Part II: PPP Revisions and Second PPP Loans

This is the second Client Alert in our four-part series titled “Coronavirus Stimulus Legislation: A Primer on Phase 5 Negotiations.” It details proposed improvements to the existing Paycheck Protection Program (PPP) and the terms of the PPP Second Draw Loans included as part of the Senate Republicans’ proposed $1 trillion coronavirus stimulus package, commonly referred to as the “HEALS Act.”  Part I in our series, titled “President Trump’s Executive Actions,” can be found here.  

Overview of Proposals

The HEALS Act was announced by Republican members of the U.S. Senate on July 27, 2020, as a response to the U.S. House of Representatives’ Health and Economic Recovery Omnibus Emergency Solutions Act (HEROES Act), which was introduced by the Democrats on May 15, 2020. These two pieces of proposed legislation, as well as other proposals from various members of Congress and the White House, have set the stage for the ongoing negotiations surrounding what most are referring to as “Phase 5” of the coronavirus stimulus – “Phase 4” being the Coronavirus Aid, Relief, and Economic Security Act, as amended (CARES Act), which was signed into law on March 27, 2020.  

Unlike the HEROES Act, which is one bill, the HEALS Act is comprised of the following eight pieces of legislation:  

  1. The Continuing Small Business Recovery and Paycheck Protection Program Act, sponsored by Senators Marco Rubio (R-FL) and Susan Collins (R-ME); 
  2. The Coronavirus Response Additional Supplemental Appropriations Act, 2020, sponsored by Senator Richard Shelby (R-AL); 
  3. The Restoring Critical Supply Chains and Intellectual Property Act, sponsored by Senator Lindsey Graham (R-SC); 
  4. The American Workers, Families, and Employers Assistance Act, sponsored by Senator Chuck Grassley (R-IA); 
  5. The Supporting America’s Restaurant Workers Act, sponsored by Senator Tim Scott (R-SC); 
  6. The TRUST Act, sponsored by Senator Mitt Romney (R-UT); 
  7. The SAFE TO WORK Act, sponsored by Senator John Cornyn (R-TX); and
  8. The Safely Back to School and Back to Work Act, sponsored by Senator Lamar Alexander (R-TN). 

In addition to the HEALS Act and the HEROES Act, another relevant piece of proposed legislation that is related to supporting a large number of businesses and employees is the Reviving the Economy Sustainably Towards A Recovery in Twenty-twenty Act (RESTART Act), sponsored by Senators Michael Bennet (D-CO) and Todd Young (R-IN).  We will address the RESTART Act in Part III of this series. 

As mentioned above, this Client Alert details the proposed improvements to the existing PPP and the new PPP Second Draw Loans, both of which are included in legislation titled the Continuing Small Business Recovery and Paycheck Protection Program Act, co-sponsored by Senators Marco Rubio (R-FL) and Susan Collins (R-ME). 

Improvements to the Existing PPP 

The two primary areas of improvement in the proposal are: (1) including several new permitted eligible uses for a PPP loan, and (2) easing the forgiveness requirements for borrowers with lower loan amounts. 

Additional Permitted Uses

The proposed legislation adds the following permitted uses of any PPP loan proceeds to the existing list (i.e., covered payroll costs, covered mortgage obligations, covered rent obligations, and covered utility payments): 

  1. Covered Operations Expenditures: These cover costs related to “business software or cloud computing service that facilitates business operations, product or service delivery, the processing, payment, or tracking of payroll expenses, human resources, sales and billing functions, or accounting or tracking of supplies, inventory, records and expenses.”
  2. Covered Property Damage: These cover “cost related to property damage and vandalism or looting due to public disturbances that occurred during 2020 that was not covered by insurance or other compensation.”
  3. Covered Supplier Costs: These cover payments “to a supplier of goods pursuant to a contract in effect before February 15, 2020 for the supply of goods that are essential to the operations of the entity at the time at which the expenditure is made.”
  4. Covered Worker Protection Expenditures: These would generally cover operating or capital expenditures required to comply with rules established by governmental agencies, the purchase of personal protection equipment, and other investments to provide a safer operating environment.  

Even though the proposed legislation expands the definition of permitted expenditures, it does not modify the forgiveness calculation, which requires at least 60% of the loan to be used for payroll costs during the covered period to maximize forgiveness. For more information on forgiveness see our Frequently Asked Questions: Paycheck Protection Program Loan Forgiveness

While these details may change in the final legislation, it is expected that some or all of the items will be included since they do not directly increase the cost of the program and they, along with the PPP Second Draw Loans program, generally have bi-partisan support. 

