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Keeping American Workers Paid and Employed Act – Is it free money time?

One-hundred fifty-years ago the United States offered a generous program to rail companies to build a transcontinental railroad.

Last Friday, the President signed legislation adopting the Keeping American Workers Paid and Employed Act (the “American WPE Act”), part of the CARES Act. Accordingly, the federal government through the Small Business Administration (the “SBA”) is now offering a nearly as generous $349 billion program to loan all small businesses up to a maximum of $10 million to help them stay afloat. And, as discussed below, under certain conditions, the balance of the loan will be forgiven, if used to pay:

  • continuing employee’s payroll, described below;
  • interest on mortgages existing as of February 15, 2020;
  • rent on leases existing as of February 15, 2020; and
  • utilities in place as of February 15, 2020.

This article does not cover all of the rules. And, it is one of two different loan programs being offered. Anyone wishing to use this program, however, should not wait; the allocated funds may be completely committed within a matter of days or weeks.

Background to SBA Loans

The American WPE Act is a bit complicated, but not impossible to understand. It may help to understand, first, a bit about SBA loans.

In particular, Section 7(a) of the Small Business Act created the SBA loan program which offers small businesses access to bank and other lender credit at reasonable interest rates. Section 7(a) of the Small Business Act authorized the SBA to generate loans for: “plant acquisition, construction, conversion, or expansion, including the acquisition of land, material, supplies, equipment, and working capital, and to make loans to any qualified small business concern, including those owned by qualified Indian tribes, for purposes of this Act.”

Under this program, authorized banks and other lenders are federally guaranteed to recover most (but not all) of the principal loaned, upon a default, wherein at least 10 percent of the risk of loss remains with the lender. It usually requires collateral security, personal guarantees, and other lender provisions. The interest rates are capped by the SBA.

Paycheck Protection Program Loans

The Paycheck Protection Program piggybacks on loans under Section 7(a) of the Small Business Act. Loan conditions are made easier and loan principal is partly (and in some cases) fully forgiven. [1] Under the American WPE Act Section 1102, there are several key terms to know:

Covered Loan. A “covered loan” means a loan made from February 15, 2020 through June 30, 2020 under this program. [2] Existing loan applications may be converted into the Paycheck Protection Program or refinanced to obtain additional funds by June 30, 2020.

Payroll Costs. Payroll costs, referred to under this Program, which are important to both the amount of the loan given and to loan forgiveness, are defined to include the following:

  • Salary, wage, commission, or similar compensation;
  • Cash tips or equivalent;
  • Vacation, parental, family, medical, or sick leave;
  • Dismissal or separation allowances;
  • Employer required payments under group health care benefit plans, including insurance premiums;
  • Retirement benefits (such as, continuation health care for retirees);
  • Employer assessed state and local taxes on employee compensation; and
  • Reported payments made as compensation to a sole proprietor or independent contractor that would be considered a wage, commission, income, net earnings from self-employment, or similar compensation, but not more than $100,000 in 1-year, pro-rated for the covered period.

Excluded from covered payroll are the following:

  • FICA, federal withholding from wages (Chapters 21 and 24) and equivalent rail road retirement benefits under Chapter 22 of the Code;
  • Compensation for employees principally residing outside the United States; and
  • Sick leave and family leave, qualifying for credit under the Families First Coronavirus Response Act, but not excess benefits offered beyond the credit.

Eligibility. A borrower must be eligible. Being eligible includes any business concern – a self-employed person or business entity, a nonprofit organization, veterans organization or Tribal Concern – each subject to not having more than 500 employees. A greater number is allowed if the SBA authorizes a greater number based on the standard, i.e., average size business in the industry. Special exemptions apply to exclude consideration of employees who work for affiliated entities; also, employers having a NAICS Code beginning with “72” (i.e., hospitality, restaurants, etc.) may treat each location as a separate employer, rather than require all employees at all business locations within a business concern to be counted. [3]

For a sole proprietor or an independent contractor making an application, there is the further condition that he or she must show receipt of payroll tax filings reported to the Service, 1099-Misc, and income and expenses. Obviously an “under-the-table” independent contractor will not qualify.

