As outlined in previous alerts, the CARES Act incudes within it the Paycheck Protection Program, or PPP which prioritizes millions of Americans employed by small businesses by authorizing up to $349 billion in federal assistance toward job retention and certain other expenses.
Specifically, under the PPP, businesses with principal places of residence is in the United States and that employ not more than 500 employees, including employees of affiliates, may obtain a forgivable loan from the U.S. Small Business Administration (SBA) rooted in a business’ good-faith certification that the loan is necessary for that business to continue employing its workers and meeting it costs of operation during the COVID-19 pandemic. What’s more, forgiven loan amounts under the PPP are to be excluded from the receiving business’ gross income and will not be taxable as income.
Businesses may apply PPP funds to payroll, including compensation to employees, paid leave, group health benefits, retirement benefits, state and local payroll taxes, and compensation to independent contractors paid out from February 15, 2020 – June 30, 2020. The funds may also be used to pay mortgage interest, rent, and utilities paid during that same period.
The maximum loan amount under the PPP is the lesser of 2.5 times the business’ average monthly payroll cost or $10 million. Based on the SBA’s latest application form, year-round PPP applicants should calculate their average monthly payroll cost using calendar year 2019, despite the fact the statute and the SBA’s Interim Final Rule provide otherwise.
What constitutes an ‘affiliated business’ under the PPP for the purpose of counting employees?
In determining whether affiliation exists, the SBA considers the ‘totality of the circumstances’ and weighs such factors as ownership; management; previous relationships with or ties to another business concern; and contractual relationships.
Ultimately, the SBA’s affiliation determination is closely aligned with control, and is deemed to exist when one business concern controls or has the power to control another, or when a third party (or parties) controls or has the power to control both businesses. It does not matter whether control is exercised, so long as the power to control exists.
Per the SBA’s latest guidelines, published April 3, 2020, affiliation under any of the circumstances described below is sufficient to establish affiliation for the PPP:
- Affiliation based on ownership.
A concern is an affiliate of an individual, concern, or entity that owns, or has the power to control more than 50 percent of the concern’s voting equity.
If no individual, concern, or entity is found to control based on voting equity, the SBA will deem the Board of Directors or President or CEO (or other officers, managing members, or partners who control the management of the concern) to be in control of the concern.
Importantly, the SBA’s affiliation guidelines make clear that control may be affirmative or negative. Negative control includes, but is not limited to, instances where a minority investor has the ability to prevent a quorum or otherwise block action by the board of directors or shareholders.
- Affiliation arising under stock options, convertible securities, and agreements to merge.
The SBA considers stock options, convertible securities, and agreements to merge (including agreements in principle) to have a present effect on the power to control a concern, treating such options, convertible securities, and agreements as though the rights granted have been exercised.
However, options, convertible securities and agreements that are subject to conditions precedent that are incapable of fulfillment, speculative, conjectural or unenforceable under state or federal law, or where the probability of the transaction (or exercise of the rights) occurring is shown to be extremely remote are all excluded for the purpose of affiliation.
Likewise, letters of Intent and agreements to open or continue negotiations toward the possibility of a merger or a sale of stock at some later date are not considered ‘agreements in principle’ and are thus not given present effect.
Finally, an individual, concern or other entity that controls one or more other concerns cannot use options, convertible securities or agreements to appear to terminate such control before actually doing so. In other words, the SBA will not give present effect to individuals’, concerns’ or other entities’ [mere] ability to divest all or part of their ownership interest to avoid a finding of affiliation.
- Affiliation based on shared management and/or board control.
Affiliation arises where the CEO or President of the applicant concern (or other officers, managing members, or partners who control the management of the concern) also controls the management of one or more other concerns. Likewise, affiliation arises where a single individual, concern or entity that controls the Board of Directors of one concern also controls the Board of Directors of one or more other concerns.
