On January 6, 2020 the SBA issued approximately 120 pages of new regulations regarding PPP loans. I am currently working through all of the details that the Interim Final Rules contain and will issue a more extensive article tonight (special thanks to my wife Marcia for not making me come home for dinner), but the following will provide you with significant details about how each new feature of these rules will work. Hats off to the SBA because these rules are well-written and they are not ambiguous or unclear in any significant way.
Second Draw PPP Loan Eligibility Requires that Borrower will have spent the “Full Amount” of the First Loan Before Receiving the Disbursement of the Second Loan:
The ‘Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act” (referred to as the “Economic Aid Act” in the Interim Final Rules) provides that a Second Draw PPP Loan may only be made to an eligible borrower that (1) has received a First Draw PPP Loan, and (2) has used, or will use, the full amount of the First Draw PPP Loan on or before the expected date on which the Second Draw PPP Loan is disbursed to the borrower.
The Interim Final Rules clarify that:
- The borrower must have spent the full amount of its First Draw PPP Loan on eligible expenses under the PPP rules to be eligible for a Second Draw PPP Loan; and
- “The full amount” of the borrower’s First Draw PPP Loan includes the amount of any increase on such First Draw PPP Loan made pursuant to the Economic Aid Act.
“Gross Receipts” Defined for Purposes of Determining Whether There Has Been a 25% Drop in Revenues to Qualify for Second Draw:
The Economic Aid Act does not include a general definition of “gross receipts” for purposes of determining a borrower’s revenue reduction.
The Interim Final Rules provide that gross receipts include the following:
- “All revenue in whatever form received or accrued (in accordance with the entity’s accounting method) from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances.”
The Interim Final Rules provide that gross receipts do not include the following:
- “Taxes collected for and remitted to a taxing authority if included in gross or total income (such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees);
- Proceeds from transactions between a concern and its domestic or foreign affiliates; and
- Amounts collected for another by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder or customs broker.”
Additionally, the Interim Final Rules also state that “all other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from gross receipts.”
The SBA notes that the definition for gross receipts in the Interim Final Rules is “consistent with the definition of receipts in 13 C.F.R. 121.104 of SBA’s size regulations because this definition appropriately captures the type of income that is typically included in a small business’s gross receipts.”
“Any Forgiveness Amount” of a First Draw PPP Loan is Excluded from a Borrower’s Gross Receipts
Borrowers of First Draw PPP Loans that are looking to receive a Second Draw PPP Loan will be relieved to know that the Interim Final Rules clarify that “any forgiveness amount of a First Draw PPP Loan that a borrower received in calendar year 2020 is excluded from a borrower’s gross receipts.”
The Interim Final Rules state that excluding the forgiveness amount from a borrower’s gross receipts is “consistent with section 7A(i) of the Small Business Act, which expressly excludes PPP forgiveness amounts from being taxed as income.”
Additionally, the Interim Final Rules provide that this clarification “ensures the effectiveness of the second draw loan program by ensuring that a borrower is not disqualified from receiving a Second Draw PPP Loan because it received forgiveness on a First Draw PPP Loan.”
Borrowers May Use any 365 Day Period Beginning on January 1, 2019 to Calculate Their Average Monthly Payroll Costs:
In general, the Economic Aid Act provides that the maximum loan amount a borrower may receive for a Second Draw PPP Loan is the lesser of two and half months of the borrower’s average monthly payroll costs or $2 million. The Act also provided that the time period that is used for calculating a borrower’s average payroll costs for a Second Draw PPP Loan is either “the 1-year period before the date on which the loan is made” or “calendar year 2019.”
The Interim Final Rules provide that the borrower is permitted to use the precise 1-year period before the date on which the loan is made to calculate payroll costs if they choose not to use 2019 or 2020 to calculate payroll costs. The Act itself was interpreted to mean that a borrower’s average monthly payroll costs had to be calculated based upon 12 consecutive calendar months. This can now be any consecutive 365 day period and can start as soon as Jan 1, 2019, but can be, for example, March 12, 2019 to March 11, 2020.