Simplifying the Forgiveness Process 

One of the most consequential proposed changes to the PPP is the revision greatly simplifying the forgiveness application process for loans under $150,000, which account for approximately 85% of all PPP loans. Under the proposal, these loans would automatically be forgiven if the borrower signs an attestation that it “made a good faith effort to comply with the requirements” of the PPP and if it agrees to retain supporting documentation for at least three years. 

The legislation also proposes to simplify the forgiveness process for loans between $150,000 and $2,000,000 by: (1) only requiring borrowers to submit a forgiveness application, as opposed to an application with supporting documentation, and (2) limiting the lender’s review of the forgiveness application to “whether the lender received a complete application, with all fields completed, initialed, or signed, as applicable.” The primary purpose of this adjustment is to allow borrowers to “self-certify” the amounts in their forgiveness application, which revises the language under the CARES Act that lenders are required to make a “decision on the application.”  

Lenders and the banking lobby have pushed hard for these program changes for at least two months (see here and here). These proposals have resulted in a total stalling of the forgiveness process since the Small Business Administration (SBA) did not begin accepting forgiveness applications until August 10 and many larger banks are still not processing applications (see here). Lenders have also expressed concern about potential liability if they are required to make a “decision” on each forgiveness application when, in many cases, the lender does not have a significant relationship with the borrower and is relying completely on the information provided by the borrower. In addition, by one estimate from AQN Strategies, it would take a business 20 to 100 hours and cost between $2,000 and $4,000 in time and third-party expenses to complete its forgiveness application, which is a significant cost given there are over 3.6 million approved loans under $150,000. 

PPP Second Draw Loans 

The proposed PPP Second Draw Loan program is formally titled the Paycheck Protection Program Improvements (PPPI) legislation and it would update the version of the PPP contained in the CARES Act. The three primary components of the PPPI are (1) revised eligibility criteria, (2) additions to “permitted expenses,” and (3) changes to the covered period. 

Eligibility Criteria 

As expected, the PPPI includes much more restrictive eligibility criteria for participating businesses. The two primary eligibility components of the PPPI are based on the “size” of the applicant (when combined with its affiliates) and a decrease in the applicant’s (when combined with its affiliates) gross receipts in either Q1 or Q2 of 2020 by more than [35%] when compared to its gross receipts during the corresponding quarter in 2019. 

The Size Standard

Except for (1) the new limitations on “small business concern” and employee count, and (2) the expansion of the list of ineligible applicants and omission of certain exceptions to the size of applicants that were specifically included in the CARES Act, the size standards under PPPI are somewhat similar to those in the PPP. 

For guidance related to the SBA’s interpretation of the affiliation rules, see the SBA’s Interim Final Rule on Applicable Affiliation Rules (found here) and the SBA’s guidance on Size Eligibility and Affiliation Under the CARES Act (found here). 

Under the proposed PPPI legislation, the applicant, when combined with its affiliates, meets the size standard if it satisfies one of the following criteria: 

  1. it is a “small business concern” based on the SBA’s annual receipts size standard (solely to the extent applicable);
    • The SBA’s size standards divide applicants into industries based on their NAICS code. The SBA’s Size Standards Tool can be found here and the full list is here.
    • The SBA calculates annual receipts based on the applicant’s (and its affiliates’) average (1) total receipts (or revenue), or (2) total income plus cost of goods sold, during the three full fiscal years before the date of the application. For additional details on the calculation of annual receipts see 13 CFR § 121.104
    • Applicants in industries with size standards based on “annual receipts” are permitted to use this requirement to determine eligibility. Applicants in industries where the size standard is based on the number of employees are prohibited from using this size standard. 
  2. it meets the “alternative size standard” established under the PPP; or
    • As per the SBA’s FAQ #2 (found here), “a business can qualify for the Paycheck Protection Program as a small business concern if it met both tests in SBA’s ‘alternative size standard’ as of March 27, 2020: (1) maximum tangible net worth of the business is not more than $15 million; and (2) the average net income after Federal income taxes (excluding any carry-over losses) of the business for the two full fiscal years before the date of the application is not more than $5 million.”
  3. it employs no more than 300 employees.
    • This is based on the total W-2 employees and is not limited to full-time employees or full-time equivalents. 

The proposed PPPI legislation specifically excludes businesses that are currently ineligible under PPP, as well as a number of new businesses. 

