SBA PPP: IFRs on Forgiveness and Loan Reviews

You know the old saying “if it ain’t broke, don’t try to fix it?”  Well, there are at least five different bills circulating in Congress that are, well, ”billed” as PPP fixes.   That pretty well captures the sentiment on how well Congress and others think the program is working.  More on that below, but first here are some additional notes on the two IFRs –Forgiveness and Loan Review – that came out on Friday. 

1.       As noted below, bonuses and hazard pay are now expressly included as payroll costs that will count toward forgiveness.  It appears that these amounts also count toward the cash compensation limit of $15,385 (8/52 of $100k).  Continuing SBA’s maddening inability to use consistent wording, the Forgiveness IFR references these as being subject to the total compensation limit of  “$100,000 on an annualized basis”.  Arguably, one-time amounts such as bonuses would not be “annualized” and arguably could be excluded from that $15,385 limit, but the application refers explicitly to the $15,385 amount so it seems that the bonus and hazard pay amounts must be included within such limit.  

2.       The Forgiveness IFR also provides clarity that amounts incurred prior to the forgiveness period, but paid during the forgiveness period are includable in the forgiveness amount.  The IFR also seems to imply that borrowers can prepay certain amounts that would not otherwise be due until after the forgiveness period, although the guidance could certainly be more explicit.

a. The IFR follows the CARES Act and both expressly prohibit prepayments of mortgage interest. Neither expressly prohibit prepayments of other amounts, but neither expressly permit prepayments either.

b.       The IFR provides an example of a borrower whose forgiveness period ends on July 26 and can include only “ the portion of its electrical bill through July 26” if it pays that electrical bill on the next regular billing date.  That’s not super helpful for the argument that prepayments are forgivable, but isn’t fatal either because it is an example of the second prong of forgiveness test which applies to amounts “incurred during” the forgiveness period and paid on or before such billing date.  The first prong relates simply to amounts “paid during” the forgiveness period, which doesn’t have that same “incurrence” limitation.  We may get further guidance on this, but because the non-payroll costs are capped at 25%, it seems that SBA may be comfortable allowing such prepayments.  

c.       Note that several of the “fixes” being contemplated would both extend the 8 week period to 16 weeks (House version) or 24 weeks (Rubio version) and/or eliminate the 25% cap on non-payroll costs (House version).  Stay tuned, of course.

3.       A couple of key points on the forgiveness reduction amounts:

a.       SBA had previously provided that borrowers could exclude from the FTE calculation employees who received offers to return to work on the same terms as their prior service.  The Forgiveness IFR, in addition to specifying record-keeping requirements around such offers, now requires borrowers to inform the applicable state unemployment office of such rejected offer, within 30 days of such rejection.  This, of course, is intended to prevent the employee from collecting unemployment payments for which he or she is rendered ineligible by virtue of having rejected a job offer.

b.       Also, SBA has clarified that a reduction in hours of an employee counts ONLY in the FTE reduction and does not also count as reduced wages for the Salary/Hourly Wage Reduction.  This is expressly done to avoid double counting such reduction.  Of course, as we noted before, if such employee were part-time during the base period and the borrower uses the alternative method of counting all part-time employees as 0.5 FTEs, then there would be NO REDUCTION in the FTE count, even if the employee’s hours were significantly reduced.

c.       However, it remains unclear how a borrower can avail itself of the FTE Reduction Safe Harbor by “restoring” the FTE count by June 30.  It is not clear how a borrower would demonstrate that average hours have been restored for its FTEs (i.e., what period of time must be used to demonstrate such restoration:  One day?  One week?  Other?)

d.       Finally, there is still no clarity on what if any impact there would be from a reduction in employees, hours, or compensation after the end of the forgiveness period or, if a borrower is using a safe harbor) on July 1.  To be clear, we still CANNOT answer the question as to whether borrowers could terminate all employees on July 1 and still receive full forgiveness.

4.       Timing is now much longer and may create payment issues:  Lenders make the initial forgiveness decision and report that decision to SBA within 60 days after the borrower applies forgiveness.  The 60-day period conforms to the CARES Act, which doesn’t specify to whom lenders must issue such decision.  

a.       SBA has given itself 90 days to review such decision.  The IFRs both say that SBA will “subject to any SBA review of the loan or loan application” pay any forgiven amount within 90 days after the lender’s decision.  The drafting is not clear that the “subject to” language is intended only to mean that SBA isn’t obligated to pay any loan which its review has determined ineligible  (or if it could be read to indefinitely extend the 90-day period for loans it is reviewing).  However, the Loan Review IFR later seems to clarify that this is meant to be a 90-day review period. 

b.       If SBA elects to review a loan at any time before or after the forgiveness application is submitted, it will notify the lender, who must notify the borrower within 5 business days after notice from SBA.  

c.       If the lender determines that a borrower is not entitled to forgiveness “in any amount” the lender must also notify the borrower in writing of that decision.  I am assuming (hoping?) that “in any amount” means “in whole or in part” and not that the borrower is not entitled to “any amount of forgiveness”, otherwise the borrower would not get notice of a partial rejection.   Assuming that is the case, then it seems that a borrower may assume that the lender has preliminarily approved full forgiveness of its loan unless the borrower had received, within ~60 days after submitting its forgiveness application, has received notice of (i) an SBA review or (ii) whole or partial rejection of forgiveness  decision.  However, that decision remains subject to at another 90 days of SBA review.

