What Will The Paycheck Protection Program Flexibility Act Mean For Your PPP Loan?
On June 3, 2020, the U.S. Senate passed the “Paycheck Protection Program Flexibility Act” (the “PPP Flexibility Act”), which previously had been passed by the House of Representatives on a vote of 417-1 on May 28. The President signed it into law on June 5, 2020.
The PPP Flexibility Act was the result of negotiations between the House and the Senate. It started with a much more ambitious bill, commonly called the HEROES Act, which passed in the House, but the Senate refused to consider it. In the ensuing negotiations, House Speaker Pelosi agreed to consider two slimmed-down bills that dealt only with the already enacted CARES Act. One of those bills was the PPP Flexibility Act, but the second bill, commonly called the “TRUTH Act,” failed in the House.
The PPP Flexibility Act is focused primarily on providing “relief” for PPP loan borrowers, and it succeeds in some ways. It also adds complexity to some borrowers’ planning, however, and still leaves open a number of questions that will require additional guidance from the SBA and Treasury, either in the form of additional Interim Final Rules or FAQs. There is no guarantee that any such additional guidance will be given. It also fails to provide any relief from an interpretation of the Treasury (IRS) that monies spent from a PPP loan for otherwise deductible expenses (e.g., payroll costs, interest on secured loans, rent and utility expenses) that are forgiven may not be deducted on the borrower’s federal income tax return (thus potentially causing phantom income because revenues that otherwise would be offset by deductions will not be offset).
The following is a summary of the provisions of the PPP Flexibility Act, along with our observations, in the order addressed in the statute.
LIMITED EXTENSION OF THE MATURITY DATE FOR PPP LOANS
The CARES Act provided that PPP loans would have a maturity of “up to 10 years,” but the SBA and Treasury instead decided that all PPP loans that are not forgiven would have a maturity of two years. The PPP Flexibility Act changes the maturity to five years from the date of funding, but this only applies to PPP loans that are “made” after the date of enactment of the PPP Flexibility Act. No definition of “made” is given, but other provisions make it likely that this term means when the loan is funded into the borrower’s bank account on or after the date of enactment. For this purpose, “enactment” occurred on June 5, 2020, the date that the President signed the PPP Flexibility Act into law.
Thus, for any borrower whose PPP loan was received prior to June 5, 2020, the maturity date will remain two years from the date of funding, unless a lender and borrower agree to extend the maturity date to five years.
It is interesting to note that this is the only provision of the PPP Flexibility Act that is not applicable to all PPP loans, whether received prior to, on or after June 5, 2020. This provision was heavily lobbied by the lenders, who did not want an automatic extension to five years.
EXTENSION OF TIME FOR USE OF PPP LOAN PROCEEDS
Under the CARES Act, the PPP loan program has a “covered period” that ends on June 30, 2020. This meant two things – (1) that PPP loans would only be available through June 30, and (2) that the proceeds of a PPP loan had to be used by June 30.
The PPP Flexibility Act extends this “covered period” to December 31, 2020. This is good news for small businesses which have not yet applied for or received a PPP loan, because it means that, as long as funds are available, PPP loans can be offered by lenders through December 31, 2020 (as of now approximately $511 billion of the $659 billion authorized under the program has been loaned).
- Planning Opportunity: This also offers those who already received a PPP loan some flexibility to extend the use of the funds over a longer time period, thus helping to better apply cash when it is best needed to address the continued economic downturn, rather than forcing a borrower to quickly use the funds before June 30, when its business may still be closed or limited by local ordinances. It also may help with the forgiveness process (see below).
- In Case You Were Wondering. Some may be wondering whether a person who already borrowed money under the PPP could make application for additional funds. If the person borrowed the maximum permitted by the CARES Act (essentially 2.5 times monthly payroll), the person cannot apply to borrow more PPP funds. The limit on the dollar amount that can be borrowed under the PPP was not changed by the PPP Flexibility Act.
EXTENSION OF TIME FOR USE OF PPP LOAN PROCEEDS AND TO DETERMINE FORGIVENESS
Under the CARES Act and previous guidance, the borrower only had eight weeks after the date of loan funding to use the PPP loan proceeds for purposes that would be eligible for forgiveness (subject to an “Alternative Payroll Covered Period,” for payroll costs; but although measured from a different starting date, this period still was only eight weeks). The PPP Flexibility Act extends this to the earlier of 24 weeks after loan origination or December 31, 2020. To illustrate, if a PPP loan is funded on or before July 16, 2020, then the borrower will have a full 24-week period in which to use the proceeds and count that use toward forgiveness, but if a PPP loan is funded after July 16, then the borrower’s period for use and forgiveness will end on December 31, 2020 (even though that is less than 24 weeks).
- Observation: For a borrower whose PPP loan was funded prior to June 5, 2020, the borrower has the discretion under the PPP Flexibility Act to choose to use either the new 24-week covered period or the original eight-week covered period for calculating forgiveness of the PPP loan, even if the eight-week period will end after June 30, 2020 (i.e., the June 30 date no longer has relevance).
