Legal Analysis of the Coronavirus Aid, Relief & Economic Security (CARES) Act

Legal Analysis of the Coronavirus Aid, Relief & Economic Security (CARES) Act

LEGAL DISCLOSURE: The Contents Of This Document Should Not Be Construed As Legal Advice, Nor Does Its Distribution Or Acceptance Constitute The Formation Of An Attorney Client Relationship. Nothing Contained Herein Should be Acted Upon Without First Consulting Professional Legal Counsel. Please Contact One Of Our Experienced Attorneys If You Have Additional Questions. 

UPDATED 5/21/2020: Executive Summary of Paycheck Protection Program 

Note: the 5/21/2020 update noted above includes the release of the PPP Loan Forgiveness Application and Instructions.

Compiled by S. Graham Simmons, William L. Brewer, and Douglas R. Brown
With additional contributions by Robert C. Gabrielski 

What’s available to you and your business under the Paycheck Protection Program Loans?  Our Executive Summary covers Sections 1102 and 1106 of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), as amended by the Paycheck Protection  Program and Health Care Enhancement Act (Paycheck II), which significantly expands the availability of Small Business Administration (SBA) loans to help businesses survive the economic impact of COVID-19.

Between the CARES Act and Paycheck II, Section 1102 makes $659 billion available for loans under Section 7(a) of the Small Business Act [15 U.S.C. § 636(a)] and creates Paycheck Protection Program loans by adding Paragraph 36 to Section 7(a) of the Small Business Act. Section 1106 of the CARES Act creates a loan forgiveness program and discusses the various rules related to the loan forgiveness availability and process.  The CARES Act refers to Paycheck Protection Program loans made February 15, 2020, thru June 30, 2020, as “Covered Loans,” an important term in our discussion below, and the opportunity for debt forgiveness of those Covered Loans.  The CARES Act also gave the SBA 30 days to issue further guidance and clarifications regarding Covered Loans and the associated debt forgiveness and as SBA has done so, and we address that further guidance below.

To date, the SBA has issued the following further guidance in the form of the following Interim Final Rules:

  • Business Loan Program Temporary Changes; Paycheck Protection Programdated April 2, 2020.
  • Business Loan Program Temporary Changes; Paycheck Protection Program dated April 3, 2020.
  • Business Loan Program Temporary Changes; Paycheck Protection Program – Additional Eligibility Criteria and Requirements for Certain Pledges of Loans”, dated April 14, 2020 which was focused on sole proprietors and independent contractors.
  • Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility” dated April 24, 2020.

Additionally, the Treasury Department has issued FAQs (most recently updated April 23, 2020) which together with the Interim Final Rules, we will collectively call the Guidance”.  Importantly, the Guidance states that it is immediately effective in order to begin the implementation of Covered Loans under the CARES Act.  So, what has changed since the enactment of the CARES Act?

First and foremost, we now know that Covered Loans will be offered on a first-come, first-served basis.  We also know that most lenders will only be accepting applications from their existing customers, and many are only accepting applications online.  Eligible borrowers with an existing banking relationship should immediately contact their bank to determine how they are accepting applications.  Those who do not have a pre-existing relationship with a preferred SBA lender should begin looking for institutions that are accepting applications from eligible borrowers who are not current customers.  The SBA has stated definitively that businesses cannot submit multiple applications, so now is the time to pick your lending relationship and get an application submitted!

As far as what has changed, the Guidance provides that the SBA, in consultation with the Secretary of the Treasury, determined that interest rates for Covered Loans will be one percent (1%), and the maturity date for a Covered Loan will be two years, which the SBA and Treasury Secretary determined is appropriate because it provides low-cost funds to borrowers to meet payroll costs and other eligible expenses, it offers an attractive interest rate relative to the cost of funding for comparable maturities, and they believe a one percent (1%) interest rate is higher than the yield on Treasury securities of comparable maturity.  The SBA and Treasury Secretary also determined, with respect to loan maturity, that a two (2) year loan term is sufficient in light of the temporary economic disruption caused by the coronavirus, which is expected to abate well before the two year maturity date and expectations are that borrowers can return to business as usual and pay-off any outstanding balances on their Covered Loans.

What else has changed?  The Guidance requires the payment deferral on Covered Loans to be six (6) months, even though the CARES Act authorizes the SBA to defer loan payments for up to one year, and at least seventy-five (75%) of the Covered Loan proceeds must be used for payroll costs.  While the Guidance acknowledges that the CARES Act allows Covered Loans to be used for payroll, rent, utilities and certain mortgage payments, the SBA however, believes that finite appropriations and the structure of the CARES Act warranted this requirement to use a substantial portion of the loan proceeds for payroll costs because “it is consistent with Congress’ overarching goal of keeping workers paid and employed.”

