CARES Act: SBA Loan Program Expansion

On March 25, 2020, the Senate unanimously passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in response to COVID-19, and the House is scheduled to vote on the CARES Act on March 27, 2020. President Trump has announced his intention to sign the bill.

If the CARES Act is passed by the House and implemented as law in the form passed by the Senate, the CARES Act will provide additional funding and expand certain eligibility metrics for the provision of:

• Loans advanced from February 15, 2020 to June 30, 2020 under the Small Business Administration’s (SBA) Business Loan Program consisting of the 7(a) Loan Program (Covered 7(a) Loans).
• Loans advanced from January 1, 2020 to December 31, 2020 under the SBA’s Disaster Loan Program consisting of Economic Injury Disaster Loans (Covered EIDLs). Covered EIDLs and Covered 7(a) Loans are referred to herein as Covered Loans.

Businesses may want to consider whether they qualify for financial assistance from the above expanded SBA loan programs as a result of COVID-19’s impact on their business.  This Client Alert provides an overview of: eligibility for Covered 7(a) Loans; eligibility for Covered EIDLs; affiliation provisions; Covered 7(a) Loans; Covered EIDLs; and forgiveness of Covered 7(a) Loans.

In assessing whether or not a business qualifies for a Covered Loan, we intend to provide a high-level overview of key considerations rather than an exhaustive summary of the various regulations and exceptions thereto that may be applicable to a business or a transaction. Additionally, a business will want to review the documentation governing its existing credit facilities (if any) to ensure the incurrence of indebtedness pursuant to a Covered Loan is permitted thereunder.

Eligibility for Covered 7(a) Loans under the CARES Act

A business concern (a Concern) may be eligible for a Covered 7(a) Loan under the CARES Act if it (1) qualifies as “small business concern” under the existing SBA regulations (SBC) or (2) employs no more than the greater of (a) 500 employees (the New Employment Threshold) and (b) if applicable, the SBA’s size requirements based on employees for the Concern’s primary industry (set forth by industry NAICS code here).

A Concern qualifies as an SBC if it satisfies the SBA’s size requirements for its primary industry based on receipts, employees or another specified size standard.

Where the size requirement is based on employees, employees include all individuals employed on a full-time, part or temporary basis and employees of the Concern’s affiliates (unless the applicability of the affiliation provisions is waived, as discussed below).

In addition to expanding eligibility for Covered 7(a) Loans to certain Concerns that are not SBCs, the CARES Act also further expands eligibility for Covered 7(a) Loans for Concerns operating in a primary industry with a NAICS code beginning with 72 by providing that the New Employment Threshold applies on a per physical location basis.  Thus, Concerns in the restaurant, food and beverage and hospitality industries with well over 500 employees aggregated across locations may still qualify for financial assistance.

The primary industries with NAICS codes beginning with 72 are as follows:

Additionally, the CARES Act also waives the applicability of the affiliation provisions for a Concern satisfying any of the following:

• Operates in a primary industry with a NAICS code beginning with 72 that satisfies the New Employment Threshold.
• Operates as a franchise that is assigned a franchise identifier code by the SBA (a list of which can be found here).
• Receives financial assistance from a Small Business Investment Company (SBIC). Financing under the SBIC regulations means outstanding financial assistance provided to an SBC by an SBIC licensee, whether through loans, debt securities, equity securities, guarantees, or purchases of securities of a small business through or from an underwriter.

Lastly, for Covered 7(a) Loans, the CARES Act also waives the requirement that a Concern be able to show that it is unable to obtain financing from sources other than an SBA loan program.

Eligibility for Covered EIDLs under the CARES Act

A Concern may be eligible for a Covered EIDL under the CARES Act if it (1) qualifies as a SBC or (2) employs no more than 500 employees. Additionally, a Concern must be located in a declared disaster area (listed here) and have suffered substantial economic injury as a result of the disaster (meaning the Concern is unable to meet its obligations and to pay its ordinary and necessary operating expenses).

For Covered EIDLs, the CARES Act waives rules regarding the provision of a personal guarantee for advances and loans in an amount less than $200,000 and the requirements that a Concern be in business for one year (except a Concern must have been in business on January 1, 2020) and unable to obtain financing from sources other than an SBA loan program. However, a Concern will have to show it is unable to meet its obligations and pay its ordinary and necessary operating expenses.

A Concern may not qualify for a Covered EIDL and a Covered 7(a) for the same purpose; however, if a Concern obtained an economic injury loan between January 31, 2020 and the date Covered Loans become available and such economic injury loan was obtained for a different purpose, such Concern may still qualify for a Covered 7(a) Loan.

Affiliation Provisions

To appropriately determine whether a Concern satisfies the applicable size requirement for a Covered Loan, the appropriate identification of a Concern’s affiliates is essential.  Below is a high-level overview of certain common factors (though not all) that establish affiliation between a Concern and other businesses or individuals under the SBA regulations.

