On March 27, 2020, the Corona Virus Relief and Economic Security Act (“CARES Act”) became effective. Included within the CARES Act is the Paycheck Protection Program (“PPP”), which authorizes the Small Business Administration (“SBA”) to guarantee loans to certain eligible small businesses. One of the unique features of the PPP loans is that, unlike traditional SBA loans, the lender may request to have the principal amount of the loan forgiven. There are limitations on the total amount of the loan forgiveness that a PPP borrower should be aware of to ensure the maximum amount of the PPP loan is forgiven.
Only The Loan Principal Will Be Forgiven
The total amount that may be forgiven may not exceed the loan principal, meaning the total amount of the loan borrowed. That means the borrower needs to make payments on the interest, which is capped at a rate of 4% per annum, because the interest charges will not be forgiven.
Only Eligible Costs Incurred and Paid For During The Covered Period Will Be Forgiven
A borrower can only use the PPP loan to pay for certain types of operating costs during the covered period (which is the 8-week period following the origination date of the PPP loan). The types of costs eligible for forgiveness are (i) payroll costs, which includes employee healthcare benefits and other costs specified within the CARES Act, (ii) mortgage interest, but only if the mortgage was entered into before February 15, 2020, (iii) rent payments, but only if the lease was entered into before February 15, 2020, and (iv) utility costs. If the borrower uses any portion of the PPP loan to pay any other type of cost, the amounts paid will deducted from the amount of the loan to be forgiven.
When the borrower incurs the cost and/or makes payment for the cost out of the loan proceeds is also relevant to whether the borrower can seek forgiveness of the loan. To be eligible for forgiveness, the costs must be incurred during and/or paid for during the covered period. As mentioned above, the covered period is the 8 week period following the origination date of the loan.
Borrowers should be aware they are required to provide evidence that the loan proceeds were used to pay for the eligible costs during the covered period. For that reason, borrowers should be sure to instruct their bookkeepers to track every penny spent out of the loan proceeds and should consider putting the proceeds of the PPP loan in a separate bank account.
The Amount of Loan Forgiveness Will be Reduced for Work Force Reductions
If a borrower reduces its full-time equivalent employees (“FTE”) during the covered period, the total amount of the loan that may be forgiven will be reduced by the total percentage reduction of the FTEs. To calculate the reduction of the forgiveness, multiply the loan principal by the fraction, the numerator of which is the borrower’s average total FTEs employed in the last full quarter prior to the date of the loan, and the dominator of which is the average total FTEs employed in during the current period.
The loan forgiveness reduction will not apply to reductions of FTEs by a borrower during the period of February 15, 2020 and April 26, 2020 if the borrower rehires a number of FTEs at least equal to the number of FTEs the borrower had on February 15, 2020 by no later than June 30, 2020.
Loan Forgiveness Reduction for Compensation Reductions
The amount of loan forgiveness will be reduced if the borrower reduces the total compensation paid to any employee during the covered period who earned less than $100,000 annualized in the last full quarter prior to the origination date of the loan. The amount of the loan forgiveness will be reduced dollar for dollar by the amount of reduction of each employee whose total compensation was reduced by an amount in excess of 25% of the employee’s total compensation paid in the most recent full quarter prior to the loan date.
The loan forgiveness reduction will not apply to reductions to the compensation of any employee by a borrower during the period of February 15, 2020 and April 26, 2020 if the borrower increases each employee’s compensation to an amount at least equal to the employee’s compensation on February 15, 2020 by no later than June 30, 2020.
Reductions in Both FTEs and Compensation
A borrower is permitted to both reduce its FTEs and the compensation paid to employees under the PPP, but both reductions will be applied separately to reduce the amount of the loan forgiveness.
In the event the borrower has reduced both its FTEs and its employee compensation during the period between February 15, 2020 and April 26, 2020, the loan forgiveness reduction will not apply if the borrower (i) rehires a number of FTEs equal to the number of FTEs it had on February 15, 2020, by no later than June 30, 2020 and (ii) increases each employee’s compensation to an amount at least equal to the employee’s compensation on February 15, 2020, by no later than June 30, 2020.
A PPP loan is a great tool for a startup to obtain operating capital with limited consequences to help it overcome the impact of COVID-19 on its work force; but it is important that company keep in mind the above limitations. If the company fails to do so, it will lose a substantial portion of the benefits provided by the PPP.