So, what’s the latest?  Following the first round of funding for Covered Loans, and likely in response to public outcry over some of the businesses that obtained Covered Loans, SBA is now cautioning that all borrowers must review carefully the required certification that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  The Applicant must make certification in good faith, taking into account current business activity and their ability to access other sources of liquidity sufficient enough to support ongoing operations which would not be “significantly detrimental.”

The Guidance also makes it clear that it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith.  Furthermore, the Guidance has clarified that hedge funds and private equity firms are not eligible for Covered Loans.  While a portfolio company owned by a private equity fund could potentially be eligible, they not only must take into consideration the applicable SBA affiliation rules, they must also carefully consider the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

The Guidance has provided a safe harbor such that if a potentially ineligible borrower who received a Covered Loan prior to April 24, 2020 pays back or returns the Covered Loan by May 7, 2020, the SBA will consider their original certification for eligibility to have been made in good faith.


SBA Guaranty of Covered Loans: Section 1102 generally allows the SBA to guarantee Covered Loans under the same terms, conditions, and processes as any other Section 7(a) loan, and requires the SBA’s 100% participation in any agreement to participate in a Covered Loan on a deferred basis.

Eligibility for Covered Loans: Section 1102 expands the eligibility for Covered Loans beyond traditional “small business concerns” to any business concern, nonprofit organization, veterans organization, or Tribal business concern if (1) it was in operation on February 15, 2020 paying employees or independent contractors, and (2) the entity employs no more than the greater of: (a) 500 employees; or (b) if applicable, the size in number of employees established by the SBA as standard for the industry in which the entity operates. Under Section 1102 for purposes of determining eligibility, the term “employee” includes individuals employed on a full-time, part-time, or other basis.

Also eligible for Covered Loans under Section 1102 are individuals operating under sole proprietorships or as independent contractors, if they submit the necessary documentation (e.g., payroll tax filings, Forms 1099–MISC, and income and expenses from the sole proprietorship); and business concerns that employ no more than 500 persons at each physical location, provided they are accommodation and food services assigned a NAICS code beginning with 7.

What has Changed:  The Guidance clarifies that a partner in a partnership cannot submit a separate PPP loan application for himself or herself as a self-employed individual.  The self-employment income of general active partners is to be reported as a payroll cost of the partnership, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.  With this Guidance the SBA acknowledges that rent, mortgage interest and utilities are incurred at the partnership level, not the partner level.

The SBA  also clarified that participation in an ESOP does not trigger the affiliation rules, and a small business that otherwise is eligible for a PPP loan will not be rendered ineligible if it is owned by a person who also is an outside director or owner of less than 30% of the proposed PPP lender.

The Guidance clarifies that an applicant would be ineligible for a Covered Loan if: (1) they are engaged in any illegal activity; (2) they are a household employer (i.e., individuals who employ nannies or housekeepers); (3) they are a 20% owner (or greater) of the business and are incarcerated, on probation, on parole; presently subject to an indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or have been convicted of a felony within the last five years; (4) the applicant or any other owner’s of applicant’s business has ever obtained a direct or guaranteed loan from SBA or any other Federal agency that is currently delinquent or has defaulted within the last seven years and caused a loss to the government; (5) the applicant’s business is one described in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10; (6) the business is a hedge fund or private equity firm; or (7) the business is currently a “debtor” in a bankruptcy proceeding.

To establish eligibility for a Covered Loan, the Guidance requires borrowers to submit payroll processor records, payroll tax filings, or Form 1099-MISC, or income and expenses from a sole proprietorship, while borrowers that do not have that documentation must submit other supporting documentation, such as bank records.

What has Changed: The Guidance clarifies that applicant that is self-employed regardless of whether he or she has filed a 2019 tax return with the IRS, has to provide the 2019 IRS Form 1040 Schedule C with the PPP loan application to substantiate the applied-for loan amount.

Amounts of Covered Loans: Under Section 1102, the maximum Covered Loan amount is $10 Million. The maximum loan amount calculation will depend on whether the applicant is a seasonal employer (as determined by the SBA), or was in business from February. 15, 2019, through June 30, 2019. The amount would ultimately be the lesser of (1) the sum of 2.5 times the average total monthly payments for “Payroll Costs” incurred during the 1-year period before the loan is made, plus the outstanding amount of a loan under subsection (b)(2) (SBA Disaster relief) made during the period beginning January 31, 2020, and ending on the date when Covered Loans are made available to be refinanced under the Covered Loan; or (2) $10 Million.