• Equity Ownership.  A Concern is affiliated with any business or individual that controls or has the power to control such Concern (or vice versa), and any business under common control with the Concern.  Control means the ownership or power to control more than 50% of a Concern’s voting equity or if no person is found to have such control, the board of directors or other officers, managing members, or partners who control the management of such Concern. A minority shareholder will be deemed to control a Concern if such shareholder has the power under such Concern’s governing documents to prevent a quorum or otherwise block action by the board of directors or shareholders.  Subject to certain exceptions (such as conditions precedent that cannot be fulfilled), the SBA considers stock options, convertible securities, and agreements to merge as though the rights granted have been exercised when assessing control.
• Management.  A Concern is affiliated with any business managed by the same board of directors (or the same persons that control the board of directors) or other officers, managing members, or partners who control the management of the Concern and any business that controls the management of the Concern via a management agreement.
• Other Affiliations and Considerations.  In addition to the above relationships that establish affiliation, certain other relationships with identical or substantially identical business or economic interests (such as close relatives operating Concerns in the same or similar industry in the same geographic area, individuals or firms with common investments or firms that are economically dependent through contractual or other relationships) may be treated as affiliates.   However, we note that if a Concern is a franchisee, the Concern will generally not be considered affiliated with its franchisor so long as the Concern has the right to profit and bears the risk of loss consistent with ownership.

Notwithstanding the foregoing, there are exceptions to the affiliation regulations, with a noteworthy exception being for Concerns owned in whole or substantial part by an SBIC.

Covered 7(a) Loans

Each Covered 7(a) Loan will be in a principal amount equal to (but in no event in excess of $10,000,000) the sum of the following:

• Two and one-half times the Concern’s average total monthly payroll costs during the one year preceding issuance of the Covered 7(a) Loan (with different measurement periods applicable to Concerns that are seasonal employers or that were not in business during the period beginning on February 15, 2019, and ending on June 30, 2019).
• The outstanding amount of a Covered EIDL incurred from January 30, 2020, until the date Covered 7(a) Loans are made available.

The interest rate applicable to Covered 7(a) Loans will not exceed 4% and maturity date applicable to any balance remaining after application for loan forgiveness will not exceed 10 years.

A Concern may use the proceeds of a Covered 7(a) Loan (in addition to existing permitted uses under the SBA regulations) to fund payroll costs, costs related to the continuation of group healthcare benefits, insurance premiums, employee salaries and similar compensation, mortgage and/or rent payments, utilities, and interest on any other debt obligations incurred prior to February 15, 2020.

In addition, the SBA will not require any collateral for or personal guaranty of Covered 7(a) Loans, and the Covered 7(a) Loan or a portion thereof may qualify for forgiveness (discussed below).  Covered 7(a) Loans will be non-recourse except where proceeds are not applied to a permitted use.

Covered EIDLs                                                                                                                                  

Each Covered EIDL will be in a principal amount based on the Concern’s economic injury, up to $2,000,000. The proceeds of Covered EIDLs may be used to provide paid sick leave to employees unable to work due to the direct effect of COVID-19, maintain payroll, meet increased costs to obtain materials unavailable due to interrupted supply chains, make rent or mortgage payments and repay obligations that cannot be met due to revenue losses.

A Concern applying for a Covered EIDL may also request that an initial advance be made in an amount not to exceed $10,000 within three days of the Concern’s application for such Covered EIDL.  A concern shall not be required to repay such initial advance, even if the Concern’s application for a Covered EIDL is subsequently denied.
 

Covered 7(a) Loan Forgiveness

A Concern shall be eligible for forgiveness of indebtedness on a Covered 7(a) Loan in an amount equal to the sum of the following payments made by the Concern using proceeds of the Covered 7(a) Loan during the eight week period following the date a Covered Loan is advanced (the Covered Forgiveness Period):

• Payroll costs.
• Payments of interest on any indebtedness or debt instrument (excluding any prepayment of or payment of principal) incurred in the ordinary course of business that (a) is a liability of such Concern, (b) is secured by a mortgage on real or personal property and (c) was incurred prior to February 15, 2020.
• Rent payments pursuant to a lease in effect prior to February 15, 2020.
• Utility payments for electricity, gas, water, transportation, telephone, or internet access for which service began prior to February 15, 2020.

To qualify for forgiveness, payments of all qualifying amounts must be evidenced by acceptable documentation.

With respect to payroll costs, the amount of forgiveness with respect thereto shall be reduced by the following:

• An amount equal to (a) the average number of full-time equivalent employees during the Covered Forgiveness Period (determined by calculating the average number of full-time equivalent employees for each pay period falling within a month) multiplied by (b) a percentage obtained by dividing (i) the average number of full-time equivalent employees per month during the Covered Forgiveness Period by (ii) the average number of full-time equivalent employees per month employed from, at the Concern’s election, February 15, 2019 – June 30, 2019 or January 1, 2020 – February 29, 2020 (with different measurement periods applicable to Concerns that are seasonal employers or were not in operation before June 30, 2019).
• The amount of any reduction in total salary or wages of any full-time equivalent employee during the Covered Forgiveness Period in excess of 25% of the total salary or wages of such employees during the most recent full quarter prior to the Covered Forgiveness Period.

An employee for the purposes of calculating reductions to the amount of a Covered 7(a) Loan that may be forgiven is any employee who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay in excess of $100,000. Further, reductions will be determined without regard to otherwise applicable reductions in workforce or wages or salary if the reduction occurred in the period commencing on February 15, 2020 and ending 30 days after the enactment of the CARES Act but the Concern has eliminated the otherwise applicable reduction in workforce or salary or wages on or prior to June 30, 2020.

Additionally, for any Concern that switches from a Covered EDIL to a Covered 7(a) Loan, any initial advance made to such Concern shall reduce the loan forgiveness amount for the subsequent Covered 7(a) Loan.

Loan amounts forgiven pursuant to the above summarized provisions of the CARES Act will be excluded from gross income for tax purposes.

If you have any questions about how the CARES Act could impact your business, please contact the authors of this alert.