The roll out of the Paycheck Protection Program (PPP) loans triggered a rush for funding at the end of March. The $349 billion in funding for the program provided by the Coronavirus Aid, Relief, and Economic Security (CARES) Act ran out mid-month, and President Trump signed a stopgap measure to provide an additional $320 billion in funding on April 24.

The rate at which funds ran out raised questions about where the initial round of funding went. Details began to emerge that the emergency coronavirus relief loans were not being used as intended. In light of these discoveries, the U.S. Department of the Treasury recently announced it would be reviewing the applications and certifications made by any entity that received a PPP loan in excess of $2 million.

How the Program Was Supposed to Work

The CARES Act expanded existing loan programs offered by the Small Business Administration (SBA), including the 7(a) and 7(b) loan programs. Generally, SBA loans provide more flexible lending arrangements to smaller organizations that may have a harder time accessing capital from traditional lenders.

Congress intended the PPP loans, an SBA 7(a) loan expansion, to support employee retention among organizations with 500 or fewer eligible employees. PPP loans can be borrowed in amounts that are the lesser of 2.5 times an organization’s monthly payroll costs for the past 12 months or $10 million. The loan will be forgiven to the extent organizations demonstrate PPP loan funds supported qualifying payroll functions during an eight-week period beginning on the date the loan is funded. The amount of loan forgiveness is also subject to a condition that the organization did not significantly reduce its headcount, and that the organization did not reduce payroll by more than 25% during the loan forgiveness eligibility period. The amount of loan forgiveness also will be reduced if more than 25% of loan funds are applied toward non-payroll functions during the eight-week period. The unforgiven balance is due two years after the loan origination date and accrues interest at a rate of 1%.

To apply, organizations must prove the loan was necessary to navigate the uncertain economic conditions. Specifically, each applicant had to certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

Initially that seemed a relatively low bar to pass due to the President’s declaration on March 13 of a nationwide disaster under the Stafford Act. Additionally, PPP loan applicants must be able to demonstrate that they will use the PPP funds to retain workers, maintain payroll, and make lease or mortgage, health insurance and/or utility payments. No personal guarantees nor collateral are required to apply for the loans, attributes that made them particularly of interest to small business owners and not-for-profit organizations.

What Happened

In roughly a two-week period, the CARES Act funding for the PPP loans and an expansion to the SBA’s Emergency Injury Disaster Loan (EIDL) program were depleted. Needless to say, there were questions about how $349 billion had been allocated so quickly, particularly among the hundreds of thousands of organizations whose PPP loan applications remained in the SBA’s queue.

Further investigation by industry watchdogs found that some of the organizations that received funding in the initial round did not fit the target profile for relief. An estimated 220 public companies had applied, and some notable ones received loans, including the owners of Ruth’s Chris Steak House and Auto Nation. The Los Angeles Lakers organization also received a PPP loan. Many of the larger recipients pledged to give their loans back, including Ruth’s Chris Steak House, Auto Nation, Shake Shack, and the Los Angeles Lakers, but the findings raised questions about how many more similar scenarios might have occurred.

What’s Next for PPP Loans

The SBA released a joint statement with the U.S. Department of Treasury on April 28 that it will be reviewing any loans of greater than $2 million to ensure the loans are being used as intended by the audience intended. Additional regulatory guidance surrounding these reviews is expected. By the end of the day, Treasury Secretary Steven Mnuchin expanded that review to all PPP loans.

Organizations that have received PPP loans should be prepared for this detailed review. Presumably, larger companies will be the first to face scrutiny. Companies will need to consult immediately with their legal counsel to determine the potential impact of these new pronouncements on their businesses, including any decision to repay the loan by May 7. Hopefully, there will be greater guidance on whether the certifications were made correctly and in good faith, but in the meantime, companies who do not intend to repay the PPP loans by May 7 need to consult with their counsel to develop a game plan to support the truth of the certification.

Furthermore, in order to support loan forgiveness, they will need to be able to produce a clear record of eligible expenditures from PPP loan proceeds. Such expenditures over the eight-week forgiveness period include gross salaries and wages (without subtracting federal taxes that are imposed on the employee or withheld from employee wages), employee health insurance, employee retirement plan costs, rent, utility, and mortgage interest costs. One way to produce this clear record is to establish two new bank accounts that will be dedicated to PPP loan functions, where one account is funded by 75% of the loan proceeds, and the other account is funded by 25% of the loan proceeds. The larger account can then be used exclusively to provide eligible payroll costs, and the smaller account can be used exclusively to provide eligible non-payroll costs.

To clarify program eligibility, the SBA also updated its Frequently Asked Questions for the PPP loans, which can be viewed here. PPP loan recipient should review the FAQ document carefully and determine if their eligibility for the loan may be compromised based on the additional SBA guidance.

For More Information

For specific comments, questions or concerns about the SBA loan programs and other forms of available COVID-19 capital assistance, contact our team here.

This article was updated on May 4, 2020. 

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