As a practical matter, borrowers accepting PPP loans should carefully read and understand each certification in the application and the promissory note.
Now that the Small Business Administration (SBA) has funded the first wave of Paycheck Protection Program (PPP) loans under the Coronavirus Aid, Relief and Economic Security Act (CARES Act), borrowers need to be mindful of the PPP use-of-proceeds requirements for forgiveness and the penalties for the unauthorized use of proceeds.
Loan Forgiveness for PPP Loans
Under the CARES Act, PPP loans may be forgiven in full, as long as a borrower uses all of the PPP loan proceeds in accordance with the conditions for forgiveness.
Permitted Use of PPP Loan Proceeds
Borrowers are required to use PPP loans only for:
- Payroll costs;
- Interest payments on debt obligations incurred before February 15, 2020 (note that only interest on mortgage obligations can be forgiven);
- Rent payments on leases dated before February 15, 2020; and
- Utility payments under service agreements dated before February 15, 2020.
Forgiveness of Obligations – Permitted Spend and Record Keeping
To be eligible for loan forgiveness, a borrower must ensure compliance with the following:
- At least 75% of the loan proceeds must be used for payroll costs.
- The use of the remaining 25% of the proceeds may be used for permitted non-payroll costs (see above).
- The proceeds must be used over the eight-week period beginning on the date that the lender makes the disbursement to the borrower.
The SBA has not released guidance on whether payments for payroll costs must be evenly distributed over the eight-week period or may be provided in one or multiple lump-sum payments. Further guidance from the SBA may clarify this issue, but no such requirement currently exists.
Process for Loan Forgiveness
To apply for loan forgiveness, a borrower must take the following steps:
- Submit documentation to the lender servicing the PPP loan detailing the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease and utility obligations.
- The lender must make a decision on loan forgiveness within 60 days of receiving the borrower’s application.
To expedite the loan forgiveness process, consider taking the following steps:
- Clearly document all eligible payroll and non-payroll-related expenses.
- Keep PPP loan proceeds in a separate bank account to avoid comingling with other funds in order to track how funds are used. This is not a requirement but will facilitate the forgiveness analysis by the lender.
Reduction of the Loan Forgiveness Amount
Even if the loan proceeds are used for forgivable expenses, forgiveness is subject to proportionate reduction if there is a reduction in employee head count, a reduction in the salaries of employees or if less than 75% of the PPP loan proceeds are used for payroll costs.
Employee Head Count Reduction
The loan forgiveness amount will be reduced in proportion to any reduction in the number of full-time equivalent employees of the borrower. This is calculated by multiplying (i) the forgivable costs by (ii) the quotient obtained by dividing (a) the average number of full-time equivalent employees per month during the eight-week period following the first disbursement of the loan by (b) the average number of full-time equivalent employees per month from either of the following two time periods (at the election of borrower): (1) February 15, 2019, to June 20, 2019, or (2) January 1, 2020, to February 29, 2020.
Borrowers may avoid any reduction of the loan forgiveness amount if the number of full-time equivalent employees is restored by June 30, 2020, as compared to the applicable period of reference.
Employee Salary Reduction
The loan forgiveness amount will also be reduced by the amount of any reduction in total salary or wages of any employee of the borrower during the eight-week period following the first disbursement of the loan that is in excess of 25 percent of the total salary or wages during the most recent full quarter during which the employee was employed. However, employees who received wages or salary for any pay period in 2019 of more than $100,000 annualized are excluded for purposes of this calculation.
Borrowers may avoid any reduction of the loan forgiveness amount if the salaries and wages of applicable employees are restored by June 30, 2020.
Allocation of at Least 75% of Loan Proceeds to Payroll Costs
Generally, to maximize loan forgiveness from a lender, a borrower must use at least 75% of the proceeds of a PPP loan on eligible payroll costs over the eight-week period following disbursement of the PPP loan proceeds. While the SBA stated in the interim final rule issued on April 2 that the threshold of 75% is appropriate in determining loan forgiveness, the guidance is unclear as to whether the failure to achieve a 75% use will result in a proportional reduction of the amount of forgiveness or whether using more than 25% of the loan proceeds for non-payroll costs is a complete bar to loan forgiveness. We anticipate further guidance to clarify this point.
Liability for the Unauthorized Use of PPP Loans
Guidance released by the SBA provides that borrowers of PPP loans may be subject to charges of fraud for the unauthorized use of proceeds. The SBA’s interim final rule released on April 3, 2020, provides that if a borrower uses PPP funds for “unauthorized purposes,” the SBA will direct them to repay those amounts. Further, if a borrower knowingly uses the funds for unauthorized purposes, the borrower will be subject to criminal liability for charges such as fraud. In addition, if a borrower’s “shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA will have recourse against the shareholder, member, or partner for the unauthorized use.” So far, there is no further guidance on the extent of recourse against shareholders, members or partners for unauthorized use of PPP loans.
Certifications Required for PPP Loan Borrowers
Pursuant to Section 1102(a)(1)(G)(i) of the CARES Act and the PPP Borrower Application Form, a borrower must make the following good faith certifications:
- “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.”
- “[t]he funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud.”
- “[t]he information provided in this application and the information provided in all supporting documents and forms is true and accurate in all material respects. I understand that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.”
The interim final rule released by the SBA on April 14, 2020, provides additional guidance on the issue of unauthorized use of PPP loan proceeds. While this interim final rule focused on sole proprietors, self-employed partners and self-employed individuals, the SBA clarified that PPP loan proceeds are intended for the maintenance of existing operations, not for business expansion. Therefore, borrowers should develop plans to utilize PPP loan proceeds for existing business and employee needs rather than expansion.
As a practical matter, borrowers accepting PPP loans should carefully read and understand each certification in the application and the promissory note (which may require recertification of the representations made in the application form). It is the responsibility of borrower, not lender, to ensure that the promissory note (and the previously submitted application) contains accurate information, that the borrower is in compliance with the PPP rules, and that the loans are used in compliance with the PPP requirements.
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