Last week, the Federal Reserve Board announced changes to its long-awaited Main Street Lending Program (Main Street Program) that improve loan terms for borrowers and allow more small and medium-sized businesses to take advantage of the program.
The changes issued by the Fed last Monday include:
- Minimum loan size reduced from $500,000 to $250,000
- Maximum loan size increased to $35 million, $50 million, and $300 million, for the three respective loan facilities—MSNLF, MSPLF, and MSELF
- Loan terms extended from four years to five years
- Principal payments delayed for two years - interest is still delayed for one
- Amortization schedule delayed to 15 percent paid at the end of year three, 15 percent at the end of year four, and a balloon payment of 70 percent at the end of year five
- Reserve Bank’s participation raised to 95 percent for all three loan facilities—previously 85 percent for Main Street Priority Loan Facility
I. Main Street Lending Program
The Main Street Lending Program is a $600 billion loan program supported by a $75 billion Treasury Department equity investment of funds appropriated under Section 4027 of the CARES Act. Similar to the Paycheck Protection Program (PPP), it is a CARES Act program designed to provide a much needed lifeline to businesses suffering from the economic disruption caused by COVID-19. That may be where the similarities end.
- PPP administered by the Small Business Administration; Main Street Program is administered by the Federal Reserve System
- PPP loans are potentially forgivable; Main Street loans must be paid back with interest
- PPP loan maximum is only 2.5 times monthly payroll (capped at $10 million); Main Street loans can be up to six times 2019 EBITDA or as high as $300 million
- PPP loans have a one percent interest rate; Main Street loans are LIBOR + 300 basis points, plus origination fees
- Nonprofits may qualify for PPP loans; they (currently) cannot qualify for Main Street loans
- PPP loans are designed for small businesses—fewer than 500 employees, with certain exceptions; Main Street borrowers can have up to 15,000 employees or 2019 annual revenues of $5 billion or less
- There is no minimum PPP loan size; Main Street loans must be at least $250,000
- Banks retain no risk of loss in PPP loans; banks must maintain at least 5 percent risk in Main Street loans
II. Borrower and Lender Risks
As with the PPP, borrowers face potential criminal, civil, and administrative risks when obtaining federal loans under the Main Street Program. While PPP borrowers are required to make a host of certifications, those certifications pale in comparison to the list required by the Main Street Program. In addition, as reflected by a frequently asked questions document that has already climbed to 63 pages, the rules under the Main Street Program are even more complicated than PPP and leave significant room for interpretation.
As for lenders, the PPP was designed with significant lender protections, including a provision entitled “Hold Harmless” related to lenders’ obligations during the loan forgiveness process. The Main Street Program, on the other hand, contains eleven pages of transaction specific lender certifications and covenants, and requires more lender review and underwriting than PPP does. The memories of multi-billion dollar settlements by banks under the False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) stemming from financial crisis lending, and Federal Housing Administration insured loans, are far too fresh for lenders to jump into the Main Street Program without trepidation—and rightfully so.
III. Key Borrower Certifications and Covenants
On June 11, the Federal Reserve issued updated borrower and lender certifications and covenants under the Main Street Program. The borrower certifications and covenants must be made by the principal executive officer of the borrower and its principal financial officer.
A. Borrower is a Business
The borrower must certify that it is a business. Nonprofits are currently excluded from participation in the Main Street Program, although the Federal Reserve announced on June 8 that it is working to develop one or more loan options that are suitable for nonprofits. In addition, a joint venture with more than 49 percent participation by foreign business entities would not qualify as a business.
B. Date Business Established
The borrower must certify that it was established prior to March 13, 2020. A similar requirement exists under PPP, namely that the borrower was in operation on February 15, 2020. The early wave of criminal cases brought by the Department of Justice against PPP borrowers have included alleged fraud related to this certification.
C. Borrower is not an Ineligible Business
The borrower must certify that after reasonable, good faith diligence, it has no reason to believe it is an Ineligible Business. This certification requires affirmative effort on the part of the borrower to ensure that it is not among the list of Ineligible Businesses in 13 CFR § 120.110(b)-(j), (m)-(s). These include certain financial businesses, passive businesses, pyramid sales, private clubs, gambling institutions, and others. The Federal Reserve has stated that private equity funds are ineligible businesses for the Main Street Program as they are primarily engaged in investment or speculation. The determination of whether a business fits within 13 CFR § 120.110 is not always clear, and each application should carefully review the applicable regulations.
D. Size Qualification and Size of Loan
The borrower must certify that it has 15,000 employees or fewer, or that it had 2019 annual revenues of $5 billion or less. Importantly, borrowers must include employees and revenue of their affiliates, as described in 13 C.F.R. § 121.301(f), when making this assessment. The SBA’s affiliation rules captured in 13 C.F.R. § 121.301(f) require a fact-dependent analysis and provide significant room for interpretation and debate. Indeed, the regulation even provides that while “no single factor is sufficient to constitute affiliation, SBA may find affiliation on a case-by-case basis where there is clear and convincing evidence based on the totality of the circumstances.” Thus, questions of affiliation will not always be clear, yet borrowers must certify that the employees and revenues of affiliates are included when determining loan qualification.
In addition, depending on the loan facility utilized, a borrower’s loan amount is capped at either four or six times its adjusted 2019 earnings before interest, taxes, depreciation, and amortization (EBITDA), and the borrower must provide financial records in support of this calculation. The EBITDA methodology used must be a methodology that the lender utilized prior to April 24, 2020 when extending credit to similarly situated borrowers. Determining a borrower’s maximum loan amount will require collaboration between the borrower and the lender. While the borrower is responsible for its financial records and EBITDA calculation, it must use a methodology that is permitted by the lender.
