Update Regarding Loan Forgiveness Under the Paycheck Protection Program
As of May 26, 2020
On March 27, 2020, Congress passed and the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which is an approximately $2 trillion stimulus and economic relief package. One principal feature is the loan program known as the Paycheck Protection Program (“PPP”), to be administered by the Small Business Administration (“SBA”). On April 24, 2020, the President signed into law the Paycheck Protection Program and Health Care Enhancement Act, providing additional funds for the PPP (the “Enhancement Act”). The most significant feature of a PPP loan is if the borrower complies with certain requirements, some or all of the PPP loan will be forgiven.
On Friday, May 15, 2020, the SBA released the Loan Forgiveness Application that borrowers will be required to submit to determine how much, if any, of their PPP loan will be forgiven, together with detailed instruction on how to complete such application (collectively, the “Application”).
Building on the guidance it provided in the Application, on May 22, 2020, the SBA, in consultation with the U.S. Treasury, issued its Interim Final Rules on Loan Forgiveness (the “Rules”), which provides additional guidance on Loan Forgiveness and which clarifies a number of matters relating to Loan Forgiveness.
We previously prepared a detailed Frequently Asked Questions blog (as of May 18, 2020), relating to issues arising out of such Application (the “May 18 FAQ”). This Update is a supplement to such May 18 FAQ.
A. Do the Rules provide a clearer description of payroll costs?
Yes, Footnote 2 of the Rules provides a more detailed description of “Payroll Costs” than prior guidance, namely that “Payroll Costs” consist of:
(i) compensation to employees (whose principal place of residence is the United States) in the form of salary, wages, commissions, or similar compensation; cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good faith employer estimate of such tips);
(ii) payment for vacation, parental, family, medical, or sick leave;
(iii) allowance for separation of dismissal;
(iv) payment for the provisions of employee benefits consisting of group health coverage, including insurance premiums, and retirement;
(v) payment of state and local taxes assessed on compensation of employees; and
(vi) for an independent contractor or sole proprietor — wages, commissions, income or net earnings from self-employment, or similar compensation.
NOTE: The Rules did not provide any definition as to what “retirement” means. Presumably, it would include employer contributions to a qualified 401k plan, a pension, and a profit-sharing plan, but we are still waiting for additional guidance from the SBA.
B. What guidance do the Rules provide on the $100,000 cap, bonuses and tips?
For each individual employee the total amount of cash compensation eligible for forgiveness may not exceed an annual salary of $100,000, which equates to $15,385 during the Covered Period (or Alternative Payroll Covered Period). The Rules provide additional guidance on this limitation in a number of ways:
1. General; 75/25. Per guidance provided with the Application, for a non-sole proprietor/independent contractor borrower, only Items A(i), (ii), and (iii) above are subject to such $100,000/$15,385 limitation. Still, while health insurance premiums, employer contributions to retirement, and state and local payroll taxes are not subject to such limitation, they are considered “Payroll Costs” for purposes of the rule that 75 percent of PPP Loan proceeds to be forgiven must be spent on Payroll Costs.
2. Bonuses. Hazard pay and bonuses are permitted to be paid to an employee during the Covered Period (or Applicable Payroll Covered Period) and generally will be considered a forgivable expense; provided that such employee’s total cash compensation does not exceed $15,385 over the Covered Period (or Applicable Payroll Covered Period).
3. Tips. The Rules definition of “Payroll Costs” makes clear that tips may be included as cash compensation eligible for forgiveness (even though tips come from customers and not the borrower/employer); provided that such employee’s total cash compensation, including such tips, does not exceed $15,385 over the Covered Period (or Applicable Payroll Covered Period).
C. What further guidance do the Rules provide on non-payroll costs?
1. General. Generally, forgivable Non-Payroll Costs consist of the following:
(a) Business Mortgage Interest Payments. Interest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020 (but not any prepayment or payment of principal);
(b) Business Rent or Lease Payments. Payments on business rent obligations on real or personal property under a lease agreement in force before February 15, 2020; and
(c) Business Utility Payments. Business utility payments for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.
2. No Prepayments; No Principal. Advanced payments of interest (i.e., prepayments) on a covered mortgage obligation are not eligible for loan forgiveness. Principal payments are not eligible for forgiveness under any circumstances.
3. Timing of Non-Payroll Cost Payments. Non-Payroll Costs (e.g., mortgage interest, rent, and utilities) can be paid or incurred during the Covered Period and still be eligible for forgiveness; provided that it is paid on or before the next billing date with respect to such cost, even if the billing date is after the Covered Period.