In addition, in evaluating eligibility, the lender will consider these requirements:

  • Employer was in operation February 15, 2020; and
  • Employer had either reportable paid employees or paid independent contractors.

Maximum Loan Amount. In addition, the borrower must have payroll. In fact, the maximum loan amount under this Program is based on 2 ½ months (about 10-weeks) of the employer’s average payroll, but is limited to a $10 million maximum loan.

The measure of payroll is actually computed based on the average total monthly payments for payroll for the 1-year period on the date prior to the date on which the loan is made multiplied by 2.5. Special provisions are made for seasonal employers.

Because there can be only one SBA loan, subject to the $10 million loan limit, the loan may be increased by the amount of any existing SBA loan made after January 21, 2020, that is refinanced, i.e., converted. In addition, a recipient that was not in business between February 15, 2019 and June 30, 2019, will be allowed to just compute average monthly payroll based on the first two months of the 2020-year.

Use of the Loan. The amounts obtained on the loan may be used to provide for any of the following expenses: (i) payroll costs – as described above; (ii) health care benefits during paid leave, employee salaries, commissions or similar compensation; and (iii) payments of interest (but not principal) on any mortgage obligation, rent, utilities, and interest on any other debt.

Getting a Paycheck Protection Program Loan

Application and Certification. This loan is obtained by an application to the SBA. Borrower’s declaration that a loan could not be obtained elsewhere is waived. The borrower must make a good faith certification:

(i) that the uncertainty of the current economic conditions makes the loan necessary;
(ii) that the funds will be used to retain workers and maintain workers (or will be used to make mortgage, lease, and utility payments); and
(iii) that there is no other application pending for this loan for the same purpose and duplicative of the amounts applied for or received.

While the SBA itself may not charge a fee, a lender may charge fees and costs, subject to SBA approval as to the amount of the fees charged.

Loan Terms. The terms of the loan are specified by law. Subject to Section 1106 of the American WPE Act loan forgiveness, the loan must be repaid and the repayment term may not exceed 10-years; the loan may not bear interest of more than 4 percent. The borrower must be given a repayment deferment of at least 6-months, but not more than 1-year, which includes principal, interest, and loan fees.

What is new from current SBA loans is that the loan itself is nonrecourse against any shareholder, member, or partner of an eligible recipient; the SBA’s requirement for a personal guaranty is waived.

Loan Forgiveness

Section 1106 of the American WPE Act provides that a portion of the loan principal may be forgiven. And, all amounts actually forgiven will not be subject to Section 108, cancellation of indebtedness (“COD”) income recognition for federal income tax reporting purposes.[4]

To obtain a reduction, i.e. forgiveness to any part of the loan, it must be requested by the borrower with proper documentation of the qualifying expenditures and applicable forgiveness carve-down; the lender must determine within 60 days of that reduction application the actual amount that is required to be forgiven. [5] By statute, subject to a possible reduction, the amount forgiven is tentatively set at the amount of moneys spent within 8 weeks of the funding of the loan (the “Covered Period”) for the following expenditures:

  • Covered Mortgage Obligation. Interest paid upon any loan incurred in the course of business that is due by borrower, as a mortgage against real or personal property incurred before February 15, 2020;
  • Covered Rent Obligation. Rent paid upon any rent obligated under a leasing agreement in force before February 15, 2020;
  • Covered Utility Payment. Any payment for the distribution of electricity, gas, water, transportation, telephone, or internet access, where service began before February 15, 2020; and
  • Payroll Costs. The payment of payroll costs, as described above, which includes certain employee benefits, paid leave (not subject to credit), state employer taxes, and other amounts previously described. The additional wages from tips are included.[6]

Example: Builder Bob owes $10 million on a housing development project, which is secured by 40 lots; his interest rate is 6 percent ($600,000 interest per year or $50,000 per month.) Builder Bob also has in-house staff payroll of $40,000 per month, and pays $30,000 per month for rent and $10,000 per month for utilities. Assume that Builder Bob is qualified for a loan.
Assuming no payroll reductions, Builder Bob may only borrow $100,000 (2.5 times average monthly payroll.) If within 8 weeks of the loan funding, Builder pays all of the foregoing bills, then Builder may request that the entire $100,000 SBA Program loan be forgiven. [The lesser of the loan amount of $120,000 or $260,000 (2 x ($50K + $40K + 30K + 10K.)]

