Most Paycheck Protection Program ("PPP") borrowers are working toward full forgiveness of their PPP loans and are anxious to get this process started. A borrower generally may submit a loan forgiveness application any time on or before the maturity of the loan—including before the end of the covered period—if the borrower has used all of the loan proceeds. But that does not mean a borrower should submit a loan forgiveness application as soon as possible. There are many considerations you should take into account when deciding when to submit forgiveness applications to the lender. Patience and adequate preparation might be more than just virtues in the PPP loan forgiveness context; they might lead to financial benefits for borrowers as well. This article discusses the timing considerations and other items that might affect a borrower's decision to submit the loan forgiveness application to its lender.
Forms and Readiness of the Small Business Administration ("SBA") and the Lender
Forms and Process: As of October 9, 2020, there are three types of loan forgiveness application forms: Form 3508, Form 3508EZ, and Form 3508S. Form 3508S was posted on October 8, 2020, for PPP loans of $50,000 or less. Neither of the first two forms has been updated since June 16, 2020, and all three of the forms have rolling expiration dates to the end of the current month (on October 13, 2020, the SBA noted that the expiration date will be extended, and when approved, the same forms with the new expiration date will be posted). In addition, there are legislative proposals to reduce this paperwork and streamline the process for loans under $150,000. As such, we expect changes to these loan forgiveness applications.
SBA Timing: The SBA opened up its new platform to accept PPP forgiveness submissions from lenders on August 10, 2020, subject to extension if any new legislative amendments to the forgiveness process necessitate changes to the system. We expect further legislative changes.
Lender Timing: Even if a borrower is ready to apply for forgiveness, its lender might not be ready to receive and review loan forgiveness applications. The SBA allows lenders to have their own "lender equivalent form." Most lenders have opened up their portals, but are taking applications in batches or by invitation only, including some based on the date of the loan. Other banks are not allowing forgiveness applications until the covered period ends. Please contact your bank to see what process they are following. In addition, although the SBA and the U.S. Treasury Department have issued some guidance, we expect that more guidance might be needed for lenders to finalize their forgiveness processes.
Necessity Questionnaires: Starting around October 26, 2020, the SBA asked some PPP lenders to provide certain questionnaires to PPP borrowers with loans over $2 million. There are two forms: Form 3509 for for-profit borrowers and Form 3510 for non-profit borrowers. We do not know if these forms are in final form. Given their content, we expect further guidance. For more information, see the section below titled "Loans Over $2 Million" and see the article PPP Loans Over $2 million and the PPP Necessity Questionnaires.
Time Is on Your Side
Extended Coverage; Deadline for Forgiveness Application: The covered period of PPP loans was extended, so there is no need for a borrower to rush the loan forgiveness application process. The Paycheck Protection Program Flexibility Act of 2020 ("PPPFA") was enacted on June 5, 2020, and it extended the covered period from 8 weeks to the earlier of December 31, 2020, or 24 weeks from the date of the loan. If a borrower received its PPP loan before June 5, 2020, the PPPFA allows the borrower to elect to use an 8 week covered period. The covered period extension was made with retroactive effect as if it were originally enacted in the CARES Act. Borrowers may submit a loan forgiveness application any time before the maturity date of the loan, which is either two or five years from loan origination. However, if the borrower does not apply for loan forgiveness within 10 months after the last day of the covered period, or if the SBA determines that the loan is not eligible for forgiveness (in whole or in part), the payments on the PPP loan are no longer deferred and the borrower must begin paying principal and interest. Taking advantage of the full 24 weeks might give a borrower more time to take steps that will help them qualify for full loan forgiveness. This is especially true for the self-employed and owner-employees whose compensation was capped at 2.5 months' worth of 2019 net profit. However, it should be noted that waiting might increase the amount of interest a borrower pays with respect to any part of the loan that will not ultimately be forgiven. In addition, there might be other reasons, not to wait—see below.