Payroll Costs: Under Section 1102, “payroll cost” equals the sum of (1) payments of  compensation to employees that is (a) salary, wage commission, or similar compensation; (b) cash tip or equivalent; (c) payment for vacation, parental, family, medical, or sick leave; (d) allowance for dismissal or separation; (e) payment required to provide group health care benefits, including insurance premiums; (f) retirement benefits; or (g) state or local tax assessed on employee compensation; and (2) compensation to or income of a sole proprietor or independent contractor of not more than $100,000 in 1 year, pro-rated for the Covered Period (February 15, 2019, through June 30, 2020).

Payroll Costs do not include: (1) salary of an individual employee exceeding $100,000 annually, prorated for the Covered Period; (2) taxes imposed or withheld under chapters 21, 22, or 24 of the IRS Code of 1986 during the Covered Period; (3) compensation of an employee whose principal residence is outside the United States; (4) sick leave wages for which credit is allowed under section 7001 of the Families First Coronavirus Response Act (Public Law 116–127).  The Guidance further clarified that independent contractors are not counted for purposes of Covered Loan calculations.

In addition to providing examples on how to calculate the amount of a Covered Loan, the Guidance offers a five-step process for calculating average monthly “Payroll Costs” to determine your Covered Loan amount as follows:

Step 1: Aggregate “Payroll Costs” (as defined above) from the last twelve months for employees whose principal place of residence is the United States.

Step 2: Subtract any compensation paid to an employee in excess of an annual salary of $100,000 and/or any amounts paid to an independent contractor or sole proprietor in excess of $100,000 per year.

Step 3: Calculate average monthly payroll costs (i.e., divide the amount from Step 2 by 12).

Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5.

Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL COVID-19 loan (because it does not have to be repaid).

What has Changed:  The Guidance provides that on loans to self-employed persons, loan forgiveness for amounts spent on owner compensation replacement will be limited to 8 weeks (i.e. 8/52) of 2019 net profit reported on Schedule C, capped at $15,385.00.

Use of Covered Loans: Section 1102 permits eligible recipients to use Covered Loan proceeds through June 30, 2020, for payroll costs, costs of continuing group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums; employee salaries, commissions or similar compensations; interest payments on any mortgage obligation (not including any prepayment or payment of principal on a mortgage obligation); rent; utilities; and interest on any other debt obligations incurred before February 15, 2020. These uses are in addition to the normally allowable uses of a Section 7(a) loan.  Keep in mind, however, that the Guidance requires at least seventy-five (75%) of the Covered Loan proceeds to be used for payroll costs.

What has Changed:  The Guidance provides that for purposes of determining the percentage of use of proceeds for payroll costs (but not for loan forgiveness purposes) the amount of any refinanced SBA EIDL (Economic Impact Disaster Loan) will be included.  The Guidance clarifies that an applicant who has received an EIDL between January 31, 2020 through April 3, 2020 is still eligible for a PPP loan, but the PPP loan must be used to refinance the portion of the EIDL that was used for payroll costs.

Delegation to Lenders: Section 1102 delegates authority to SBA-approved lenders to make and approve Covered Loans, subject to Section 1102 and any related regulations promulgated by the SBA. Section 1102 requires a lender, when evaluating a borrower’s eligibility, to consider whether the borrower: (1) was in operation on February 15, 2020; and (2) had employees for whom the borrower paid salaries and payroll taxes; or paid independent contractors.

Refinancing Disaster Relief Loans: Section 1102 specifically authorizes Covered Loans to refinance any disaster relief loans made by the SBA from January 31, 2020, through the date when Covered Loans are made available.

Non-recourse: Section 1102 provides that the SBA will have no recourse against any individual shareholder, member, or partner of an eligible recipient of a Covered Loan for non-payment, unless the Covered Loan proceeds are used for a purpose not authorized under Section 1102.

The Guidance provides that if a borrower uses Covered Loan proceeds for unauthorized purposes, the SBA will direct the borrower to repay those amounts. Furthermore, under the Guidance, if you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud, and the SBA will have recourse against shareholders, members, or partners who use Covered Loan proceeds for unauthorized purposes.