The Interim Final Rules explain the above as follows:
- “Subsection (f) of the IFR uses “calendar year 2020” to refer to “the twelve-month period prior to when the loan is made.” Calculating payroll costs based on calendar year 2020 rather than the twelve months preceding the date the loan is made will simplify the calculations and documentation requirements for borrowers because payroll records are more commonly created and retained on a calendar-year basis. Allowing borrowers to calculate payroll costs based on calendar year 2020 is also not expected to result in a significant difference in payroll costs compared to the twelve months preceding the date the loan is made because all Second Draw PPP Loans will be made in the first quarter of 2021.”
Calculation of Average Monthly Payroll Costs for NAICS Code 72 Entities That Qualify as Seasonal Employers or as New Entities:
The maximum amount of a Second Draw PPP Loan is calculated different for seasonal employers and new entities than it is for NAICS Code 72 businesses (businesses in the accommodation and food services sector). Noticing that a NAICS Code 72 entity may also qualify as a seasonal employer or a new entity, the SBA clarifies in the Interim Final Rules that a NAICS Code 72 entity that also fits into one of these separate categories may calculate their payroll costs used to determine their loan amount based upon the formula that applies to the entity, or the standard formula used to calculate payroll costs for every other type of borrower, while still being allowed to utilize the 3.5 times multiplier that is applied to NAICS Code 72 entities under the new Act.
Bankruptcy Prevents Borrowers from Receiving a Second Draw PPP Loan:
The Interim Final Rules provide that borrowers will not be approved for a PPP loan if their business is in bankruptcy. This is very confusing because Congress specifically provided in the new law that SBA has the authority to allow bankruptcy judges to determine that a loan can be paid. The SBA apparently chose not to pull the switch, but the next Administrator of the SBA, when appointed, certaintly may. For now, the Interim Final Rules state the following:
- “If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the applicant or the owner of the applicant becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant’s obligation to notify the lender and request cancellation of the application. Failure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes. The Borrower Application Form for PPP loans (SBA Form 2483), which reflects this restriction in the form of a borrower certification, is a loan program requirement. Lenders may rely on an applicant’s representation concerning the applicant’s or an owner of the applicant’s involvement in a bankruptcy proceeding.”
There is a New Way to Substantiate a 25% Revenue Reduction to Qualify for a Second PPP Loan:
The Interim Final Rules provide that “a borrower that was in operation in all four quarters of 2019 is deemed to have experienced the required revenue reduction if it experienced a reduction in annual receipts of 25 percent or greater in 2020 compared to 2019 and the borrower submits copies of its annual tax forms substantiating the revenue decline.”
This won’t really help any borrower from a technical standpoint because any borrower that would have qualified before will certainly pass this test, but it does simplify the process of determining that the test is met and proving it if it was.
The following highlights the SBA’s reasoning for implementing this variable method for borrowers to substantiate their revenue reduction:
- “This provision will allow a borrower to provide annual tax return forms to substantiate its revenue reduction. The Administrator, in consultation with the Secretary of the Treasury (Secretary), has determined that this is necessary to improve administrability of Second Draw PPP Loans by providing borrowers an additional verifiable method for substantiating their revenue reduction. This method will be particularly important for small borrowers that may not have quarterly revenue information readily available. Moreover, this approach is appropriate because, if annual filings show a 25 percent revenue reduction, then at least one quarter in 2020 would have had at least a 25 percent revenue reduction.”
For borrowers that did not experience a 25 percent annual decline in revenues, and for borrowers that were not in operation in all four quarters of 2019, the revenue reduction requirement for receiving a Second Draw PPP Loan can still be met under the modified law by demonstrating that the borrower had a 25 percent reduction in gross receipts during the first, second, third or fourth quarter in 2020 when compared to the same corresponding quarter in 2019.
Second Draw PPP Loan Application and Documentation Requirements:
The Interim Final Rules did not provide the Second Draw PPP Loan application, which should be made available soon, but it does specify that the application and documentation requirements that borrowers can begin to gather are as follows:
“The documentation required to substantiate an applicant’s payroll cost calculations is generally the same as documentation required for First Draw PPP Loans. However, no additional documentation to substantiate payroll costs will be required if the applicant:
- (i) used calendar year 2019 figures to determine its First Draw PPP Loan amount,
- (ii) used calendar year 2019 figures to determine its Second Draw PPP Loan amount (instead of calendar year 2020), and
- (iii) the lender for the applicant’s Second Draw PPP Loan is the same as the lender that made the applicant’s First Draw PPP Loan.”
The Interim Final Rules provide that in such cases described above, “additional documentation is not required because the lender already has the relevant documentation supporting the borrower’s payroll costs.”