Guidance May Evolve: Because of the constantly evolving guidance with respect to loan forgiveness, borrowers should consider waiting before they file their loan forgiveness applications. For example, consider the plain language of the PPPFA that the SBA interpreted differently in a later Interim Final Rule. Section 3(b)(8) of the PPPFA expressly provides that unless 60% or more of the loan proceeds are used for payroll, no forgiveness will be allowed. However, the SBA announced later that it would not be interpreting the PPPFA in that manner. Instead, the SBA indicated that the proper interpretation of Section 3(b)(8) of the PPPFA is that it does not make loan forgiveness under the PPP an all-or-nothing proposition for the borrowers. Rather, the 60% number is to be applied on a proportional basis instead of a cliff, thus allowing borrowers to seek forgiveness even though less than 60% of the loan proceeds were used for payroll costs. Although the plain language of the acts related to the PPP might seem clear, the constantly evolving guidance from the SBA and Treasury may change interpretations. Because new interim final rules are coming out and further pandemic aid bills are still being introduced into Congress, hurrying up the process of filing for loan forgiveness might not be warranted if the forgiveness landscape continues to change.
More Guidance Is Expected: We are expecting more guidance in a number of areas. Some guidance was posted in August and October 2020 (see links below) and related to owner-employee compensation, the eligibility of nonpayroll costs, certain calculations for reductions in employee salary or hourly wages, and borrower submission of excess costs. But gray areas remain. If any of these gray areas are critical for a borrower's loan forgiveness, the borrower might want to consider waiting for additional guidance. On August 4 and 11, 2020, the SBA posted 11 pages of guidance—the Frequently Asked Questions (FAQs) on PPP Loan Forgiveness—and updated the Interim Final Rule on Appeals of SBA Loan Review Decisions under the PPP, and on August 24, 2020, it posted the Interim Final Rule on Treatment of Owners and Forgiveness of Certain Nonpayroll Costs; and on October 8, 2020, it posted Interim Final Rule on Additional Revisions to Loan Forgiveness and Loan Review Procedures Interim Rules. We expect more guidance.
Deductibility of Certain Expenses: On April 30, 2020, the IRS issued Notice 2020-32 clarifying that no deduction is allowed under the IRS Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan and the income associated with the forgiveness is excluded from gross income. With that in mind, borrowers who are considering having all or a portion of those loans forgiven must consider the collateral tax consequence of that forgiveness. To the extent a borrower would have deducted from the taxpayer's income amounts spent on eligible expenses, the borrower should evaluate whether or not it might pay more in taxes than to pay back some or all of the original loan or how the taxpayer will pay the taxes due on those expenditures. Taxpayers will also want to separately account for those expenditures so they are easy to pull out and identify in preparing their 2020 (or fiscal year) tax returns affected by the Notice. It was the expectation that Congress would overrule this position, but that has not happened to date. In the meantime, taxpayers would be best served analyzing the potential tax consequences of the Notice and preparing for those tax consequences now. See IRS Issues Guidance Regarding PPP Loan Forgiveness and Deductibility of Expenses (May 1, 2020).
Documents Are Critical: The forgiveness applications issued by the SBA require that they be accompanied by detailed documentation and that additional documents be retained by the borrower. If the lender identifies errors in the borrower's calculations or a material lack of substantiation in the borrower's supporting documents, the lender is to work with the borrower to remedy the issue. A borrower should take the time to make sure they have both the accompanying documentation and the documents to be retained available at the time of the submission. Don't put off getting the "retained" documents together. The SBA has a right to request that retained information as part of its review. If the borrower does not promptly provide documents, this might cause delay and possibly denial of forgiveness. Furthermore, as the rules for PPP loan forgiveness contain so many gray areas, borrowers should also document how a conclusion was reached and what guidance they used to reach the conclusion. See " Key Consideration for PPP Documentation" and " A Guide to the SBA PPP Loan Forgiveness Review Process."
Calculations: The borrower is responsible for accurately calculating the loan forgiveness amount, even though most lenders will have their own calculators. The American Institute of CPAs (AICPA) and Biz2Credit, Inc. have put together a PPP Forgiveness Tool, which some borrowers might find helpful to double check their bank's calculator. We were not involved with the preparation of this tool. We do not make any warranties regarding the accuracy or propriety of the information that is provided by the tool. Each borrower should seek its own accounting and legal advice regarding its calculations.
