is also reduced to the extent that an individual employee’s salary or wages is decreased by more than 25% of what the employee earned in salary and wages during the last full calendar quarter that the employee worked for the business. (Note that more guidance is likely needed from the SBA to answer questions about how this calculation will work for employees who were not employed for a full previous calendar quarter, among other things). The bottom line is that businesses seeking forgiveness will need to submit payroll documentation covering both the prior year and the eight week forgiveness period for the necessary comparisons and calculations to be made. Businesses should therefore reserve time to meet with their accountant and payroll service to discuss the documentation needed and calculations being made. Businesses should generally start gathering appropriate documentation from the prior year now (to the extent they haven’t done so already) and be prepared to obtain the documentation for the eight week covered period soon after such period ends in order to apply for loan forgiveness as quickly as possible.

An incredible number of applications for PPP loans have been submitted to lenders and with the most recent increase in appropriations for such program, the applications continue to be made. Once the loans have been made, the period for making forgivable payments begins running. Businesses therefore need to be ensured they are smartly spending loan proceeds now in order to maximize forgiveness later. Lenders also need to be aware of the documentation, and information verification they will need to be provided in order to process forgiveness requests within 60 days of a written request of a borrower as mandated by the CARES Act. While the SBA has not yet issued much in the way of specific guidance on the mechanics of loan forgiveness, now is the time to prepare for what is sure to be a massive wave of loan forgiveness requests, questions, analysis and potential pushback by the lenders to the extent insufficient evidence of the use of such funds qualifying for forgiveness is not provided. 

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.

  • Joseph P. Corish
    Shareholder

    Joseph Corish is a shareholder of Bean, Kinney & Korman, practicing primarily in commercial finance and complex loan transactions. He has a depth of knowledge in real estate loans, asset based loans, commercial and industrial loans ...

  • Blake W. Frieman
    Associate

    Blake Frieman is an associate attorney at Bean, Kinney & Korman who specializes in commercial lending. He routinely represents lenders in the documentation, negotiation, and closing of commercial loan transactions, including ...