Example: A borrower’s Covered Period begins on June 1 and ends on July 26. The borrower pays its May and June electricity bill during the Covered Period and pays its July electricity bill on August 10, which is the next regular billing date. The borrower may seek loan forgiveness for its May and June electricity bills, because they were paid during the Covered Period. In addition, the borrower may seek loan forgiveness for the portion of its July electricity bill through July 26 (the end of the Covered Period), because it was incurred during the Covered Period and paid on the next billing date.
NOTE: A borrower is not permitted to “prepay” obligations arising after the Covered Period. Thus, even though the borrower may pay the bill on the next billing statement after the Covered Period, only the portion of the bill relating to the Covered Period is eligible for forgiveness. However, a borrower is permitted to pay Non-Payroll Costs incurred prior to the Covered Period (e.g., the May electricity bill). These prior-due Non-Payroll Costs are forgivable provided such contracts were in place as of February 15, 2020, and such prior-due Non-Payroll Costs are actually paid during the Covered Period.
D. What guidance do the Rules provide regarding reduced forgiveness based on FTE reduction and reduced compensation?
As previously discussed in the May 18 FAQ, subject to certain exemptions and the Safe Harbor rules (described below), the amount of the PPP loan otherwise forgiven will be reduced by the percentage amount of the headcount reduction in Full-Time Equivalent (“FTE”) employees. Similarly, the PPP also reduces the amount of the PPP loan otherwise forgiven if the borrower reduces any employee’s salary or hourly wages by more than 25 percent.
The Rules provide further clarification to prevent a double penalty in the case where a borrower has reduced the hours of an employee but has not reduced such employee’s hourly rate. The Rules make clear that while reduction of hours may result in a reduction in FTE headcount, it will not also cause a reduction based on compensation paid. Specifically, the Rules provide that “the salary/wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction.”
Example: An hourly wage employee had been working 40 hours per week during the borrower’s selected reference period (FTE employee of 1.0) and the borrower reduced the employee’s hours to 20 hours per week during the covered period (FT employee of 0.5). There was no change to the employee’s hourly wage during the covered period. Because the hourly wage did not change, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction and the borrower is not required to conduct a salary/wage reduction calculation for that employee.
E. What if a borrower terminates the employee for cause or the employee resigns or requests a reduction in hours?
The Rules clarify that a borrower’s loan forgiveness amount will not be reduced if an employee is fired for cause, voluntarily resigns, or voluntarily requests a schedule reduction.
F. How do the Rules treat the reduction exemption if the borrower offers to rehire the employee or restore hours?
The Rules provide further clarification regarding what happens when a borrower offers to rehire a previously laid-off employee or offers to restore the reduction in hours to an employee whose hours were previously reduced, and the employee declines the offer. The Rules clarify that a borrower may exclude any reduction in Full-Time Equivalent employee headcount that is attributable to an individual employee if:
(i) the borrower made a good faith, written offer to rehire such employee (or, if applicable, restore the reduced hours of such employee) during the Covered Period or the Alternative Payroll Covered Period);
(ii) the offer was for the same salary or wages and same number of hours as earned by such employee in the last pay period prior to the separation or reduction in hours;
(iii) the offer was rejected by such employee;
(iv) the borrower has maintained records documenting the offer and its rejection; and
(v) the borrower informed the applicable state unemployment insurance office of such employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer.
NOTE: Item (v) is a new requirement. In addition, a footnote to the Rule states that “Further information regarding how borrowers will report information concerning rejected rehire offers to state unemployment insurance offices will be provided on SBA’s website.”
G. How do the Rules treat the FTE reduction and compensation Safe Harbors?
1. FTE Reduction Safe Harbor: The Rules confirm that if the FTE employee headcount was reduced between February 15, 2020 and April 26, 2020 (the Safe Harbor Period) but the borrower eliminates those reductions by June 30, 2020 or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in FTE employees.
2. Compensation Safe Harbor: The Rules confirm that if certain employee salaries and wages were reduced between February 15, 2020 and April 26, 2020 (the Safe Harbor Period) but the borrower eliminates those reductions by June 30, 2020 or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in salaries and wages.
Keith T. Zimmet is the Chair of our Commercial Finance Practice Group, and President and Managing Shareholder of our firm.
This information provides an overview of a specific developing situation. It is not intended to be, and should not be construed as, legal advice for any particular fact or situation.