E. United States Business
The Main Street Program requires that the business be created or organized in the United States and that it has significant operations in, and a majority of its employees based in, the United States. Significant U.S. operations include companies with more than 50 percent of their assets in the U.S. or that generate more than 50 percent of their net income, net operating revenues, or operating expenses in the U.S. In addition, a majority of its employees must be in the United States. To calculate whether a business has significant operations in the U.S. or a majority of its employees in the U.S., subsidiaries must be included, but parent companies or sister affiliates need not be.
F. Conflicts of Interest
The borrower must certify that it is not a Covered Entity. To make this determination, a borrower must conduct due diligence to ensure that a Covered Individual (certain government officials and family members) does not directly or indirectly hold a Controlling Interest (20 percent or more) in the business.
G. Restrictions During Loan Term
Borrowers must agree to comply with a host of requirements and restrictions during the duration of their loan. These include certain limits on compensation to officers and employees, limits on repurchases of equity securities, and limits on distributions. These restrictions should be closely analyzed by any business considering a Main Street loan.
H. Unavailable of Credit
Unlike the PPP, which expressly waived the requirement that a small business concern be unable to obtain credit elsewhere, the Main Street Program requires the borrower to certify that it is unable to secure “adequate credit accommodations” from other banking institutions. This does not mean that the borrower must show it is unable to obtain credit, but rather that it is unable to obtain credit on terms that are adequate for the borrower’s needs “during the current unusual and exigent circumstances.”
A borrower must also certify that it is not Insolvent. This is not limited to borrowers in bankruptcy or an insolvency proceeding, but also includes borrowers that were “generally failing to pay undisputed debts as they became due” during the 90 days preceding the date of the loan. This does not apply, however, if the borrower’s failure to pay debts was due to the COVID-19 pandemic. In addition, the borrower must certify that after giving effect to the loan, it can meet its financial obligations for at least the next 90 days.
J. Other Certifications
Additional borrower certifications relate to other funding received, financial records, early repayment of other debt, subordination of debt, use of the loan proceeds, notification and reporting requirements during the loan term, document retention, and more.
Finally, while not captured in a specific certification, the statute provides that “until September 30, 2020, the eligible business shall maintain its employment levels as of March 24, 2020, to the extent practicable, and in any case shall not reduce its employment levels by more than 10 percent from the levels on such date.” CARES Act, H.R. 748, Section 4003(c)(2)(G). The Federal Reserve, in FAQ G.8, states that a borrower should undertake “good-faith efforts to maintain payroll and retain employees” in light of its capacities, resources, its need for labor, and the economic environment.
IV. Key Lender Certifications and Covenants
Most of the lender certifications and covenants relate to compliance with various terms and conditions under the respective loan facility. Thus, careful drafting of the loan agreements and loan terms will help lenders to comply. Additional requirements, however, may present more challenge and risk of noncompliance.
A. Due Inquiry Required
A lender must certify, following due inquiry, that it has no knowledge or reason to believe that the borrower certifications as to its status as a business or its establishment prior to March 13, 2020 are untrue. The lender is expected to receive and review documentation reflecting the borrower’s legal formation in connection with this certification. Notably, the lender is not required to certify that the business is not an Ineligible Business which, as described above, is a more complicated inquiry.
B. EBITDA Calculation
The lender must certify that the loan amount does not exceed the borrower’s adjusted 2019 EBITDA by either four times or six times, depending on the loan facility. While the lender may rely on the financial records provided by the borrower and the borrower’s calculations, it must require the borrower to utilize a methodology that the lender has utilized for similarly situated borrowers on or before April 24, 2020—or in the case of the Expanded Loan Facility, the same methodology it used when originating or amending the eligible loan. Since the maximum loan amount is based on the EBITDA calculation, this is an area that lenders should monitor to ensure compliance with previously utilized EBITDA methodologies. In addition, if a borrower notifies the lender that an affiliate has received or applied for Main Street Lending, additional calculations using the affiliate’s EBITDA are required.
C. Loan Subordination
The lender must certify that the loan is not subordinate in terms of priority to any other borrower loans or debt instruments (with certain exceptions). The lender also must promise not to take actions that would result in the borrower’s loan becoming subordinate to its obligations owed to another creditor.
D. Risk Retention
The lender must certify that it will retain its 5 percent direct ownership share in the loan until either the loan matures, or the government no longer holds an interest.
E. Pass Rating
If a borrower had other loans outstanding with the lender as of December 31, 2019, the lender must certify that any such loans had an internal risk rating equivalent to a “pass” in the Federal Financial Institutions Examination Council’s supervisory rating system on that date.
F. Other Certifications
The lender must also certify that it will not require the borrower to repay other debt extended by the lender, unless repayment is mandatory, that it will not cancel or reduce existing committed lines of credit to the borrower, and that it will promptly notify the Special Purpose Vehicle and Reserve Bank of any material breach of a covenant made by the lender or any material breach by the borrower that it becomes aware of through the borrower’s self-reporting.
While it is unlikely that the Main Street Program will experience the same level of demand seen in the early days of the PPP, it is an important source of funds to help many small and medium-sized businesses in need. This includes businesses that already received PPP loans and need additional funding, as well as businesses that were too large to qualify for a PPP loan. Although, as with any federal loan program, significant strings attach, and borrowers and lenders should carefully weigh the risks before signing up.
Here at Potomac Law, we are tracking Main Street Lending Program developments and will update clients as new guidance comes out. If you are a borrower or lender seeking advice in connection with the Main Street Program, please reach out to firstname.lastname@example.org.
Note: This bulletin is for general use and should not be construed to provide legal advice as to particular factual situations.