Congress Has Passed Phase III of the Federal Coronavirus Relief Legislation: Here’s What You Need to Know about the Legislation’s COVID-19-related Small Business Administration Loan Resources


The Coronavirus Aid, Relief, and Economic Security (CARES) Act – the third phase of Congress’s response to COVID-19, which was enacted on March 27, 2020 – includes a Paycheck Protection Program. The proposed program would, among other things, expand the scope of the Small Business Administration’s available 7(a) loans during a “covered period” beginning on February 15, 2020 and ending on June 30, 2020. (The Small Business Administration (SBA) provides 7(a) loan guarantees for certain loans made by participating lending institutions to qualifying small businesses.) Certain key elements of the Paycheck Protection Program are described below, followed by a discussion of various other SBA loan resources. The final version of the bill reflects substantial changes from the version introduced into the Senate on March 19, 2020.

Paycheck Protection Program Overview

For loans under the Paycheck Protection Program during the covered period (“covered loans”), the SBA’s guaranty will be 100 percent of the amount advanced by participating lenders to eligible recipients. The interest rate on a covered loan will not exceed 4 percent.

Eligible borrowers. Eligible borrowers include any business concern, nonprofit organization, and certain other borrower types in each case that employs 500 or fewer employees.[1] In addition, eligible borrowers also include the traditional category of “small business concerns,” as defined under the pre-existing SBA statute and regulations, which apply employee or receipt size standards for various industries as relevant (e.g., for the “scheduled passenger air transportation” industry, as defined under the North American Industry Classification System (NAICS), the relevant threshold is 1,500 employees).

Maximum loan amount. The maximum loan amount available to a borrower will be equal to the product of (i) the average total monthly payments by the borrower for “payroll costs” (as described below) incurred during the one-year period before the date on which the loan is made, multiplied by (ii) 2.5, subject to a cap of $10,000,000.[2] (Certain adjustments to this formula are available for borrowers that are seasonal employers, as well as for borrowers that were not in business during the period from February 15, 2019 through June 30, 2019.)

The term “payroll costs” consists of (i) salary, wage, commission, or similar compensation, (ii) payment of cash tip or equivalent, (iii) payment for vacation, parental, family, medical, or sick leave, (iv) allowance for dismissal or separation, (v) payment required for the provisions of group health care benefits, including insurance premiums; (vi) payment of any retirement benefit; or (vii) payment of State or local tax assessed on the compensation of employees. Various enumerated items, however, are excluded from payroll costs. Significantly, one such exclusion is that payroll costs do not include compensation of an individual employee in excess of an annual salary of $100,000, as prorated for the covered period (i.e., February 15, 2020 through June 30, 2020). Also, any compensation of an employee whose principal place of residence is outside of the United States are also excluded from payroll costs.

Allowable uses of covered loans. Allowable uses of loan proceeds include, among others, the following: (i) payroll costs; (ii) costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums; (iii) employee salaries, commissions, or similar compensations; (iv) payments of interest on any mortgage obligation (which shall not include any prepayment of or payment of principal on a mortgage obligation); (v) rent (including rent under a lease agreement); (vi) utilities; and (vii) interest on any other debt obligations that were incurred before the covered period.

Non-recourse; waiver of personal guarantee and collateral requirements. The SBA will have no recourse against any individual shareholder, member, or partner of a borrower for nonpayment of a covered loan, except to the extent such shareholder, member, or partner uses the covered loan proceeds for a purpose not authorized under the foregoing (i) through (vii) allowable uses. Additionally, during the covered period, no personal guarantee or collateral will be required for a covered loan.

Deferment relief. During the covered period, the SBA will require lenders to provide complete payment deferment relief for “impacted borrowers” with covered loans for a period of at least six months and no more than one year, including payment of principal, interest, and fees. The term “impacted borrowers” means a borrower in operation on February 15, 2020 and that has a covered loan application in process or pending on or after the enactment of the Paycheck Protection Program.

