On March 27, 2020 , after many sectors of the economy have come to a virtual stand-still and millions of Americans have filed for unemployment as a result of the novel coronavirus (COVID-19) pandemic, the United States Congress passed, and President Trump signed, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Among other things, the CARES Act is an unprecedented financial assistance package for small and mid-size businesses, including franchisors and franchisees. Many of the provisions were supported by the International Franchise Association. Although this post focuses on issues specific to the franchise and hospitality industries, it is equally applicable to all small and mid-size businesses.
Assuming that many readers will be looking at the loan programs in both the CARES Act and earlier legislation that was adopted in earlier March, this post it is organized as follows: (1) what businesses should do now; (2) the expanded SBA Section 7(a) loan program and the SBA Economic Injury Disaster Loan (EIDL) program; and (3) other business favorable elements of the CARES Act.
SBA LOAN PROGRMS:
- SBA Section 7(a) loan program: “LIVE”
- SBA Economic Injury Disaster Loan (EIDL) program: “LIVE”
- SBA CARES Act “Paycheck Protection Program” Loans: “NOT LIVE”
What Should Businesses Do Immediately?
First, every business should contact its banker(s). The expanded SBA Section 7(a) loans, sometimes referred to as the “Paycheck Protection Program,” will be administered by banks and other financial institutions. Some reports state that banks will prioritize existing customers first and loans to new customers second. Although rules for the expanded SBA Section 7(a) loans have not been released as of the date of this post, they will be released within a week according to current expectations. Businesses will want to “get in line” if needed.
Second, evaluate, with its banker and potentially other professional advisors, whether it qualifies for expanded SBA Section 7(a) and/or EIDL loans (see below for more information). Franchisors not in the restaurant or hospital space (Sector 72) should consider applying to be on the SBA’s franchise directory.
Third, assemble company documents, such as certificates or articles of incorporation, bylaws, operating agreements, and certificates of good standing (make sure that the company is in good standing).
Finally, assemble financial information of a type that borrowers would ordinarily expect a lender to want to review, including financial statements, tax returns, and payroll information. As you will see below, payroll information is of particular importance for the expanded SBA Section 7(a) loans.
SBA Expanded 7(a) Loan Program and Economic Injury Disaster Loan Program
Expanded SBA Section 7(a) Loan Program
SBA Section 7(a) loans are the typical SBA loans that are commonly available through numerous banks and other lenders. These loans are typically thought of when discussing SBA loans. The CARES Act created a new loan program – the “Paycheck Protection Program” Loans. Paycheck Protection Program loans may have a principal loan amount of up to $10 million (see below for limitations). Loans may have a term of up to 10 years and bear interest at a rate of no more than 4% per annum (with payments to be deferred for at least 6 months and at most 1 year). The loan can be prepaid without penalty. In addition, Paycheck Protection loans will be allowed to be used for the following additional purposes:
- Payroll support (including paid sick or medical leave);
- Employee salaries;
- Mortgage, rent and utility payments;
- Insurance premiums; and
- Other debt obligations.
The Paycheck Protection Program covers businesses with 500 or fewer employees, unless the covered industry’s SBA size standard allows more than 500 employees, which were operational on Feb. 15, 2020. The size standards are tested on an affiliate basis—combined with all businesses under common control (50% ownership or contractual control)—counting on an aggregate basis towards the size test.
The affiliation test may disqualify venture or private equity backed borrowers, other than those with a NAICS Sector Code beginning with 72 (hospitality and restaurant businesses), franchises on the SBA directory, and recipients of Small Business Investment Company (SBIC) investment. Many venture and private equity investors hold capital stock that have so-called “protective provisions” which permit the investors to block certain corporate actions. These protective provisions, therefore, would result in the employees from the investors’ other “controlled” investments to be deemed affiliated with the borrower, unless expressly excluded from the affiliation tests. Borrowers should consult their bankers and professional advisors to evaluate the affiliation rules.
This means that the 500-employee threshold is measured for certain businesses on a location-by-location basis. For instance, a hotelier with more than 500 employees nationwide may seek loans for individual properties. In addition, restaurants and other businesses with multiple operating entities under a common parent should consider in conjunction with their advisors whether each entity can and should apply for its own Paycheck Protection Program loan.
How Much can be Borrowed
The maximum loan amount available to a borrower will be the lesser of (1) $10 million or (2) the product obtained by multiplying average total monthly payments for payroll costs of the business during the 1-year period before the loan is made by 2.5. Payroll costs include salary, wage, vacation, parental, family, medical or sick leave, severance, health care benefits, and local taxes. Thus, payroll costs include much more than aggregate salary. For example, if the loan is made on April 1, 2020, and payroll costs for the period April 1, 2019, to April 1, 2020, were $1,500,000, the maximum loan amount would be $3,750,000.