Loans Over $2 Million: The SBA has indicated that it will review loans in excess of $2 million, and the SBA loan forgiveness applications have a box relating to PPP loans in excess of $2 million (including affiliates). Starting around October 26, 2020, the SBA asked some PPP lenders to provide certain questionnaires to PPP borrowers with loans over $ 2million. The purpose of the forms according to the SBA "is to facilitate the collection of supplemental information that will be used by SBA loan reviewers to evaluate the good-faith certification that [a borrower] made on [its] PPP Borrower Application ... that economic uncertainty made the loan request necessary. Although both the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and FAQ #31 instructed borrowers to assess their need for the loan at the time of application, the SBA's new forms gather information to assess need both at the time of application and during the use of the funds. This is a surprise for most borrowers who were prepared to provide information about "necessity" at the "time of the application" but were not anticipating scrutiny about necessity over the period of use of the funds. With that said, at this time, we don't know whether the information "during the use of the funds" will be used by the SBA to determine "necessity" or whether the SBA is merely gathering information. Borrowers with loans over $2 million should gather the requested information now in anticipation of the lender's request. Given the uncertainty as to how this process will be administered and how the information will be used, and the fact that clarifications are needed and there are tight timelines, borrowers should seek legal advice prior to submitting a forgiveness application. These borrowers should also consider delaying to apply for forgiveness until some of these open issues are clarified. For more information, see PPP Loans Over $2 Million and the PPP Necessity Questionnaires.
Furthermore, the SBA has highlighted that borrowers must have "an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance." In addition, the SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to SBA review for compliance with program requirements set forth in the PPP interim rules and in the borrower's PPP loan application. In addition to the Necessity Questionnaire Form information, borrowers should take the time to prepare, gather, and organize these other documents in contemplation of this review. In addition, given the long audit period, borrowers might want to consider purchasing PPP loan insurance to cover a business in the event the SBA subsequently determines that the company was ineligible for the PPP loan at the time of application. A borrower that, together with its affiliates, received PPP loans totaling $2 million or greater cannot used Form 3508S.
Does the Borrower Want to Be the First One through the System: The PPP process has been uneven and frustrating for many borrowers. The loan forgiveness process will be a new system for the lenders and for the SBA. Borrowers should consider whether they want to be the first ones through the system or whether they want to wait for the process to get established before submitting an application.
Loan Documents May Need to Be Amended: Some lenders' PPP loan documents require a borrower to apply for forgiveness within a certain time period or have set maturity dates or interest payment dates. Some lenders specified explicit terms, such as how much of nonpayroll expenses are forgivable, covenants regarding eight-week covered periods, or a requirement to not take out additional PPP loans. The recent legislative changes and expected additional legislation will likely alter these previously established loan terms. The SBA released guidance on October 7, 2020, clarifying that lenders must give immediate effect to the extended deferral period for borrower payments of principal, interest, and fees on all PPP loans, requiring lenders to notify borrowers of the change to the deferral period, and confirming that no formal modification to the promissory note is required for this purpose. With that said, it would be well worth reviewing those documents to determine if they contain other provisions, what the consequences might be for failing to meet the deadlines or covenants, or if the provisions may be extended or corrected with an amendment to the loan document. This may be very important if the borrower has cross default provisions in other loan documents or leases or important contracts, like major supplier/vendor contracts, as these other parties might take advantage of these "technical breaches." In addition, the lender's forgiveness applications may require the borrower to certify that the borrower has met all the terms of the loan documents, resulting in a potential false certification if the terms are not changed or updated. In the past, the SBA has been very strict and unforgiving of "technical false certifications."
Changes to Business Structure: Many borrowers have had to revise their business structure in the face of the pandemic. Changes to a business's legal structure, a decrease in employee count, or eliminating a division or subsidiary after a borrower takes out a PPP loan might affect the borrower's ability to receive full or partial loan forgiveness. Depending on the timeline of these changes, it might be beneficial to apply for forgiveness before the changes take place, especially if the borrower is relying on FTE Reduction Safe Harbor 2, which is tied to the date of the forgiveness application. In addition, if a borrower applies for forgiveness before the end of the covered period and has reduced any employee's salary or wages in excess of 25%, the borrower must account for the excess salary reduction for the full covered period. See also below, on the need for prior lender consent for "changes in business structure."