Loan Forgiveness under the Paycheck Protection Program

Loan forgiveness is a highly significant component of the program. A borrower will be eligible for forgiveness of indebtedness on a covered loan for the following costs incurred during the eight-week period beginning on the origination date of a covered loan (the “loan forgiveness covered period”): (i) payroll costs, (ii) interest payments on any covered mortgage obligation, (iii) payments on any covered rent obligation, and (iv) covered utility payments.[3] Notably, as mentioned above, “payroll costs” exclude, among other things, (A) compensation of an individual employee in excess of the prorated portion of an annual salary of in excess of $100,000 earned within the loan forgiveness covered period and (B) compensation of an employee whose principal place of residence is outside of the United States. Within 90 days after the date on which the amount of such forgiveness is determined, the SBA will remit to the lender an amount equal to the amount of forgiveness, plus any interest accrued through the date of payment.

The amount of loan forgiveness will be reduced (but not increased) in direct proportion to (i) the average number of full-time equivalent employees during the loan forgiveness covered period divided by (ii) the average number of full-time equivalent employees during either, at the election of the borrower, (A) the period from February 15, 2019 through June 30, 2019 or (B) the period from January 1, 2020 through February 29, 2020. (Certain adjustments to this formula are available for borrowers that are seasonal employers.) Accordingly, loan recipients that have aggressively expanded the number of their employees since February 15, 2019 will select the first testing period, and loan recipients that have undergone workforce reductions unrelated to the COVID-19 pandemic prior to January 1, 2020 will select the second testing period. 

Additionally, the amount of available loan forgiveness will be reduced by the amount of any reduction in total salary or wages of any covered employee during the loan forgiveness covered period in excess of 25 percent of the total salary or wages of the covered employee during the most recent full quarter during which the covered employee was employed before the loan forgiveness covered period. “Covered employee” refers only to any employee who did not receive, during any single pay period during 2019, wages or salary at an annualized rate exceeding $100,000.

The CARES Act appropriated $349 billion for commitments for 7(a) loan guarantees during the covered period. In addition, the CARES Act provides COVID-19-related relief in other areas of the SBA’s purview, including, among others, entrepreneurial development, the state trade expansion program, the women’s business center program, the minority business development agency, and subsidies for certain loan payments.

Some Practical Considerations Regarding the Paycheck Protection Program

Affiliation rules. For purposes of the 500 employee threshold (or other applicable SBA size standard), the SBA counts the employees not only of the borrower entity but also those of its U.S. and non-U.S. affiliates. The SBA’s affiliation rules are fairly expansive and nuanced. Accordingly, determining the aggregate number of employees of a borrower entity and its affiliates can be a complex and fact-intensive process. This may be particularly the case for portfolio companies of private equity, venture capital, or hedge funds. Essentially, each such portfolio company would identify all other entities with respect to which it is under common control (or that it controls or is controlled by) and aggregate the employee numbers of all such affiliates with its own number of employees.[4]

Under the SBA’s affiliation rules, generally affiliation exists when one company controls or has the power to control another or when a third party (or parties) controls or has the power to control both companies. Control may arise through ownership, management, or other relationships or interactions between the parties. Notably, control may be affirmative or negative. Negative control includes instances where a minority shareholder has the ability, under the company’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.

The SBA’s affiliation rules also cover various specific elements that may be deemed to trigger affiliation. These include, among others, the following:

  1. Stock ownership (e.g., control of 50% or more of voting stock; control of less than 50% voting stock, but large compared to others; control of less than 50% voting stock by multiple minority owners; or voting stock is widely held (in which case the Board of Directors, CEO, or President may be deemed to have the power to control)).
  2. Stock options, convertible securities, and agreements to merge (e.g., a company holds an option to purchase a controlling interest in another company).
  3. Common management (e.g., controlling members of a company’s Board of Directors occupy three out of five positions in another company’s Board of Directors).
  4. Identity of interest between individuals or businesses, including family members (e.g., several officers of a company are also officers of another company, and the two companies are in the same line of work and extensively subcontract with each other).
  5. Contractual relationships or economic dependency (e.g., a company performs subcontracts for another company that account for 90% of the first company’s revenues).
  6. Newly organized concerns (e.g., the former CEO of a company organizes a new company that receives subcontracts from the first company.).

The SBA regulations state that the employees of a former affiliate are not counted if affiliation ceased before the date used for determining size. Thus, for example, if an investor were to waive a negative control right in advance of a 7(a) loan application (potentially, although not entirely clear, even if such waiver applied only on a temporary basis), it appears that such waiver may cause portfolio companies that would otherwise constitute affiliates to become former affiliates, in which case their employee numbers need not be aggregated.