- Planning Opportunity: For a borrower whose PPP loan was funded early, so the borrower is currently in the latter weeks of the original eight-week period, it may still make sense to elect to stay with the eight-week covered period, if planning already has achieved its goal of maximizing forgiveness. For example, if the PPP loan proceeds were used to maintain the workforce to preserve full forgiveness, an additional time period might jeopardize the ability to obtain full forgiveness, if there are not sufficient funds to retain all of the employees over the balance of the 24-week period (so the borrower would need to furlough or lay off employees after the initial eight weeks). On the other hand, if a borrower needs more time, the PPP Flexibility Act gives 16 more weeks in which to pay costs to maximize forgiveness, so utilizing the 24-week period could make sense. This can be substantial for a borrower with one or more employees (or employee-owners) whose annualized compensation is in excess of $100,000, because it increases the amount of payroll cost for these people from a maximum of $15,385 to a maximum of $46,154 (based upon the calculation formula used by the SBA in its IFR on Loan Forgiveness). Each borrower will need to make that calculation based upon its, his or her individual circumstances.
- Observation: As it is drafted, it appears that the default will be the new 24-week covered period, so we will need to wait for further SBA guidance on how a borrower could elect to stay with the eight-week covered period. Presumably, the SA will publish a revised Loan Forgiveness Application in the near future.
EXTENSION OF TIME FOR RESTORATION OF FTES AND SALARY/WAGES TO AVOID REDUCTION IN FORGIVENESS
Under the CARES Act and previous guidance, a borrower had until June 30, 2020 to restore its number of FTEs to pre-February 15, 2020 levels and to restore salary/wage rate cuts in order to avoid a proportionate reduction in the forgiveness amount. By eliminating June 30 as a relevant date, the PPP Flexibility Act extends the period until December 31, 2020. Thus, as long as a borrower restores its FTE count to pre-February 15, 2020 levels or restores salary or wage cuts by December 31, 2020, there will be no reduction in the forgiveness amount under the CARES Act’s safe harbor. This could be a significant benefit for many borrowers who will not return to full open capacity by June 30, 2020.
- Observation: There still are open questions in this regard, and given that the SBA has yet to address these open questions, it is possible that we will never have answers. For example, the PPP Flexibility Act says restoration of FTES or salary/wages must occur “no later than” December 31, 2020. What if a borrower achieves full restoration at a point before December 31, but loses several FTEs before December 31? Can the borrower hire staff to achieve full restoration on December 31, and then lay off those people shortly thereafter?
NEW EXEMPTIONS FROM FORGIVENESS REDUCTION
As we discussed in our Client Alert on the SBA’s IFR on Loan Forgiveness, the SBA added a number of situations in which a borrower will not need to count a loss of FTEs for a reduction in the forgiveness amount. These include firing an employee for cause, an employee voluntarily quitting, an employee requesting reduced hours, and the borrower offering the employee a return to work at the same wage rate and hours and the employee rejects the offer (subject to the borrower notifying the State unemployment agency).
The PPP Flexibility Act adds two new statutory exemptions. First, a borrower is not required to include an FTE if the borrower can document: (1) “an inability to rehire individuals who were employed by [the borrower] on February 15, 2020,” and (2) “an inability to hire similarly qualified employees for unfilled positions on or before December 31, 2020.” Note that this is a two-part test, and both parts must be satisfied to qualify for this new exemption.
- Observation: This statutory exemption raises new unanswered questions: What constitutes “inability”? Would lack of funds, a market compensation in excess of what the borrower paid the previous employee, or the need to pay recruiting fees, moving expenses and the like qualify? Can the borrower limit its search for new hires just to the local community, or does it need to cast a wider net?
- Observation: We do not know whether the SBA will retain its regulatory safe harbor for offering a return to a position that is rejected, or whether it might choose to replace that exemption with this statutory exemption. If the latter, that would not be good news, because the two parts of this exemption appear to be more difficult to achieve than the requirements of the SBA’s regulatory exemption.
Second, the borrower will not need to count a loss of FTEs if the borrower “is able to document an inability to return to the same level of business activity as such business was operating at before February 15, 2020, due to compliance with requirements established or guidance issued by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration during the period beginning on March 1, 2020, and ending December 31, 2020, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.”
- Observation: There is significant ambiguity in this language, so we hope to receive guidance on this exemption from the SBA.
