Paycheck Protection Program: Preparing for Round 3

After several months of negotiations, Congress has finally passed a new stimulus package that includes additional funding for the Paycheck Protection Program (“PPP”). The Consolidated Appropriations Act (the “Act”) allocates $284.5 billion to the Small Business Administration, with most of the funds going to a third round of PPP (“Round 3”) and the remainder reserved to cover principal and interest payments for qualifying standard 7(a) and 504 SBA loans as well as a portion to a new grant program for live venue operators.[1] Once President Trump signs the Act into law, the SBA will have ten days to establish the rules for Round 3.

This client alert summarizes the major PPP provisions outlined in the Act, but specific details of Round 3 requirements will need to be outlined in rules issued by the SBA. The SBA needed several weeks to release the more substantive initial interim final rules after passage of the CARES Act. The details to flesh out Round 3 will be included in formal rules and additional guidance. We remain hopeful that the SBA will issue most guidance by the time Round 3 begins, which could be as early as next week—this could avoid some of the significant confusion that plagued borrowers and lenders in the initial rounds of the PPP. The Act provides that the SBA must issue regulations within ten days of enactment, but this is a tall order considering the extent of changes outlined in the Act.

$284.5 Billion in New PPP Funding

In total, Congress set aside an additional $284.5 billion for new and second draw PPP loans in Round 3, which will extend until March 31, 2021, to the extent funding lasts.[2] The new funding includes set asides of $15 billion for loans made by community financial institutions and a separate $15 billion for loans made by banks and credit unions with fewer than $10 billion in total assets. 

The SBA is also directed to set aside no less than $35 billion for first time PPP loans. Additionally, no less than $25 billion is to be reserved for small businesses with fewer than 10 employees or that are requesting PPP loans of $250,000 or less.

Second Draw Loans

Congress authorized second draw loans to allow certain small businesses to receive a second forgivable Paycheck Protection Program loan. These loans are intended for businesses that were the hardest-hit and employ 300 or fewer employees. The maximum amount that a borrower may receive as a second PPP loan is $2 million, which must be based on two and a half months of annual payroll or three and a half months for entities classified under NAICS Code 72.

To be eligible for a second PPP loan, borrowers have to show a 25 percent decrease in revenue during any quarter in 2020 compared to the same quarter in 2019. Certain exceptions apply to entities that were not in existence for the entirety of 2019. The Act creates a streamlined revenue reduction requirement for loans of $150,000 or less—borrowers are only required to submit a certification statement regarding the revenue loss at the time of submitting the loan application and must provide proof of the revenue loss at the time they submit a forgiveness application.

Applicants for second draw loans of up to $150,000 are eligible for a simplified certification of revenue test. These applicants may certify that the business meets the applicable revenue loss requirements at the time the application is submitted, but may be required to provide documentation supporting the reduction in revenue at the time the borrower submits an application for forgiveness.

Expanded Borrower Eligibility

Congress added several new categories of eligible borrowers. Eligibility for Round 3 has been expanded to the following organizations:

• news organizations–certain news organizations with less than 500 employees;
• 501(c)(6) and destination marketing organizations–small nonprofit business associations, such as chambers of commerce, and destination marketing organizations, such as tourism offices, with fewer than 300 employees and that engage in limited lobbying activities;
• bankrupt businesses–trustees and debtors in possession may seek a PPP loan on behalf of the bankrupt entity; and
• housing cooperatives–cooperative housing corporations with fewer than 300 employees.

The Act clarifies that businesses that were not in operation on February 20, 2020 are not eligible and also excludes entities involved primarily in political or lobbying activities, as well as entities affiliated with the Peoples Republic of China and registrants under the Foreign Agents Registration Act.

Lender Hold Harmless

One of the more significant provisions in the Act involves hold harmless language for lenders. This should provide lenders with a bit more comfort with respect to participation in the PPP. Lenders are permitted to rely on any certification or documentation submitted by an applicant that supports the application for the loan as well as the applicant’s eligibility for the PPP. An enforcement action may not be brought against a lender that acts in good faith relating to loan origination or forgiveness and otherwise complies with applicable federal, state and other regulatory requirements. The hold harmless language is made effective as if included in the CARES Act. In other words, it is retroactive to March 31, 2020.

Understanding the applicability of the hold harmless provision in the Act requires a nuanced analysis. Please note that the phrase “hold harmless” is often a bit of a misnomer as there are a variety of instances when a lender could still face liability in connection with the PPP. Please reach out to us if you have any questions regarding the hold harmless language. We intend on preparing a separate client alert analyzing the hold harmless provision, and lender liability generally, in the coming weeks (no doubt after the holidays).

Simplified Forgiveness for Loans $150,000 or Less

The Act includes a streamlined forgiveness process for loans under $150,000. Specifically, the SBA is required to develop a one-page certification that only requires eligible borrowers to provide a description of the number of employees the borrower was able to retain because of the PPP loan, the estimated amount spent on payroll costs, and the total amount of the loan—the certification will likely look very similar to the current Form 3508S for loans under $50,000. The SBA and lenders are not permitted to require any additional information to substantiate forgiveness amounts. Borrowers eligible to submit the streamlined forgiveness application must attest that they have accurately provided the required certifications and complied with the PPP rules. For lenders who have not used our or other “form” certifications that go beyond what the SBA promulgated, now is the time to capture such protections. The record retention requirements are four years for employment records and three years for all other records related to the PPP. The Act also reaffirms the ability of the SBA to review any loan in any amount.

