Last night, Congress passed the Paycheck Protection Program Flexibility Act of 2020, amending the CARES Act. Once signed by the President, this new law will provide much needed flexibility for small businesses and non-profit organizations that have received loans under the Paycheck Protection Program (PPP).
We previously issued client alerts regarding the PPP’s need-based certification, as well as the rules for loan forgiveness. In those alerts, we discussed challenges that borrowers would face to obtain full loan forgiveness, including reductions for FTE and salary/wage cuts, a cap on non-payroll expenses, and other limitations.
While the PPP Flexibility Act does not change loan qualification requirements, including the need-based certification, it does provide significant help to borrowers seeking loan forgiveness. In this alert, we examine the key changes.
1) Covered period extended from 8 weeks to 24 weeks
Section 1106 of the PPP allows borrowers to seek loan forgiveness for eligible “costs incurred and payments made” during an 8-week period. Through interim final rule SBA-2020-0032, the Small Business Administration (SBA) provided additional flexibility by allowing costs to be incurred or paid during the 8-week period. The SBA also permitted borrowers with bi-weekly or more frequent payroll cycles to begin their 8-week period (for payroll expenses) on the first day of the first pay period following loan disbursement, rather than on the date of loan disbursement.
While these adjustments helped, they did not address a core problem—many businesses have not fully reopened (either by choice or by order) and are operating with significantly reduced staffing. As a result, their eligible expenses during the 8-week period may fall far short of the full amount of their PPP loan. The PPP Flexibility Act seeks to address this, in part, by extending a borrower’s covered period for loan forgiveness from 8 weeks to 24 weeks. This allows borrowers an additional 16 weeks to use their loan proceeds towards eligible payroll and nonpayroll expenses and then to seek forgiveness for those expenses (capped at the principal and interest of their loan). Borrowers that received PPP loans prior to the PPP Flexibility Act may still elect to utilize their original 8-week period, however it is expected that most will instead select the 24-week period in order to maximize their loan forgiveness.
2) Extension of FTE and salary/wage safe harbors
Borrowers face reduction of their eligible loan forgiveness amount if their average FTE during their covered period (now 24 weeks) is less than the average FTE during the borrower’s reference period (for non-seasonal borrowers, either February 15, 2019 to June 30, 2019 or January 1, 2020 to February 29, 2020). Likewise, for certain employees, salary/wage cuts of more than 25 percent may also result in a forgiveness reduction. The PPP Flexibility Act does not eliminate the potential for these reductions to apply. But it does provide more flexibility for borrowers to meet safe harbors and avoid such a result.
Under the PPP, safe harbors existed for borrowers that cut FTE or salary/wages between February 15, 2020 to April 26, 2020, and then eliminated those reductions by June 30, 2020. The FTE safe harbor required that a borrower eliminate the collective FTE reductions by June 30, 2020 to qualify. Given that some states are still under stay-at-home orders and business activities are curtailed, many borrowers were not going to meet these safe harbors by the June 30 deadline.
The PPP Flexibility Act extends the June 30 deadline to December 31, 2020, giving borrowers an additional six months to restore FTE counts or salary/wage cuts that occurred between February 15, 2020 and April 26, 2020. Moreover, if a borrower is unable to rehire the employees it let go, or to rehire similarly qualified employees by December 31, 2020, the borrower may still qualify for the FTE safe harbor.
In addition, the PPP Flexibility Act creates a new safe harbor. It exempts a borrower from the FTE reduction to loan forgiveness if that borrower is “able to document an inability to return to the same level of business” it was operating at before February 15, 2020. That inability, however, must be because of an HHS, CDC, or OSHA requirement or guidance issued between March 1, 2020 and December 31, 2020, related to sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19. The contours of this safe harbor will likely be an area of much debate, and guidance from the SBA would be helpful.
3) 75 percent rule is reduced to 60 percent (well, kind of)
The PPP allows for forgiveness of payroll expenses, as well as certain designated nonpayroll expenses, including mortgage interest, covered rent, and covered utilities. While the statute does not require a certain percentage of the borrower’s loan to be spent on payroll costs, through interim final rule SBA-2020-0015 the SBA required that at least 75 percent of the loan forgiveness amount be spent on payroll expenses. This has a significant impact on restaurants and other businesses with higher fixed costs that were planning to use a significant portion of their loans on nonpayroll expenses.