d.       Thus the forgiveness time table looks something like: 

                                                   i.      The forgiveness period is 8 weeks, ending 56 days after disbursement, or later if the borrower uses the alternative forgiveness period);

                                                 ii.      borrowers will likely need at least 1-3 business days to compile final payroll and payment records to submit with their forgiveness application (this will besignificantly longer if the borrower would be submitting cancelled checks as proof of payment – borrowers should probably use ACH or wire transfers whenever possibleto expedite payment verification);

                                               iii.      lenders have 60 days to review the forgiveness application forgiveness and issue a decision to SBA (note that this only starts when the borrower submits its “complete application” with all required documents);

                                               iv.      SBA has 90 days to review the application and, if approved, remit the forgiveness amount to the lender;

                                                 v.      the lender then must remit such amount to borrower, but there is no time period specified for this.

e.       That’s a total of at least ~257 daysfrom disbursement.   That’s not good.  It creates a payment issue for borrowers.  Principal and interest payments are deferred only for 6 months (180 days) from disbursement.  This means that even borrowers may have to make at leastone PAYMENT prior to receiving a forgiveness decision (and perhaps 2 or even 3 depending on the calendar of the payroll periods vs loan payment dates).   

                                                   i.      Most of the loan documents that we have seen provide for 18 equal monthly payments of principal in months 7-24 (i.e., after the deferment period ends.).

                                                 ii.      Many of the loan documents that we have reviewed are unclear whether the first 6 months of interested are effectively capitalized and added to principal and thus amortized over those last 18 months or if they are simply deferred and thus payable on the first payment date in month 7.  (see more on interest below)

                                               iii.      For those borrowers, because there will be no known forgiveness amount, their notes will likely require them to pay 1/18th of the full original principal amountplus at least 1 month of accrued interest (and perhaps as many as 7).  Multiply that by 2-3 depending on the calendar.  This could create significant cash flow issues for borrowers who are counting on having their loans fully forgiven.  Despite the potential hardships this could cause, SBA seems to be fully aware of it and notes that lenders may have to make repayments of forgiven amounts back to borrowers. 

f.        It also will have a much-longer than anticipated effect on future transactions involving PPP borrowers as buyers of, investors in and lenders to such companies will not have to deal with uncertain forgiveness and thus uncertain equity valuations and/or leverage multiples for such through the end of 2020 and, for later borrowers, well into Q1 of 2021.

g.       Borrowers are required to keep all records relating to the loan for a period of six years, which periodstarts on the date the loan is forgiven or repaid, which again further extends the “at-risk” period for PPP borrowers and their buyers, lenders and investors.

5.       As noted below, SBA is making  it clear that it is preserving the right to pursue all “other available remedies” against borrowers and potentially their equity holders.

a.       SBA may “pursue other available remedies” in addition to loan repayment.  Presumably, this does NOT apply to the certification issue and would apply only to borrowers who were ineligible due to the applicable size standards or ineligible under 120.110 which lists ineligible businesses (lobbyists, lenders, sin businesses, etc.) or had other defects in their application.  As I said on Saturday, they can’t be re-re-treading on the certification issue … right? (But I suppose that it’s worth noting that the prior guidance on that was only in an FAQ, and this IFR would theoretically supersede that.  Such borrowers would seem to have pretty strong reliance defenses though.)

b.       The Loan Review IFR also notes that the CARES Act nonrecourse provision does not apply to the equity holders of an ineligible borrower who fails to repay its PPP loan  (As noted below, it’s not immediately clear how SBA would propose to “pierce the veil” against such equity holders who certainly haven’t signed guarantees, but stay tuned).

6.       Not wanting lenders to feel left out of the full Flounder treatment for having trusted SBA, the Loan Review IFR now provides that lenders are not eligible for processing fees on loans to ineligible borrowers and:

a.       That for a period of one year after disbursement, SBA can claw backloan fees previously paid to the lender who made the loan to the ineligible borrower (despite the CARES Act and all prior IFR and FAQ basically exempting lenders from doing much of anything beyond BSA / KYC).  This determination however, will not impact the SBA guaranty of such a loan.

b.       SBA can also claw back WITHOUT ANY TIME LIMIT processing fees paid to lenders who failed to comply with the limited lender requirements in IFR 1 or the lender document collection and retention requirements AND SBA may also determine that such loan is not eligible for a guaranty.   

Our policy team is monitoring the various bills pending in Congress.  It sounds like the House may pay the extension version noted above (16 seeks of forgiveness) by “proxy” this week and that the Senate could potentially pass some version of the Rubio bill  (24 weeks of forgiveness) by unanimous consent.  Congress would then would have to reconcile such bills … if the Senate even agrees that a bill passed “by proxy” in the House was in fact validly passed.  (It seems a perfect commentary on this situation to note that while the entire country is working remotely, Congress can’t manage to agree whether there is some reasonable way for them to vote other than in person.)    

Note that Congress needs to act quickly on this, as the initial PPP borrowers are running out of time to adjust their use of proceeds.  According to early figures released by SBA, $36B of PPP loans were approved before April 6.  The statutory 8-week forgiveness periods for those loans could be expiring as early as next week, unless they opt for the alternative covered period. 

Stay tuned.