Thus, it stands to reason that private equity funds under common management control are deemed affiliates. Likewise, a portfolio company of a private equity fund that is under common control with another private equity fund will likely be deemed affiliated with both private equity funds and their controlled portfolio companies.
- Affiliation based on identity of interest.
Affiliation arises when there is an identity of interest between close relatives, as defined in 13 CFR 120.10, with identical or substantially identical business or economic interests (such as where the close relatives operate concerns in the same or similar industry in the same geographic area).
Where the SBA determines that interests should be aggregated under this provision, an individual or firm may rebut that determination with evidence showing that the interests deemed to be one are in fact separate.
Importantly, even where affiliation is deemed to exist, the SBA has indicated that for the purposes of PPP eligibility it will not count employees of a business concern’s non-U.S. affiliates, only its U.S. employees.
Are there business for which the affiliation rules are waived for purposes of the PPP?
Yes. The PPP expressly waives the inclusion of otherwise affiliated employees for:
- Hotel and food services businesses – Businesses with an NAICS code starting with 72 can have up to 500 employees per location and qualify;
- Businesses operating as a franchise and are listed on the SBA franchise registry; and
- Businesses which receive financial assistance from a Small Business Investment Company which is licensed under section 301 of the Small Business Investment Act of 1958.
Any business which falls within one of the three categories does not have to consider affiliation rules when determining whether it meets or exceeds the maximum employee headcount for PPP loan eligibility. Those franchise systems not currently listed on the SBA franchise registry should work with their franchise attorney to become listed as soon as possible.
Bottom line: Depending upon the organizational structure of your business(es), affiliation can be a highly nuanced question – and one central to your PPP loan eligibility and forgiveness. Thus, before applying for a loan under the PPP, companies approaching the 500-employee threshold by any conceivable measure should seek counsel concerning their particular facts.
Under what circumstances will a PPP loan be forgiven?
Business’ PPP loan amounts properly applied toward eligible payroll costs should be forgiven in full.
If, however, the business’ number of employees during the PPP loan period is already less than its number of employees from February 15, 2019 – June 30, 2019 or January 1, 2020 – February 29, 2020, the loan amount forgiven will be incrementally reduced.
The PPP loan amount eligible for forgiveness will likewise be incrementally reduced should the business-recipient decrease the salary or wages paid to any employees between February 15, 2020 – June 30, 2020 by more than 25%, as compared to the last full quarter before PPP loan origination.
Under certain circumstances, businesses may potentially ‘recover’ any reductions in PPP loan forgiveness eligibility by ‘curing’ its languishing employment numbers or reductions in employee compensation, but those exceptions are beyond the scope of this Alert.
Finally, it is worth noting that not more than 25% of the forgiven amount may be used for non-payroll costs (e.g., rent, utilities, interest on mortgage payments and other debt obligations).
What if some or all of a PPP loan is ultimately deemed ineligible for forgiveness?
In the event some or all of a PPP loan is ultimately deemed ineligible for forgiveness, businesses taking advantage of the program are still likely to find a measure of comfort in its repayment terms.
The interest rate on any amounts not forgiven is a slight one percent (1.0%), and any amounts owed may be paid back over a two-year period. Interest will accrue from the date of origination, but payment will be deferred for six months.
If you believe a PPP loan is right for you, contact your banking institution and Manning Fulton promptly.
If you are confident a PPP loan is right for you, the lending institution at which you maintain your bank accounts is the place to start the application process.
PPP applications are being accepted through June 30, 2020, or until the $349 billion in federal funds allocated for this program are exhausted. In other words, time is of the essence as PPP loans (to eligible borrowers, having satisfied all criteria) will be granted on first come, first serve basis.
As additional SBA guidance is issued on key aspects of the PPP, you can expect regular updates from Manning Fulton as we strive to keep you fully apprised.
If you have questions about any aspect of the Paycheck Protection Program, the application of the PPP to your business, the CARES Act of which it is a part, or any business issue you are facing in these unprecedented times, please contact Ritchie Taylor or your Manning Fulton relationship attorney.