Additional Eligible Expenses

Congress added four new categories for eligible non-payroll uses of PPP loan proceeds. These new categories include the following types of expenses:

• operations expenditures for software and cloud computing;
• property damage related to public disturbances not covered by insurance;
• supplier costs for contracts or orders placed prior to the receipt of a PPP loan; and
• worker protection equipment (PPE) purchased in connection with safety requirements relating to COVID-19.

Each of the above categories is still subject to the requirement that 60 percent of the loan must be used for payroll costs. These changes apply retroactively to all PPP borrowers, unless forgiveness funds have already been received.

Additionally, the Act includes expanded eligibility for certain utilities as well as a definitional change to clarify that group insurance payments are considered eligible payroll costs. In other words, group life, disability, vision, and dental insurance expenses are considered payroll expenses that may be included in the 60 percent payroll expense calculation.

EIDL Advance Treatment

Many lenders and borrowers were caught by surprise when the SBA denied full forgiveness due to Economic Injury Disaster Loan (“EIDL”) advances. This resulted in lenders having small PPP balances on their books that carried significant servicing burdens. The Act repeals the provision in the CARES Act that required the reduction of the forgiveness amount by the amount of the EIDL advance received by a borrower—Congress set aside $20 billion for this purpose. It is unclear how the SBA and Treasury will remedy the many borrowers that have already begun making payments on the EIDL advance or who may have already paid it back in full, but the SBA is required to promulgate rules to ensure any such borrowers are made whole.

Deductibility of PPP Expenses

Another significant change covered in the Act is that business expenses paid for with proceeds of PPP loans are tax deductible, which is consistent with Congressional intent in the CARES Act. The IRS had taken the position that borrowers cannot deduct forgiven PPP expenses, but this has now been reversed legislatively.[3] Congress clarified in the Act that all expenses paid with PPP loan proceeds are 100 percent deductible. This should provide borrowers with a significant benefit as we approach the 2020 tax season.

Clarification of Covered Period Termination

What we already suspected should be the case was formalized in the Act when Congress clarified that the “covered period” may end on any date selected by the borrower so long as the date is within the 8-week or 24-week general covered period selected by the borrower. This provides significant relief for borrowers who struggled with reporting employment statistics for the covered period when they expended funds prior to the end of the applicable period. While it remains to be seen how this provision will be implemented by the SBA, it should increase the effectiveness of the various safe harbors that exist to protect borrowers from foregoing forgiveness when they had to make reductions in payroll after their PPP funds were exhausted.

Authorization for Increasing Round 1 and 2 Loan Amounts

The Act charges the SBA with establishing new rules that ensure eligible recipients of loans from the initial rounds of the PPP are eligible to reapply for loans if they are entitled to additional funds in light of new requirements. Borrowers that have already received their PPP loan funds and are technically eligible for larger loan amounts due to rules and guidance issued after the loan was received are permitted to reapply in Round 3 for the additional funds to which they are entitled. Borrowers that returned a portion of their PPP funds, perhaps related to subsequent rules leading borrowers to question whether they received the proper amount, did not accept the full amount for which they initially qualified or when there were simple math errors made by the borrower or the bank, are entitled to reapply for a PPP loan under Round 3 in an amount equal to the difference between the amount obtained, if any, and the maximum amount permissible.

Agent Fees

Lenders are only required to pay agents when they contract directly with the agent. This adds significant clarity as lenders will not be subject to claims from agents that the lender had no knowledge of during the application process. If a borrower has received assistance from an agent, they are responsible for paying the agent’s fees and are not authorized to use funds from the PPP loan for such payment. Again, we encourage the use of a modified Form 159 for this purpose.

SBA Oversight

Congress included a provision in the Act requiring the SBA to respond to any requests for data or information made by the Comptroller General of the United States within 15 days from the request. Additionally, the SBA Administrator and Secretary of Treasurer are required to testify before Congress at least twice a year for the next two years. This language was likely added to formalize the expectation that the SBA needs to act quickly in response to requests for information from the US government. It also will provide a forum to address issues that otherwise may be allowed by the SBA to linger.

Closing Considerations

Lenders that intend on participating in Round 3 need to carefully evaluate the lessons learned in the first two rounds of the PPP. Unlike the initial two rounds, most of the rules and guidance have now been in existence for quite some time. However, the lender hold harmless provision in the Act is significant, but should be safeguarded by lenders taking deliberate steps to show how they are working on complying with PPP rules and guidance in good faith. We strongly suggest lenders document their efforts with risk assessments, policies and procedures.

It remains to be seen whether all lenders that were authorized to make loans under the first two rounds of the PPP will be automatically granted authority to participate in Round 3. The SBA will need to issue rules and guidance that describes how a lender can become eligible for making loans in Round 3 as all lenders authority terminated automatically by the terms of the original lender agreement (Form 3506) on August 9, 2020. This is especially the case for banks that may have fallen into “troubled condition” status in the interim.

Balancing Round 3 and the ongoing forgiveness process will likely pose certain additional challenges. It will remain important to maintain a strong forgiveness process while originating new loans for Round 3. Lenders may want to consider splitting up teams to ensure both forgiveness and originations receive the proper attention. Establishing clear lines of communication between these teams will also be important.

 

[1] We refer to the new round as “Round 3” because technically the second round occurred when Congress allocated additional funding this past summer. The text of the Act is available here: https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-116HR133SA-RCP-116-68.pdf

[2] Lender processing fees are: $2,500 or 50%, whichever is less, of the loan amount for loans up to $50,000; 5% of the loan amount for loans of $50,001 to $350,000; and 3% for loans over $350,000.

[3] The IRS formalized its position, which has now been overturned, in Notice 2020-32, Rev. Rul. 2020-27, and Rev. Proc. 2020-51.