By Robert T. Smith
The Small Business Administration (SBA) recently issued a Loan Forgiveness Application (Form 3508) for borrowers with Paycheck Protection Loans. Below is a summary of some of the key considerations, issues and questions as borrowers and lenders work through the forgiveness process.
SBA Form 3508
The application consists of four parts:
1. Loan Forgiveness Calculation Form (with instructions)
2. PPP Schedule A (with instructions)
3. PPP Schedule A Worksheet (with instructions)
4. PPP Borrower Demographic Information Form
Each borrower must deliver the Forgiveness Calculation Form and PPP Schedule A to its lender when requesting forgiveness.
Covered Period
The Covered Period under the CARES Act is an 8-week (or 56-day) period beginning on the date of first disbursement of loan proceeds. Note that “day 1” is the date of first disbursement, so borrowers should count 55-days beginning with the day after disbursement to determine the end of the 8-week period (rather than simply counting forward by 8-weeks on a calendar).
Alternative Payroll Covered Period
SBA is allowing a borrower to elect to use an alternative period when determining eligible payroll costs. Any borrower with a bi-weekly or more frequent payroll period may elect to calculate eligible payroll costs using an 8-week period that begins with the first day of the first pay period following the loan disbursement date. This is referred to as the “Alternative Payroll Covered Period."
Loans in Excess of $2 million
On May 13, SBA issued FAQ #46 providing a safe harbor for the CARES Act certification regarding the necessity for a PPP loan. This safe harbor is available to borrowers who, along with their affiliates, have received PPP loans with an aggregate principal amount of less than $2 million. Form 3508 requires that borrowers check a box indicating whether they have exceeded this threshold.
Unlike the FAQ, Form 3508 clarifies that the CARES Act provision waiving affiliation in certain circumstances will apply for purposes of this disclosure. This should mean that a separate affiliate entity to which the waiver applies, and which alone received a loan of less than $2 million, would qualify for the safe harbor under FAQ #46 even if the aggregate loans among all of its affiliates exceeds $2 million.
Implementation of 75 Percent Payroll Cost Requirement
The Loan Forgiveness Calculation Form determines the “Forgiveness Amount” as the lesser of (i) the PPP loan amount, (ii) the amount determined after any adjustments for FTE and salary/wage reductions, and (iii) an amount equal to the total payroll costs divided by 75 percent.
This calculation ensures that payroll costs will not be less than 75 percent of the actual amount forgiven. Until this guidance, it was unclear what effect a failure to satisfy the 75 percent threshold would have on overall loan forgiveness. Basically, if payroll costs are less than 75 percent of eligible expenses, then a borrower will lose the benefit of forgiveness with respect to those excess nonpayroll costs.
Costs Incurred v. Payments Made: Cash, Accrual or Both?
The CARES Act provides that a borrower may be eligible for forgiveness for eligible “costs incurred and payments made” during the covered period. A simple reading of this language appears to combine cash and accrual concepts. The instructions to the Loan Forgiveness Application provide clarification.
The following rules will apply with respect to payroll costs:
(i) Forgiveness is generally available for payroll costs paid and payroll costs incurred during the Covered Period or the Alternative Payroll Covered Period.
(ii) Payroll costs are considered paid on the date that the borrower distributes checks or originates an ACH Credit transaction.
(iii) Payroll costs are considered incurred on the day that the employee’s pay is earned.
(iv) Payroll costs incurred but not paid during the covered period are still eligible if they are paid on the next payroll date following the covered period.
(v) All other payroll costs not covered by item (i) – (iii) must be paid during the Covered Period (or Alternative Payroll Covered Period).
With respect to nonpayroll costs:
(i) All eligible nonpayroll costs must be either (A) paid during the Covered Period, or (B) incurred during the Covered Period and paid on the next regular billing date even if that billing date is after the Covered Period.
(ii) The Alternative Payroll Covered Period does not apply to nonpayroll costs.
Retirement Plan Contributions
The paid/incurred rules discussed above do not require that a retirement plan contribution relate to a specific time period. This should mean that a borrower can pay contributions during the Covered Period that relate to other time periods (even if not earned with respect to that time period).
It is still unclear how SBA and the Treasury Department will view some plan contributions. For example, there should be sufficient support for a borrower to catch-up on matching contributions for 2020 year-to-date through the end of the Covered Period. However, making matching contributions for the post-Covered Period timeframe may be too aggressive even if actually “paid” during the Covered Period.
With respect to profit sharing contributions, in addition to those contributions being discretionary with the sponsor, most plans contain a minimum hour requirement and/or a requirement that employees be employed as of the last day of the plan year to receive an allocation. We have concerns on how SBA would view a borrower accelerating profit sharing contributions when typically made after year-end.