Required Borrower Certification: Any potential borrower of a Covered Loan must certify the following: (1) the uncertainty of current economic conditions makes the loan request necessary; (2) funds will be used to retain workers and maintain payroll or make other necessary payments; (3) the borrower does not have a pending application for a loan under Section 7(a) for the same purpose and amounts; and (4) during the period from February 15, 2020 to December 31, 2020, the borrower has not received such a loan under Section 7(a).

Fee Waiver: Section 1102 waives the SBA fees through June 30, 2020, for Covered Loans, and suspends the requirement that the borrower has been unable to obtain credit elsewhere.

Personal Guaranties/Collateral: Section 1102 provides that no personal guarantee and no collateral will be required for a Covered Loan.

Repayment: Under Section 1102, any Covered Loan with a balance remaining after reduction based on loan forgiveness under Section 1106 will continue to be guaranteed by the SBA, and while the CARES Act permits a maximum maturity of 10 years from the date of application for loan forgiveness, the Guidance states that the maximum maturity will be two (2) years.

Interest: While the CARES Act caps the maximum rate of interest for a Covered Loan at 4%, the Guidance has capped the interest rate at 1%.  Regardless, prepayment penalties are not permitted.

Payment Deferral: Section 1102 requires the SBA to consider all applicants for a Covered Loan as “Impacted Borrowers,” and require lenders to provide complete payment deferment relief for not less than 6 months and not more than 1 year. The Guidance has capped the payment deferrals at six (6) month.

Section 1102 protects payment deferrals from being overruled by an investor on the secondary market. If a Covered Loan is sold on the secondary market, the SBA must exercise its authority to purchase the loan through June 30, 2020, if an investor declines a requested deferral.

Further Section 1102 regulatory relief to lenders provides that insured depository institutions and insured credit unions that modify a Covered Loan due to COVID–19-related difficulties in a troubled debt restructuring on or after March 13, 2020 will not be required to comply with FASB Accounting Standards Codification Subtopic 310-40 to comply with requirements of the Federal Deposit Insurance Act until deemed appropriate by a federal banking agency or the National Credit Union Administration.

Finally, Section 1102 requires the SBA to reimburse lenders for the costs of making Covered Loans, based on a sliding scale percentage of the loan, within 5 days after loan disbursement.

Impacted Borrower: An Impacted Borrower, defined as being in operation on February 15, 2020, and having an application for a Covered Loan pending or approved following enactment of the CARES Act, is presumed under Section 1102 to be adversely impacted by COVID-19.

Priority of Borrowers: Section 1102 states that the SBA should issue guidance to lenders and agents to ensure that processing and disbursement of Covered Loans prioritizes small business concerns and entities in underserved and rural markets.  Paycheck II sets aside $30 Billion in Covered Loans to be made by banks and credit unions with between $10 Billion and $50 Billion in assets, while another $30 Billion in Covered Loans has been set aside to be made by banks and credit unions with less than $10 Billion in assets, as well as “community financial institutions.”



Loan Forgiveness: Section 1106 allows for forgiveness of Covered Loan indebtedness equal to the following costs incurred and payments made during the “Covered Period”:

  1. Payroll Costs, plus
  2. Payment of interest on any “Covered Mortgage Obligation” – that is, any indebtedness or debt instrument incurred in the ordinary course of business that (A) is a liability of the borrower; (B) is a mortgage on real or personal property; and (C) was incurred before February 15, 2020.
  3. Payment on any “Covered Rent Obligation” – that is, rent obligated under a leasing agreement in force before February 15, 2020, plus
  4. Any “Covered Utility Payment,” – that is, payment for distribution of electricity, gas, water, transportation, telephone, or internet access that began before February 15, 2020.

Note: Under Section 1106 of the CARES Act, the “Covered Period” is the 8-week period beginning on the date of loan origination, which differs from the way Section 1102 defines the term.

The Guidance, however, states that not more than twenty-five percent (25%) of the loan forgiveness amount may be attributable to non-payroll costs.  The SBA and Treasury Secretary determined that notwithstanding the provisions of the CARES Act, that the non-payroll portion of the forgivable loan amount should be limited to effectuate the core purpose of the CARES Act and ensure finite program resources are devoted primarily to payroll.

Limitations & Reductions of Loan Forgiveness: The loan forgiveness amount available under Section 1106 (1) cannot exceed the principal amount of the Covered Loan; (2) will be reduced under Section 1106 by any reductions in the number of borrower’s employees during the 8- week period following loan origination; (3) will be reduced by borrower’s reductions in salary or wages of certain employees during the same period; and (4) borrowers may receive forgiveness for additional wages paid to tipped employees.