REPLACEMENT OF THE “75/25 RULE” WITH THE “60/40 RULE”
Although the CARES Act did not include any such requirement, the SBA and Treasury independently added a requirement that at least 75% of the PPP loan proceeds must be used for payroll costs, and no more than 25% could be used for non-payroll costs, and the rule was extended to set one of the limits on loan forgiveness at an amount determined by the formula “payroll costs ÷ .75.” For example, if a borrower received a $150,000 PPP loan, then SBA would require that at least 75% ($112,500) be used for payroll costs, and no more than $37,500 could be used for non-payroll costs as eligible expenses. In addition, if the borrower only used $100,000 for payroll costs, then the maximum forgiveness that the borrower could achieve would be limited to $133,333 [$100,000 ÷ .75], and the most that the borrower could use for non-payroll costs that would count toward forgiveness would be $33,333.
The PPP Flexibility Act replaces this so-called “75/25 rule” with a new statutory requirement (the “60/40 rule”), which states that the borrower must use “at least 60 percent of the [PPP loan] amount for payroll costs, and may use up to 40 percent of such amount for any payment of interest on any covered mortgage obligation (which shall not include prepayment of or payment of principal on a covered mortgage obligation), any payment on any covered rent obligation, or any payment on any covered utility payment.”
- Observation: Although this 60/40 rule, at first sight, appears to be a liberalization of the SBA’s position (and, in fact, the heading of the provision is “Limitation on Forgiveness”), it actually is much more draconian. The provision begins with the phrase “[t]o receive loan forgiveness under this section.” In other words, while the 75/25 rule acted as a limitation on the amount of forgiveness, the 60/40 rule is an “all or nothing” proposition – either the borrower spends at least 60% of the PPP loan proceeds on payroll costs, or the borrower will receive no forgiveness. Thus, in the example above, if the borrower has a $150,000 PPP loan, then at least $90,000 (60%) must be spent on payroll costs. If only $89,999 is spent on payroll costs, there will be no forgiveness at all.
PAYMENT DEFERRAL – DEADLINE FOR FILING FORGIVENESS APPLICATION
Under the CARES Act and applicable guidance, the initial payment of the principal and interest that is not forgiven was deferred for six months from the date the PPP loan was funded. There was no stated deadline for when the loan forgiveness application needed to be filed, so it was possible that (because it takes approximately 150 days after filing for the SBA to make a final decision on forgiveness) the borrower would need to start making loan payments before the final forgiveness was known.; This put lenders in a difficult position, because they would need to make the SBA whole if it paid a PPP loan that was forgiven in full to the lender who already had received payments from the borrower. To fix this problem, the PPP Flexibility Act changes the period during which the principal and interest payments are deferred “until the date on which the amount of forgiveness determined under section 1106 of the CARES Act is remitted to the lender.” Thus, the repayment period for any unforgiven portion of a PPP loan will begin when the forgiveness amount is finally determined by the SBA and paid to the lender.
In addition, the PPP Flexibility Act adds a requirement that a borrower must file the loan forgiveness application “within 10 months after the last day of the covered period defined in section 1106(a) of the CARES Act,” or the borrower forfeits the right to forgiveness and will be required to repay the entire PPP loan amount plus accrued interest. Recall that the “covered period” under the forgiveness provision (section 1106) of the CARES Act is the earlier of the lapse of 24 weeks after the PPP loan was funded or December 31, 2020. This effectively means that payments under the PPP loan will not commence before at least ten months after the end of the loan forgiveness covered period.
- Planning Opportunity: The “deadline” created by the PPP Flexibility Act appears to give the borrower some opportunity to set its own deferral period, by deciding when to file the loan forgiveness application. Because the loan forgiveness cannot be determined until at least after December 31, 2020 (because that is the end of the safe harbor period to replace reduced FTEs and salary/wages), the borrower likely would want to wait until then, at the earliest, to file its forgiveness application (unless it is clear at the end of the eight-week period that full forgiveness has been achieved, in which case, the borrower would probably choose to file early). If the borrower’s covered period for forgiveness ends on December 31, 2020, then the borrower can delay any repayment until at least November 1, 2021. Of course, borrowers should be careful – the SBA could nix this planning opportunity if it chooses to publish a required timeline for filing the loan forgiveness application, so we will need to keep an eye on this.
DEFERRAL OF PAYMENT OF EMPLOYER PAYROLL TAXES
Separate from the PPP loan provisions, the CARES Act provided relief to employers from the payment of the 6.2% employer’s portion of FICA taxes by allowing a deferral of the taxes due in 2020 until 2022, with 50% being due in 2021 and 50% being due in 2022. However, an employer that obtained a PPP loan was denied this relief. The PPP Flexibility Act removes this exception, so an employer now can obtain a PPP loan and also take advantage of the deferral of employment taxes.
 Many expected Congress to deal with this income tax issue, because both the Chairman of the House Ways and Means Committee and the Chairman of the Senate Finance Committee (which have jurisdiction over the IRS) have publicly stated that this interpretation is contrary to the intent of Congress. No relief was included in the PPP Flexibility Act, however. It was addressed in the TRUTH Act, which did not make it out of the House. Thus, borrowers still are at a tax disadvantage from the forgiveness, unless Congress chooses to act at a later time.