Despite Treasury Secretary Steven Mnuchin’s support for the 75 percent rule, recently stating that the program is not called the “Overhead Protection Program,” Congress has now stepped in and reduced this requirement from 75 percent to 60 percent. While the decrease was intended to benefit borrowers, there are two aspects to the change that may have the opposite effect.
First, the SBA’s rule was that 75 percent of the loan forgiveness amount had to be spent on payroll costs, whereas the new statutory language refers to 60 percent of the “covered loan amount.” Thus, for some borrowers that are unable to spend their full loan proceeds on eligible expenses, the new 60 percent rule could result in a higher—not lower—requirement. For example, a borrower with a $1,500,000 loan that requests $1,000,000 in loan forgiveness would previously need to use $750,000 for payroll expenses (75 percent of the loan forgiveness amount). Now, that same borrower seeking $1,000,000 in loan forgiveness would need to show that $900,000 (60 percent of the covered loan amount) was used towards payroll expenses.
Second, the PPP Flexibility Act appears to apply an all or nothing approach. Under the SBA’s prior rule, a borrower that did not meet the 75 percent requirement would have experienced a reduction of its loan forgiveness amount but it was still eligible for forgiveness. The new statutory language, however, provides that “[t]o receive loan forgiveness under this section, an eligible recipient shall use at least 60 percent of the covered loan amount for payroll costs” and may use up to 40 percent for nonpayroll costs. Thus, according to the language, if a borrower uses 59 percent of its loan amount on payroll costs, that borrower may be ineligible to receive any loan forgiveness.
Both results appear to be unintended consequences of the PPP Flexibility Act and it would be helpful for the SBA to issue guidance clarifying how it will implement the new 60 percent rule.
4) Covered period of program extended from June 30 to December 31, 2020
Under Section 1102 of the PPP, the “covered period” was February 15, 2020 to June 30, 2020. The PPP Flexibility Act extends this “covered period” to December 31, 2020. This means that borrowers will have longer to spend their loan proceeds on allowable uses under Section 1102. Keep in mind, however, that the “covered period” utilized for Section 1102, as discussed here, is different than the “covered period” defined in Section 1106 and that is used for loan forgiveness (now extended from 8 weeks to 24 weeks).
5) Loan term increased from two to five years
The PPP provided that the loan term could not extend beyond ten years, but the statute did not set a minimum loan term. The SBA then determined, through interim final rule SBA-2020-0015, that PPP loan terms would be two years. The PPP Flexibility Act sets loan terms at a minimum of five years, meaning that borrowers will have an additional three years to pay off loan amounts which are not forgiven.
6) Longer deferment of interest
The PPP provided for interest deferment of not less than six months and not more than one year. Through interim final rule SBA-2020-0015, the SBA determined that interest would only be deferred for 6 months. The PPP Flexibility Act extends that six-month period until the date on which the amount of loan forgiveness under Section 1106 is remitted to the lender. If a borrower fails to apply for loan forgiveness within ten months of the last day of its covered period, as defined in Section 1106, then payments of principal, interest, and fees will begin at that point.
7) Delay of employer payroll taxes
Section 2302(a) of the CARES Act allows employers to delay paying their employer payroll taxes due between March 27, 2020 and December 31, 2020. Rather, fifty percent of those amounts must be paid by December 31, 2021 and the remaining fifty percent by December 31, 2022. This provision does not apply to all payroll taxes, but rather the 6.2 percent paid by employers under 26 U.S.C. § 1401(a). Nonetheless, delaying these taxes will be beneficial to businesses facing liquidity challenges during the current economic environment.
Section 2302(a)(3), however, excluded any employer from receiving this tax delay if they had indebtedness forgiven under the PPP. The PPP Flexibility Act removes this restriction and allows borrowers receiving PPP loan forgiveness to also delay their employer payroll taxes pursuant to Section 2302(a).
Here at Potomac Law Group, we are tracking PPP developments on a daily basis and will be updating clients as new developments and guidance comes out. If you are interested in an arrangement for your specific PPP loan to help maximize potential forgiveness and minimize risk, please reach out to firstname.lastname@example.org or review package offerings here to learn more.