More Certifications Required of the Borrower
Consistent with the CARES Act and the PPP application, the Loan Forgiveness Application requires the borrower to make certifications to the lender and SBA.
One provision requires the borrower to certify that “the dollar amount for which forgiveness is requested” does not “exceed eight weeks’ worth of 2019 compensation for any “owner-employee” or “self-employed individual/general partner”. This essentially caps the amount of cash compensation taken into account for those employees at $15,385 per individual.
There are several issues with this. First, while the addition of “owner-employee” is seemingly an attempt to make the treatment of owners consistent with the Interim Final Rule provision applicable to self-employed borrowers, this limitation is not found anywhere in the CARES Act. Second, the application does not include a definition of “owner-employee”, creating a problem where a borrower may be owned by another entity, and an owner of that “parent” entity receives compensation from the borrower. Third, if read literally, the certification would limit the amount forgiven to the compensation amount of the owner-employee(s). This is clearly not what was intended, and would make it impossible for most borrowers to provide this certification. SBA should promptly clarify its intentions on this point.
The certification form also notes that SBA may direct a lender to disapprove the borrower’s loan forgiveness application if SBA determines the borrower was ineligible for the PPP loan. The decision following an application for forgiveness is required to be issued by the lender within 60 days of the application.
Determining Full-time Equivalent Employees
The application confirms that a “full-time” employee is based on a 40-hour work week.
To make this determination, the borrower can either (i) use the average number of hours paid per week and divide that number by 40, rounding to the nearest tenth, or (ii) assign a 1.0 (in completing the Schedule A Worksheet) for each employee that works 40 hours or more per week and assign a 0.5 for all other employees.
The application provides that the loan amount eligible for forgiveness will not be reduced for the following:
(a) any positions for which borrower made a good faith, written offer to rehire the employee during the Covered Period or Alternative Payroll Covered Period;
(b) any employee who during the Covered Period or Alternative Payroll Covered Period: (i) was fired for cause; (ii) voluntarily resigned; or (iii) voluntarily requested and received a reduction in their hours.
Salary / Hourly Wage Reduction
Under the CARES Act, for each employee making less than $100,000 (annualized), loan forgiveness will be reduced on a dollar-for-dollar basis to the extent that any such employee’s pay during the Covered Period is reduced by more than 25 percent of his/her “total salary or wages . . . during the most recent full quarter”.
The application simplifies the implementation of this rule. Rather than comparing the actual amount of pay for the 8-week period to the previous 12-week period, the application requires a comparison of the average pay of the employee over those time periods.
Required Documentation
Each borrower is required to submit documentation to substantiate the amount eligible for forgiveness. Such documentation includes the following items:
- Payroll Documentation
- Bank account statements documenting the amount of cash compensation paid to employees
- Payroll tax filings reported, or that will be reported to the IRS
- State income, payroll, and unemployment insurance filings
- Payment receipts, cancelled checks, or account statements documenting the amount of any employer contributions to employee health insurance and retirement plan.
- Full-Time Equivalent Employees
- The application requires the Borrower to provide documentation showing the number of FTEs during the selected time period without providing guidance on the types of documentation sufficient to achieve this end.
- This should include:
- the average number of monthly FTE employees between February 15, 2019 and June 30, 2019;
- the average number of monthly FTE employees between January 1, 2020 and February 29, 2020; or
- for a seasonal employer, the average number of monthly FTE employees for either (i) one of the two time periods referenced above, or (ii) any other consecutive twelve-week period between May 1, 2019 and September 15, 2019.
- Nonpayroll Expense Documentation
- Mortgage Interest Payments: Copy of lender amortization schedule and receipts or cancelled checks verifying eligible payments from the Covered Period; or lender account statements from February 2020 and the months of the Covered Period through one month after the end of the Covered Period verifying interest amounts and eligible payments.
- Business Rent and Lease Payments: Copy of current lease agreement and receipts or cancelled checks verifying eligible payments from the Covered Period; or lessor account statements from February 2020 and from the Covered Period through one month after the end of the Covered Period verifying eligible payments.
- Business utility payments: Copy of invoices from February 2020 and those paid during the Covered Period and receipts, cancelled checks, or account statements verifying those eligible payments.
Please contact one of our attorneys if you have any questions about the Paycheck Protection Program.
Robert T. Smith heads the Finance and Commercial Transactions Practice Group. His diverse corporate practice focuses on representing companies and financial institutions in general business, transactional, securities and regulatory matters.
Disclaimer: The information included here is provided for general informational purposes only and should not be a substitute for legal advice nor is it intended to be a substitute for legal counsel. For more information or if you have further questions, please contact one of our Attorneys.