Borrowers under the Paycheck Protection Program may be eligible for loan forgiveness in an amount equal to the amount spent by the borrower during the eight-week period following the origination date of the loan on:
- Payroll costs (which may include employees that make over $100,000 but prorated);
- Interest payment on any mortgage incurred before Feb. 15, 2020;
- Rent on any lease in force before Feb. 15, 2020; and
- Utilities for which service began before Feb. 15, 2020.
The amount forgiven would be reduced in proportion to (1) any reduction in employees retained during the eight-week period as compared to the average number of employees from either (as determined by the borrower) February 15, 2019 to June 15, 2019 or from January 1, 2020 and February 29, 2020 and (2) any reduction in the pay of any employee beyond 25% of prior year’s compensation. For purposes of calculating the amount of the reduction, Employees that received annualized wages or salary of more than $100,000 are not counted.
Borrowers that rehire workers laid off prior to the origination of the loan will not be penalized for having reduced payroll at the beginning of the period. Also, please note that the forgiveness would not cause recognition of cancellation of indebtedness income for tax purposes.
Lenders must decide whether to accept a borrower’s application for forgiveness within 60 days of receipt of the application for forgiveness.
Detailed accounting and complete and accurate recordkeeping will be vital to taking advantage of these provisions.
Special Terms for Paycheck Protection Loans
- No personal or collateral guarantee will be required.
- The eligible recipient does not have to certify that it is unable to obtain credit elsewhere.
- Eligible borrowers must make a good faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by COVID-19; that funds will be used for a permitted purpose; and that they are not receiving fund from another SBA program for the same uses (see below for further information on this last point).
Existing SBA Disaster Loan Program
Congress’s second emergency bill, the Coronavirus Preparedness and Response Supplemental Appropriations Act signed into law on March 6, 2020 included the SBA’s disaster assistance loans. Under the law, the SBA expanded the ways in which businesses could obtain an Economic Injury Disaster Loan (EIDL). The SBA issues the EIDL loans directly at a low-interest (3.75 percent for small businesses) for up to $2 million and a maturity of up to 30 years. Terms are determined on a case-by-case basis, based upon each borrower’s ability to repay the loans. Applications are available now on the SBA’s website.
Importantly, under the CARES Act, a borrower that receives a Paycheck Protection Program loan for employee salaries, payroll support, mortgage payments and/or other debt obligations would not be able to receive an EIDL for the same purpose, or co-mingle funds from another loan for the same purpose. However, the Paycheck Protection loan may be used to repay an EIDL loan. The CARES Act waives the requirement for personal guarantees on EIDL loans amounts less than $200,000 and borrower is not required to have been in business for at least 1 year. The requirement that borrowers are unable to obtain credit from other sources is also waived on EIDL loans.
EIDL loans, as modified by the CARES Act, will be available until December 31, 2020 where the Paycheck Protection loan program runs only until June 30, 2020. For purposes of the EIDL loans the definition of “small business,” for the purposes of EIDL loan, include a company with no more than 500 employees, but does not waive the affiliation rules for Sector 72 businesses (hospitality and restaurant businesses).
A $10,000 emergency advance (within three days of submitting an application) will be paid while an applicant’s loan application is pending. This advance is not required to be repaid.
EIDL loans may be used to pay fixed debts, payroll, accounts payable and other costs, but are not intended to replace lost sales or profits and cannot be used for certain purposes, including to refinance debt, make payments on loans owed by another federal agency, to pay tax penalty obligations, repair physical damages, or to pay dividends to stockholders.
SBA Express Loan
The CARES Act increases the maximum SBA Express loan—a loan whose application SBA will process in 36 hours—from $350,000 to $1 million through December 31, 2020.
Other elements of the CARES Act Which Are Favorable to Business
Employee Retention Tax Credit
Small businesses may be eligible for refundable payroll tax credit for 50 percent of wages paid by employers to employees from March 12, 2020 to January 31, 2021. The credit is available to employers whose (1) operations were fully or partially suspended, due to a COVID-19 related shut-down order, or (2) gross receipts declined by more than 50 percent when compared to the same quarter in the prior year.
Advanced Tax Credits for Paid Leave
The CARES Act allows employers to receive an advance tax credit for required paid sick leave (under the Families First Coronavirus Response Act) instead of having to be reimbursed.
Delay of Payment of Employer Payroll Taxes
Employers and self-employed individuals may defer payment of the employer share of the Social Security tax they otherwise are responsible for paying.
Net Operating Loss Modifications
The provision relaxes the limitations on a company’s use of losses. Net operating losses (NOLs) are currently subject to a taxable-income limitation, and they cannot be carried back to reduce income in a prior tax year. The provision also temporarily removes the taxable income limitation to allow an NOL to fully offset income. These changes will allow companies to utilize losses and amend prior year returns, which will provide critical cash flow and liquidity during the COVID-19 emergency.
Treasury Fund for Larger Businesses
The CARES Act authorizes $454 billion for loans, loan guarantees and investments in support of facilities established by the Federal Reserve to support lending to eligible businesses, states, or municipalities.