M&A Transactions and Changes of Ownership: A PPP loan may have a variety of implications on pending and potential M&A transactions and changes of ownership.
- Changes of Ownership: The SBA form of promissory note contains certain restrictions and a specific default provision concerning transactions where a borrower "reorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender's prior written consent." Although a lender could use its own form of note, most loan documents preclude a change in ownership, change of ownership, change in business structure, change in control, or change of control during the term of the PPP loan. Typically, no threshold is defined in the loan documents. The SBA issued a procedural notice effective October 2, 2020, to SBA employees and lenders defining a change in ownership as: (a) at least 20 percent of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity; (b) the PPP borrower sells or otherwise transfers at least 50 percent of its assets (measured by fair market value), whether in one or more transactions; or (c) a PPP borrower is merged with or into another entity. This notice also sets forth when PPP lender and SBA approval are required for SBA purposes. The notice provides for additional requirements but does not replace the loan documents terms. Both the loan documentation and the notice might affect some borrowers who have planned estate planning and gifting programs, redemption programs, and stock or option programs that may change ownership of a company before the loan is forgiven. All transactions since the date of the approval of the PPP loan need to be aggregated for these thresholds. If the PPP loan is in place and approvals are required, SBA approval can be avoided by following some procedures in the notice, including applying for forgiveness and escrowing funds. However, escrowing funds might not be practical for some programs or circumstances. In any event, lender consent will likely be required and will take some time. Per the notice, SBA approval can take up to 60 calendar days, and the SBA will want an explanation as to why funds cannot be escrowed or the PPP loan satisfied. For PPP borrowers contemplating any changes of ownership, please contact your lender to discuss how the lender is handling their loan documents and the SBA notice, what the process is, and whether SBA approval is an option to escrowing funds. The SBA procedural notice clarified some areas, but not all, and some gray areas remain. See PPP Loans and Changes of Ownership, Asset Transactions and Mergers.
- M&A Transactions: With respect to M&A transactions, the recent SBA procedural notice on "changes of ownership" would specifically pick up a merger, and certain equity and asset transactions. It is unclear whether the notice also addresses new issuances of equity or indirect changes of ownership. The prior SBA procedural notice would have required SBA approval for "any change in the ownership" and may apply in these unclear areas. The standard loan documentation would also pick up these transactions without a threshold. Failure to obtain approvals could result in the denial of PPP loan forgiveness and may result in a demand for immediate repayment of the PPP loan. The recent SBA procedural notice does provide for the filing of a forgiveness application and the escrowing of funds as an alternative to SBA approval. If obtaining approval and filing an application and escrowing of funds are impractical, it might be preferable to delay the transaction timeline in order to obtain forgiveness prior to closing, or to analyze the importance of forgiveness in light of the transaction. There might also be issues in an asset transaction relating to staffing changes and the timing of the forgiveness application. Furthermore, in an M&A transaction, if the parties want to keep the PPP loan in place post-closing, then prior lender and SBA consent will likely be required. In addition, if the loan remains in place post-closing, there are a number of negotiating points that need to be covered regarding the borrower's compliance with the PPP loan terms, the representations and warranties and indemnifications regarding the loan, and control of the forgiveness application process and submission. These considerations are in addition to the items set forth in the "Changes to Business Structure" section. The SBA procedural notice also addresses situations and other requirements when the new owner or successor has a separate PPP loan and the need for segregating and delineating PPP funds. See PPP Loans and Changes in Ownership, Asset Transactions and Mergers.
Because of the many variables that affect each borrower differently, a borrower should consider discussing the loan forgiveness process with legal counsel before submitting the application. Schwabe is committed to providing our clients with up-to-date resources to understand the CARES Act and navigate the COVID-19 pandemic.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.