Waiver of affiliation rules. The CARES Act provides that, during the covered period, the affiliation rules will be waived with respect to eligibility for a covered loan for: (i) any business concern with no more than 500 employees under the NAICS code beginning with 72 (i.e., the Accommodation and Food Services sector); (ii) any business concern operating as a franchise and assigned a franchise identifier code by the SBA; and (iii) any business concern that receives financial assistance from a licensed “small business investment company.”

Loan application mechanics. The CARES Act provides that, for purposes of making covered loans for the enumerated allowable uses of loan proceeds as described above, an approved lender will be deemed to have been delegated authority by the SBA to make and approve covered loans. It appears that, in evaluating the eligibility of a borrower for such a covered loan, a lender need only consider whether the borrower (i) was in operation on February 15, 2020, (ii) had employees for whom the borrower paid salaries and payroll taxes, or (iii) paid independent contractors, as reported on a Form 1099–MISC. The authority to make such loans will be extended to additional lenders determined by the SBA and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse and service loans made with the SBA’s guarantee.

The SBA provides a “Lender Match” function, intended to help borrowers find lenders, and related links here. The interest rate (subject to the 4% cap described above), tenor, and other terms of a 7(a) loan are left to be negotiated between the lender and borrower.

Economic Injury Disaster Loans

Separately, under its Economic Injury Disaster Loan program, the SBA provides small businesses with working capital loans of up to $2 million intended to help overcome a temporary loss of revenue. The SBA’s economic injury disaster loans are generally available to businesses that have suffered a substantial economic injury and are located in a declared disaster area. COVID-19 economic injury disaster areas have been declared in all U.S. states and various territories. The SBA provides information related to such declarations here.

The CARES Act, subject to certain conditions and limitations, expands the types of eligible borrowers, waives personal guaranty (for loans up to $200,000) and certain other requirements, and provides other COVID-19-related relief with respect to the Economic Injury Disaster Loan program.

Other SBA Loan Programs

The SBA has also traditionally provided a number of other loan resources for small businesses, each of which imposes certain restrictions on the use of loan proceeds. These programs include: the Express Loan Program (providing loans up to $350,000 for no more than seven years with an option to revolve); the Community Advantage Loan Pilot Program (allowing mission-based lenders to assist small businesses in underserved markets, with a maximum loan size of $250,000); the 504 Loan Program (designed to foster economic development and job creation and retention, limiting use of loan proceeds to the acquisition or eligible refinance of fixed assets); and the Microloan Program (involving loans made through nonprofit lending organizations to underserved markets, with a maximum loan amount of $50,000 and average loan size of $14,000).

Please reach out to your Orrick contact for any questions related to these SBA loan resources or if you require assistance applying to an SBA program.

[1] For companies under the North American Industry Classification System (NAICS) code 72 (i.e., the Accommodation and Food Services sector), the CARES Act provides that the 500 employee limit will be set on a per-physical-location basis.

[2] If applicable, the outstanding amount of a loan under the SBA’s disaster loan program (discussed below) made during the period beginning on January 31, 2020 and ending on the date on which covered loans are made available to be refinanced under the covered loan, should be added to the maximum loan amount, provided that such total maximum loan amount remains subject to the $10,000,000 cap.

[3] The term “covered mortgage obligation” means any indebtedness or debt instrument incurred in the ordinary course of business that (i) is a liability of the borrower, (ii) is a mortgage on real or personal property, and (iii) was incurred before February 15, 2020. The term ‘‘covered rent obligation’’ means rent obligated under a leasing agreement in force before February 15, 2020. Finally, the term “covered utility payment” means payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

[4] A portfolio company may, in some cases, exceed 500 employees but nevertheless qualify for the Paycheck Protection Program if it constitutes a “small business concern,” as described above, and does not exceed the applicable employee or receipts threshold for the relevant NAICS industry code. If a single company within a portfolio of companies is the primary income-producing entity for the portfolio, it may be possible to apply the employee threshold or receipt threshold associated with that company’s relevant NAICS code to the entire portfolio of companies.