Reduction to “Forgiveness” of the Loan. While using all funds for covered expenditures tentatively qualifies a borrower for a full loan reduction, the amount actually forgiven will be reduced if there has been a reduction to the average number of employees overall or if any employee’s compensation was reduced by more than 25 percent. These are two separate provisions, and both may apply to reduce the portion of the loan forgiven – i.e., leaving a greater balance due.

Employee Reduction. First, the amount of the loan forgiven for covered expenditures will be reduced by a reduction in the number of employees. The employee reductions, if any, will be computed as a percentage (but not increased) by dividing the following (i) by (ii):

(i) The average number of full-time equivalent employees per month, employed by the eligible recipient during the covered period; by

(ii)

(I) at the election of the borrower – (aa) The average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on February 15, 2019 and ending June 30, 2019; or (bb) The average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on January 1, 2020 and ending on February 29, 2020;
(II) In the case of an eligible recipient that is [a] seasonal employer, as determined by the [SBA] Administrator, the average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on February 15, 2019 and ending June 20, 2019.[7]

Salary Reduction. Second, if any employee has had his or her salary or wages reduced by more than 25 percent, then the amount of the loan forgiveness will be reduced dollar-for-dollar by the amount of compensation that that employee had his or her payroll reduced. This determination will be based on the full quarter during which the employee was employed before the loan funding date.

Exception. On the other hand, Section 1106 of the American WPE Act provides relief from reduction to the portion of the loan forgiven, to address the economic downturn, including the business closures and workforce reductions over the next few months. An employer may completely avoid either the employee or salary reduction (or both) to the amount of the loan to be forgiven, if the employee or salary reduction occurred between February 15, 2020 and April 26, 2020 (30-days from enactment) and is restored by June 30, 2020. A restoration means that the employer: (i) has fully restored employment to eliminate the staff reduction (then the staff reduction limitation will not apply); and (ii) has fully eliminated the reduction in individual employee salary or wages (then the salary reduction will not apply).

Because of this exception, where there has been a staff reduction, a careful balancing act is needed between: (i) the date that the loan funds; (ii) the expenditures for the 8 weeks that follows; and (iii) the rehiring of employees. In some instances, it may be worthwhile to try to get a loan commitment, but to delay the funding of the loan into late May or early June.

Planning

The Keeping American Workers Paid and Employed Act is a tremendous opportunity. However, applications need to be quickly submitted. It would not be surprising to see all of the allocated funds completely absorbed within weeks of the enactment last Friday. However, before applying, counsel should be sought to consider the following:

  • Is the business eligible?
  • Will the payroll limitation severely limit the loan obtainable?
  • Will the loan cause a default on any existing loan?
  • Can the employer fully restore any staff or wage reductions?
  • What is the optional timing of the loan funding?

Again, while highly favorable, even if the money turns out to be nearly “free” there will be interest charges and it may result in state COD income – although usually these costs are not significant compared to the benefits. And, for larger employers, it is important to review the employee count.

Lastly, if not feasible, the SBA’s Economic Injury Disaster Loan program should be considered. It provides small businesses with working capital loans of up to $2 million. Unlike the Paycheck Protection Program, however, there is no loan forgiveness feature in the Economic Injury Disaster Loans. Additionally, security is required and guarantees are often required.

Our office is advising on these loans and recommends that before undertaking these loans, legal advice be sought.

[1] American WPE Act Section 1102(a).
[2] Id at 1102(a)(2).
[3] Id, referencing paragraph (D).
[4] While that exclusion is not presently available in California, and there would be for California tax purposes COD income unless California law changes, it is important to review whether there might be a possible position to have the loan excluded on other grounds.
[5] American WPE Act Section 1106(f) and (g).
[6] American WPE Act Section 1106 (d)(4).
[7] American WPE Act Section 1106(d)(2)(A).

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