Effect of Workforce Reductions: Reduction based on number of employees is calculated by multiplying the amount to be forgiven under Section 1106(b) by the quotient obtained by dividing the average number of full-time equivalent employees employed per month during the Covered Period by either (a) the average number of full-time equivalent employees per month from February 15, 2019, to June 30, 2019; or (b) the average number of full-time equivalent employees per month from January 1, 2020, to February 29, 2020.  The borrower decides whether to apply (a) or (b) to the calculation.

The average number of full-time equivalent employees is determined by calculating the average number of full-time equivalent employees for each pay period within a month. For a seasonal employer, the denominator is the average number of full-time equivalent employees per month from February 15, 2020, to June 30, 2019.

Effect of Payroll Reductions: Loan forgiveness will be reduced by any reduction in total salary or wages of any employees described in Section 1106(d)(3)(B) during the Covered Period in excess of 25% of total salary or wages of those employees during the most recent full quarter in which they were employed before the Covered Period. Affected employees include those that did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay of more than $100,000.

Exemption for Rehiring/Restoring Payroll: Section 1106 provides that loan forgiveness be determined without regard to reductions in borrower’s full-time equivalent employees or salary from February 15, 2020, to the date 30 days after enactment of this Act, in the event of one or both of the following: (1) between February 15, 2020, and 30 days after enactment of the CARES Act, there is a reduction in borrower’s number of full-time equivalent employees; and no later than June 30, 2020, employer has eliminated the reduction; or (2) between February 15, 2020, and 30 days after enactment of the CARES Act, the salary or wages of 1 or more employees is reduced; and not later than June 30, 2020, the employer has eliminated the reduction in the salary or wages of such employees. Section 1106 also authorizes the SBA and the Secretary of the Treasury to prescribe regulations granting de minimis exemptions from limitations on loan forgiveness set forth in Section 1106(d).

Forgiveness Application: Under Section 1106, borrowers seeking loan forgiveness must submit to the lender servicing the Covered Loan an application including (1) documentation verifying the number of full-time equivalent employees on payroll, and pay rates for the relevant periods (i.e., 8 weeks following loan origination and between February 15 and 30 days following enactment of the CARES Act); (2) documentation verifying payments on covered obligations; (3) certification from borrower’s authorized representative that the documentation presented is true and correct, and the amount for which forgiveness is requested was used to retain employees and pay covered obligations; and (4) any other documentation the SBA determines necessary. Lenders must make decisions on forgiveness applications within 60 days of receiving them.

Tax Relief: Section 1106 loan forgiveness also provides tax relief to borrowers, in that amounts normally includible in borrower’s gross income will be excluded from gross income.

Loan Terms Unaffected: Section 1106 expressly provides that if all or any portion of a Covered Loan is forgiven, cancellation of indebtedness will not otherwise modify the terms and conditions of the Covered Loan.

SBA Treatment of Loan Forgiveness: Section 1106 provides that forgiven amounts will be considered canceled indebtedness by a lender authorized under Section 7(a) of the Small Business Act; and for purposes of the SBA’s purchase of the guarantee for a Covered Loan, forgiven amounts are treated according to procedures otherwise applicable to Section 7(a) loans.

SBA Payment for Forgiveness: The SBA must remit the lender an amount equal to the forgiveness amount within 90 days after that amount is determined. Section 1106 further authorizes the SBA to purchase in advance the “expected forgiveness amount on a Covered Loan up to 100% of the principal if the lender submits a report to the SBA. The SBA must purchase the expected forgiveness amount within 15 days after receiving the report.

Expected Forgiveness Amount: Section 1106 defines this as the amount of principal a lender reasonably expects a borrower to expend during the Covered Period on the sum of any Payroll Costs, payments of interest on any Covered Mortgage Obligation, and payments on any other covered obligations. Section 1106 permits the SBA to allow a third-party participant in the secondary market to make reports for advanced purchases of expected forgiveness amounts.

Regulatory Hold Harmless: If a lender has received the documentation required under Section 1106 attesting that the borrower has accurately verified the proper use of loan proceeds during the Covered Period, an enforcement action may not be taken against the lender under section 47(e) of the Small Business Act, and the lender will not be subject to any penalties by the SBA relating to loan forgiveness for those eligible payments.

SBA Regulations: Finally, Section 1106 required the SBA to issue guidance and regulations implementing this section not later than 30 days after enactment of the CARES Act.  The Guidance indicates that further regulations are forthcoming regarding Section 1106 and loan forgiveness.

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