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Key Aspects and Unanswered Questions on Loan Forgiveness Under the Paycheck Protection Program

    Client Alerts
  • April 18, 2020

UPDATE: On May 15, the SBA and Treasury Department released the loan forgiveness application that borrowers of a Paycheck Protection Program loan must use to determine the forgivability of that loan. Please see our alert discussing key aspects of the application, including its answers to some of the questions raised below, here.

Many applicants for Paycheck Protection Program (PPP) loans under the CARES Act have begun receiving loan proceeds. Now that loan proceeds are beginning to be deployed, borrowers are now focusing on how they can use the loan proceeds and what requirements apply in order for the borrower to qualify for full or partial forgiveness of the loan amount. The rules for allowable uses and forgivability are separate but interconnected and both must be understood to make informed decisions regarding the use of PPP funds. Borrower beware: not all allowable uses may qualify for forgivability.

This client alert addresses forgivability of PPP loans. For general information regarding PPP loan terms and eligibility, please see our April 7 alert. For more details on the allowable uses of PPP loan proceeds, click here. Also note that although guidance has been provided on some aspects of the PPP, many provisions remain unclear. In particular, currently there are a number of unanswered questions regarding the details of loan forgiveness, and the implementing regulations for loan forgiveness are not required to be published until April 27, 2020. The regulations and other expected guidance should add more clarity and very well may impact how companies approach the expenditure of funds and forgivability. We plan to update this analysis as additional guidance is provided.

Forgivability Generally

In summary, up to 100% of the principal amount of the loan may be forgiven so long as:

  1. The loan proceeds were used for certain permitted purposes during the eight-week period beginning on the date the lender makes the first disbursement of the PPP loan to the borrower.
  2. Not more than 25% of the proceeds were used for non-payroll purposes.
  3. The borrower’s employee headcount and employee compensation levels during the covered period meet or exceed its headcount and employee compensation levels for specified prior periods.

Maximum Forgivable Amount

The maximum forgivable amount (MFA) of expended PPP loan proceeds equals the sum of the costs incurred and payments made during the covered period by the borrower for payroll costs and certain non-payroll costs. (We will discuss non-payroll costs below, and you can find more details on what counts as payroll costs here.) The SBA has not issued guidance on the meaning of “costs incurred and payments made,” but the implication is that to be eligible for forgiveness loan proceeds must be used to pay expenses that were both incurred and paid in the covered period. Thus, borrowers may wish to avoid using loan proceeds to prepay expenses that would otherwise not be paid during the covered period.

According to the CARES Act, forgivable non-payroll costs consist of:

  • Payments of interest on mortgage obligations on real or personal property, incurred before February 15, 2020.
  • Rent payments on leases dated before February 15, 2020.
  • Utility payments under service agreements dated before February 15, 2020.

Borrowers should be aware that based on a literal reading of the CARES Act the following do not constitute forgivable non-payroll costs even though they are allowable uses of loan proceeds: (a) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums; (b) mortgage interest, rent, and utility payments for obligations incurred after February 15, 2020; and (c) interest payments on any other debt obligations, whether incurred before or after February 15, 2020.

Reductions of the Maximum Forgivable Amount

The MFA is subject to reduction as follows:

The 25% Rule

No more than 25% of the MFA may be attributable to forgivable non-payroll costs. Thus, applying the 25% rule will decrease the MFA by the amount by which forgivable non-payroll costs exceed 25% of the MFA.

Employee Retention Requirements

After any reductions due to the 25% rule, the borrower’s MFA will be reduced by multiplying the MFA by a percentage equal to the average full-time equivalent employees per month during the covered period divided by the borrower’s average full-time equivalent employees per month from either February 15, 2019 to June 30, 2019, or January 1, 2020 to February 29, 2020. (The borrower can choose either period.)

If a borrower eliminates by June 30, 2020 any reduction in its number of employees that occurred between February 15, 2020 and April 26, 2020, then such reduction will be ignored for purposes of the employee retention calculation. At this point, without final regulations it is not clear whether this is an all-or-nothing test where the reduction is ignored only if all of the employees are hired back, or if a portion of the forgivability will be restored for hiring back some, but not all, of the employees by June 30.

Although the CARES Act allows the rehire to occur by June 30, 2020, in order to obtain valuable forgiveness, the borrower must spend the loan proceeds – with at least 75% going toward payroll costs – during the eight-week covered period. Consequently, the rehiring of employees would likely need to occur quickly during those eight weeks.

Compensation Maintenance Requirements

After application of the 25% rule and the employee retention requirement, the borrower’s MFA will be reduced dollar for dollar by the amount of compensation reduction that exceeds 25% for certain employees. Based on the plain language of the CARES Act, these certain employees are employees who did not receive salary or wages in any pay period in 2019 at an annualized rate of $100,000 or more.

The compensation reduction is to be calculated by comparing (a) the total compensation of a covered employee during the covered period with (b) the total compensation of the covered employee during the most recent full quarter during which the covered employee was employed prior to the covered period. There is no guidance at this time on how this percentage will be calculated in practice.

For those covered employees whose compensation was reduced between February 15, 2020 and April 26, 2020, a borrower can ignore these reductions when calculating loan forgiveness if the borrower eliminates the reductions by June 30, 2020. It is unclear from the statute if the borrower is required to restore the compensation of covered employees to 100% or merely restore compensation to 75% of levels as of February 15. It is also unclear if this calculation considers all applicable employees on an aggregated or individual basis.

Compensation Maintenance for Tipped Employees

The CARES Act provides that a borrower may receive forgiveness for additional compensation paid to employees who are tipped employees under the Fair Labor Standards Act.  However, at this stage, there is little guidance from the SBA on this aspect of the statute. Practically speaking, this provision may mean that the borrower can use the PPP loan proceeds to pay the tipped employees (a) their prior base-wage plus (b) what they would have made in tips during the covered period. We are hopeful this will be addressed in the forthcoming regulations.

We have a team of people at Parker Poe who are tracking all of this constantly. For more information, please contact us or your regular Parker Poe contact. You can also find our other COVID-19 related alerts here.