The list of ineligible businesses is somewhat in flux due to discrepancies in the various legislative proposals but, at a minimum, if the business is not eligible to participate in the PPP, as currently interpreted, it very likely will not be eligible to participate in PPPI. In addition, the proposed legislation includes the following new exclusions:  

  • a business organized for research or for engaging in advocacy in areas such as public policy or political strategy or has published material identifying itself as a think tank; 
  • a finance or insurance business with a NAICS code beginning with 52 that was assigned or approved for a PPP loan; 
  • a business primarily engaged in political or lobbying activities; 
  • any entity created in or organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong, or that has significant operations in the People’s Republic of China or the Special Administrative Region of Hong Kong, owns or holds, directly or indirectly, not less than 20 percent of the economic interest of the business concern or entity, including as equity shares or a capital or profit interest in a limited liability company or partnership; and 
  • any business that retains as a member of the board of directors of the business concern a person who is a resident of the People’s Republic of China. 

In addition, the proposed legislation does not include the following waivers to the affiliation rules, which were included in the CARES Act: 

  • businesses with more than 500 employees with a NAICS code beginning with 72 (primarily food service and hospitality businesses); 
  • businesses operating through a franchise to which the SBA has assigned a franchise identifier code; and 
  • businesses receiving financial assistance from a Small Business Investment Company (SBIC) or other company licensed under section 301 of the Small Business Investment Act of 1958. 

Meaning, even though the above businesses were eligible to participate in PPP they would be ineligible under the proposed PPPI legislation. 

Gross Receipts Threshold

The second eligibility requirement is the applicant (when combined with its affiliates) must have had gross receipts in Q1 or Q2 of 2020 that are at least [35%] less than its gross receipts during the corresponding quarter in 2019. Note the original PPPI legislation included a 50% threshold for gross receipts but the final threshold is expected to be between 30% and 40% (the most recent threshold announced publicly (here and here) is 35%). The proposed legislation includes calculations for businesses to use if they were not operating in some or all of 2019, but businesses must have been operating prior to February 15, 2020. 

Guidance on the SBA’s calculation of annual receipts is found in 13 CFR § 121.104, which states in relevant part the following: 

Receipts means all revenue in whatever form received or accrued from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances. Generally, receipts are considered “total income” (or in the case of a sole proprietorship “gross income”) plus “cost of goods sold” as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms (such as Form 1120 for corporations; Form 1120S for S corporations; Form 1120, Form 1065 or Form 1040 for LLCs; Form 1065 for partnerships; Form 1040, Schedule F for farms; Form 1040, Schedule C for other sole proprietorships).

Annual receipts of affiliates.

  • The average annual receipts size of a business concern with affiliates is calculated by adding the average annual receipts of the business concern with the average annual receipts of each affiliate.
  • The annual receipts of a former affiliate are not included if affiliation ceased before the date used for determining size. This exclusion of annual receipts of such former affiliate applies during the entire period of measurement, rather than only for the period after which affiliation ceased. However, if a concern has sold a segregable division to another business concern during the applicable period of measurement or before the date on which it self-certified as small, the annual receipts used in determining size status will continue to include the receipts of the division that was sold.

Probably the three most significant unresolved eligibility issues for PPPI are:

  1. Will the size standards be adjusted to include “small business concerns” that are based on the SBA’s employee size standard or to include businesses with a larger number of employees?
  2. Will there be any exceptions to affiliation rules when calculating size or gross receipts?
  3. What will be the agreed upon threshold for a decrease in gross receipts (30%, 35%, 40%, 50% or a different number)?

In addition to the above, the proposed PPPI legislation, among other things, expands the definitions of eligible expenses to include additional items, revises the loan amount calculation and simplifies the forgiveness application process. Because those do not impact eligibility, we will provide details of those and other details of PPPI once the details of the Phase 5 legislation are finalized.  

Next Client Alerts 

In Part III of our series, which will be coming out shortly, we will summarize and compare the RESTART Act, which is a proposal gaining significant traction inside and outside of Congress, and the Long-term Recovery Sector Loan program, which is based on the SBA’s 7(a) loan program. In Part IV, we will summarize the various tax incentives and other stimulus programs aimed at businesses that are included in the HEALS Act and the HEROES Act, as well as other proposals that maybe on the negotiating table.  Feel free to reach out to your Womble Bond Dickinson contact or to one of us to discuss these matters and how they may apply to your specific circumstances.