This article has been revised to reflect the SBA and Treasury Department’s joint statement on June 8.
On June 5, 2020, President Donald Trump signed the Paycheck Protection Program Flexibility Act (the Act). The Act addresses several aspects of the Paycheck Protection Program (PPP) that have concerned borrowers. The Act provides the following:
- Extended coverage period (24 weeks)
- A shift in eligible expenditure requirements to allow 40% of funds to be used for non-payroll costs
- Extended window to restore full-time equivalent employees and compensation levels
- Extended repayment period (five years) for loans granted after June 5, 2020, and the option for borrowers to renegotiate the repayment period for loans granted prior to June 5, 2020
- Permission for borrowers to take advantage of both loan forgiveness and the payroll tax deferral
While the provisions of the Act are generally positive for borrowers, certain rules may be traps for the unwary.
Extended Coverage Period
The original PPP rules allowed loan forgiveness only for eligible expenditures in the eight-week coverage period beginning when the borrower first received its funds. The Act triples the coverage period to 24 weeks.
Many borrowers, particularly those whose operations were significantly curtailed by mandatory restrictions, were unlikely to spend enough during the eight-week coverage period to achieve full loan forgiveness. Most borrowers will now comfortably reach their expenditure targets.
Borrowers generally must maintain staffing and compensation levels during the coverage period to have their loans fully forgiven. Though there are exceptions (discussed in more detail below), the extended coverage period creates a potential drawback by requiring borrowers to maintain employment levels over 24 weeks rather than eight.
Borrowers may elect to retain their original eight-week coverage period. That election may be helpful for borrowers with enough expenditures in eight weeks to merit full loan forgiveness. Those borrowers may be able to apply for forgiveness earlier and may find it easier to maintain required staffing and compensation levels.
The Act requires borrowers to spend at least 60% of PPP funds during the coverage period to be eligible for forgiveness. A borrower can use the remaining 40% of funds for non-payroll costs (rent, utilities, mortgage interest). This provision supersedes the SBA’s rule that no more than 25% of forgiven funds could cover non-payroll costs.
While the Act implies that a borrower who spends less than 60% of its PPP funds on payroll costs will be ineligible for forgiveness, the SBA and Treasury Department jointly announced that they will allow partial forgiveness for borrowers whose payroll costs fall below 60%. The SBA and Treasury’s ruling effectively replaces the previous 25% limit on non-payroll costs with a 40% limit. For borrowers whose businesses were significantly curtailed and who would have struggled to meet the 60% payroll cost level, this ruling creates the opportunity for at least some loan forgiveness.
Employment and Compensation Requirements
As we mentioned above, a borrower’s PPP forgiveness may be reduced if it fails to maintain its number of full-time equivalent (FTE) employees or if it substantially reduces employees’ compensation during the coverage period. A borrower who experiences a reduction in either of those measures may be able to avoid a reduction in forgiveness if it restores its FTE and compensation to their February 15, 2020, levels by December 31.
The measurement date for restoration under the original PPP rules was June 30. The extension to December is a result of increasing the coverage period to 24 weeks and also an acknowledgement that the overall economic recovery has been slower than the Act’s drafters originally expected. Although the change to December 31 provides more time for businesses to restore their FTE and compensation levels, it also delays their ability to apply for loan forgiveness. A borrower who relies on the restoration provisions won’t be able to apply for forgiveness until January 2021, at the earliest.
The Act provides a further exception for borrowers who haven’t been able to maintain their FTE levels. If a borrower can document that it was unable to rehire an employee on its payroll as of February 15 and was unable to hire a similarly-qualified replacement, then the borrower can exclude that employee from its FTE calculations.
A borrower may also avoid the FTE test if it can document an inability to return to the level of its February 15, 2020, business operations because of compliance with guidance and requirements issued by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention or the Occupational Safety and Health Administration during the period from March 1 through December 31, 2020. This is a new exception under the Act and will benefit borrowers whose businesses have been harmed by government actions. Likewise, it should lessen the impact of any future shutdowns if the COVID-19 epidemic worsens in the fall.
For loans that are not forgiven, SBA’s original guidance requires borrowers to repay loans within two years. For loans made after June 5, 2020, the Act extends the repayment period to five years. The Act specifically allows lenders to renegotiate loan terms with lenders who borrowed before the Act was signed. The Act does not affect the interest rate, which the SBA set at 1%.
The original PPP rules required a borrower to begin paying interest and principal on its loan six months after it received loan proceeds. With the increased coverage period and the December 31 measurement date for payroll restoration, that rule would have required many businesses to begin repaying loans before they could even apply for forgiveness. To remedy the problem, the Act defers principal and interest payments until the lender determines how much of the loan will be forgiven. The Act requires borrowers to apply for forgiveness within 10 months of the end of their coverage periods.
Payroll Tax Deferral
In addition to establishing the PPP, the CARES Act allowed employers to defer payment of their 2020 federal payroll taxes until 2021 and 2022. Originally, the payroll tax deferral was not available to a borrower that received PPP loan forgiveness. The Act removes that prohibition, so borrowers may now take advantage of both loan forgiveness and the payroll tax deferral.
The SBA is likely to issue new guidance to implement the provisions of the Act and will probably have to revise the forgiveness application it released several weeks ago. Borrowers who are at or near the end of their original coverage period should consider whether the eight-week period is more beneficial than the extended coverage period and discuss the forgiveness application with their lenders. It’s important that all borrowers understand the benefits and the potential pitfalls of the major changes that the Act makes to the PPP. As always, please contact us if you have any questions or if we can help to clarify any of the new (or old) rules of the PPP.