Notwithstanding the above, the Interim Final Rules provide that the lender may request additional documentation if it “concludes that it would be useful in conducting the lender’s good-faith review of the borrower’s loan amount calculation.”
For loans with a principal amount greater than $150,000, the Interim Final Rules state that borrowers must submit documentation “adequate to establish that the applicant experienced a revenue reduction of 25% or greater in 2020 relative to 2019.” This documentation may include:
- Relevant tax forms, including annual tax forms, or
- Quarterly financial statements or bank statements if relevant tax forms are not available.
For Second Draw PPP Loans of $150,000 or Less, Revenue Reduction Documentation is Not Required to be Submitted at the Time the Borrow Submits an Application for a Loan:
For loans with a principal amount of $150,000 or less, the Interim Final Rules provide that the previously mentioned documentation “is not required at the time the borrower submits its application for a loan, but must be submitted on or before the date the borrower applies for loan forgiveness, as required under the Economic Aid Act.”
Finally, the Interim Final Rules provide that if a borrower does not submit an application for loan forgiveness, the borrower must provide such documentation to the SBA upon the SBA’s request.
How to Request an Increase for a PPP First Draw Loan if the Borrower Returned All or Part of a Loan, or Did Not Accept the Full Amount Previously Approved:
The Interim Final Rules provide that the following borrowers can reapply or request an increase in their PPP loan amount:
- If a borrower returned all of a PPP loan, the borrower may reapply for a PPP loan in an amount the borrower is eligible for under current PPP rules.
- If a borrower returned part of a PPP loan, the borrower may reapply for an amount equal to the difference between the amount retained and the amount previously approved.
- If a borrower did not accept the full amount of a PPP loan for which it was approved, the borrower may request an increase in the amount of the PPP loan up to the amount previously approved.
The Interim Final Rules provide that a borrower’s lender may submit an electronic request through the SBA’s E-Tran Servicing site to increase the PPP loan amount. The borrower will be required to provide the lender with documentation to support the calculation of the increase.
Additionally, the Interim Final Rules state that the SBA “is developing a process to collect the information necessary for eligible borrowers to reapply or request an increase in their PPP loan amount as described in this Interim Final Rule.”
Clarification on Borrowers that are Ineligible to Receive a Second Draw PPP Loan:
Under the Economic Aid Act, the following borrowers are prohibited from receiving a Second Draw PPP Loan:
- A business concern or entity primarily engaged in political activities or lobbying activities, including any entity that is organized for research or for engaging in advocacy in areas such as public policy or political strategy, or that describes itself as a think tank in any public documents;
- Certain entities organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong, or with other specified ties to the People’s Republic of China or the Special Administrative Region of Hong Kong;
- Any person required to submit a registration statement under section 2 of the Foreign Agents Registration Act of 1938 (22 U.S.C. 612);
- A person or entity that receives a grant for shuttered venue operators under section 324 of the Economic Aid Act;
- A publicly traded company, defined as an issuer, the securities of which are listed on an exchange registered as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f).
The Interim Final Rules further clarify which borrowers are ineligible to receive a Second Draw PPP Loan by providing the following list of examples:
“You are ineligible for a PPP loan if, for example:
- You are engaged in any activity that is illegal under Federal, state, or local law;
- You are a household employer (individuals who employ household employees such as nannies or housekeepers);
- An owner of 20 percent or more of the equity of the applicant is presently incarcerated or, for any felony, presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of, pleaded guilty or nolo contendere to, or commenced any form of parole or probation (including probation before judgment) for, a felony involving fraud, bribery, embezzlement, or a false statement in a loan application or an application for federal financial assistance within the last five years or any other felony within the last year;
- You, or any business owned or controlled by you or any of your owners, has ever obtained a direct or guaranteed loan from SBA or any other Federal agency that is currently delinquent or has defaulted within the last seven years and caused a loss to the government;
- Your business or organization was not in operation on February 15, 2020; • You or your business received or will receive a grant under the Shuttered Venue Operator Grant program under section 324 of the Economic Aid Act;
- The President, the Vice President, the head of an Executive Department, or a Member of Congress, or the spouse of such person as determined under applicable common law, directly or indirectly holds a controlling interest in your business;
- Your business is an issuer, the securities of which are listed on an exchange registered as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f);
- Your business has permanently closed.”