Read Manning Fulton’s Updated Response to the Coronavirus (COVID-19) - June 25, 2020

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Since March 27, 2020 and the passage of the CARES Act, America has engaged in an unprecedented social experiment to stabilize small businesses impacted by government action to mitigate the impact of the COVID-19 pandemic. State and local governments across the country required those businesses deemed non-essential to work-from-home or otherwise reduce/close their operations. The Paycheck Protection Program loans (“PPP loans”) were designed to help stabilized small businesses so they could (i) first, retain and pay their employees and (ii) second, pay their rent, interest and utilities until their businesses could return to regular operations. Recognizing the PPP has proven to be an important lifeline to hundreds of thousands of small businesses, last week Congress funded an additional appropriation to the PPP and allocated funds are again flowing. For an overview of the CARES Act, click here, and the PPP specifically, click here.

Over last two weeks, the Treasury Department and Small Business Administration (“SBA”) have issued several noteworthy restrictions on the PPP. First, in response to public outcry regarding larger, publicly traded companies (and certain large private companies) with less than 500 employees, or otherwise meeting exceptions for the hospitality industry and franchising business model, receiving PPP loans, the SBA issued FAQ #31 specifically calling out public companies and FAQ #37, which confirmed application of FAQ #31 to privately held companies. These two FAQs, subsequently incorporated into regulation through an interim rule, set forth the SBA’s position that when a borrower makes the good faith certification on the PPP loan application that “current economic uncertainty makes this loan necessary to support the ongoing operations of the Applicant”, the borrower must take into account their business activity at the time the certification is made. Additionally, the SBA noted in the FAQs that a business should account for their ability to access other liquidity to support ongoing operations without such liquidity sources being “significantly detrimental to the business” when making the same certification. The specific example provided in FAQ #31 is the ability of a public company to tap public markets to obtain additional financing to sustain operations. FAQ #37 applies this same standard to privately held companies with “adequate sources of liquidity to support the business’ ongoing operations.” Both public and private companies were given a constructive amnesty period ending May 7, 2020 to return the money without adverse impact.

There are substantial questions revolving around whether the SBA exceeded its authority by limiting the scope of the PPP, first, by mandating how the funds would be used beyond those specified by Congress and, second, whether the SBA has the authority by administrative fiat to restrict the pool of PPP loan borrowers to those otherwise qualifying who didn’t have any other sources of liquidity. Nevertheless, the SBA has issued this administrative guidance, as well as made public claims as to their intention to substantially audit the PPP, specifically with respect to the certification in question. Accordingly, rather than belabor the point, it is better for business executives and their counsel to analyze whether they qualify under these new rules. The key takeaways from these FAQs are:

  1. Public Companies. The Treasury and SBA intend to take an aggressive position against any publicly held company who takes a PPP Program Loan.
  2. Audit Risk. The Treasury has said they intend to audit all PPP participants who received loans in excess of $2 million. Whether or not they will have the resources to fulfill that promise, PPP participants should plan ahead to make sure they can substantiate their audit position to avoid compromising loan forgiveness or other civil or criminal penalties. They should ensure they have sufficiently documented why they were unable to obtain other liquidity from sources not substantially detrimental to the business. Dilutive capital transactions for public companies appear to be required per the SBA as they would not be “substantially detrimental” to the business. We submit it would be unreasonable for the government to require private business owners to obtain additional liquidity through pledging personal assets through a personal guaranty or capital contributions. Rather, the SBA appears to simply be taking a position that prohibits private companies from participating where a private company already had adequate sources of liquidity on hand. The SBA incorrectly assumes a board of directors should simply expend “liquidity on hand” to promote the desired societal purposes of maintaining employment for employees and paying other qualifying expenses vs. rightsizing payrolls and operating expenses to the current operating requirements for the business. Guidance from your legal counsel on good corporate governance, proper documentation of undertaken analysis, and effective corporate communications will help substantiate the borrower’s good faith determination.
  3. Practical Implications. Many of these borrowers who will have to return the money by May 7, 2020 already acted in good faith to restore employment and pay other qualifying expenses before being told they would have to return the PPP loan money. We should not be surprised if these rational business owners now make rational investment decisions without the benefits of the PPP funds, which unfortunately may lead to more unemployment and other unpaid obligations.

In addition to these new regulations, the Internal Revenue Service (“IRS”) published Notice 2020-32 this week, which clarifies that otherwise ordinary and necessary business expenses incurred in a taxpayer’s trade or business, but were satisfied by a forgiven PPP loan will not be deductible for income tax purposes as such forgiven loan proceeds will not be includible in income. Absent the treatment clarified in this Notice, taxpayers would have been able to both have their qualifying expenses paid by the forgiven PPP loan and, in turn, also deduct the same expenses on their income tax return. This Notice, while not a surprise, confirms that the loophole does not exist.

If you have any questions, please contact Ritchie Taylor, Bradley Wooldridge or your Manning Fulton relationship attorney. We are here to help you and your business navigate this difficult time.

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