Note: This alert was originally released on March 29, 2020 and updated on April 3, 2020.
Earlier this week, the Senate passed the nearly $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act. This bill, known as Phase 3, is beneficial for many franchise systems and hospitality brands and includes generous and unprecedented provisions to help provide liquidity for small businesses in an effort to keep their employees on the payroll. The House of Representatives passed the CARES Act on Friday and the President signed the bill into law shortly after.
The following provides a preliminary summary of some of the financial assistance that may be available to franchisees and franchisors under the CARES Act. We have been in contact with the SBA to confirm many of the points below and believe the below represents how the law will be formally implemented, but the SBA has a period of 30 days to implement the rules and clarify any ambiguities. We will be staying on top of these developments in real time and will advise you of any changes as soon as they are made known.
Small Business Loan Provisions
The Paycheck Protection Program
The bill will provide $349 billion to support loans through a new Paycheck Protection Program, which Congress designed to keep employees on the payroll and to save small businesses. The Paycheck Protection Program is established as part of the existing SBA Section 7(a) program. In addition to increasing the financial assistance available to small businesses, it also expands the potential pool of eligible lenders in an effort to expedite the funding of these loans. The covered loan period under the Paycheck Protection Program is retroactive to February 15, 2020, and ends on June 30, 2020.
General Eligibility Requirements: The relaxed eligibility requirements for the Paycheck Protection Program mean that this program may be available to some franchisees and franchisors across different industries that traditionally would not qualify for SBA financial assistance. The general eligibility requirements under the Program for a "business concern" are that the business:
- be operational on February 15, 2020,
- had employees for whom it paid salaries and payroll tax or paid independent contractors, and
- employ no more than 500 employees (including both full-time and part-time employees). (1) (2)
(1) Unlike other SBA programs, businesses that fall within NAICS Code 72, which includes both hotels and restaurants, may also be eligible if they employ no more than 500 employees per physical location.
(2) For some industries, existing SBA size requirements for the 7(a) program may determine size by number of employees. In such an event, if the typical standard exceeds 500 employees, the higher number would apply to businesses in those industries.
Waiver of Affiliation Rules for Restaurants, Hotels and Some Franchises: SBA affiliation rules will be waived for the following businesses:
- Businesses that fall within NAICS Code 72 with no more than 500 employees,
- Franchised concepts listed on the SBA Franchise Directory (1), and
- Businesses receiving financial assistance from a company licensed under Section 301 of the Small Business Investment Act of 1958.
We note that this element of the CARES Act does not specify whether businesses can have 500 or fewer employees per physical location and be eligible for the waiver like the general eligibility requirements state. However, the fact that the provision states that franchisees of concepts that are currently listed on the SBA Franchise Directory are subject to the waiver suggests that even larger franchisees of listed franchises with more than 500 employees in the aggregate (but less than 500 per location) as an enterprise may will still qualify for the waiver. Our contacts at SBA have tentatively confirmed that the SBA is following this interpretation as well.
(1) The SBA's current position as communicated to us is that a franchised brand must be listed on the SBA Franchise Directory in order for its franchisees to be eligible, even if the business falls within NAICS Code 72. Our interpretation of this provision differs from that of the SBA and we are actively liaising with our industry and government contacts to further clarify this point. It's possible that this position will evolve as the rulemaking process plays out over the next 30 days. Nevertheless, the SBA has confirmed that executing Form 2462 (affiliation addendum to franchise agreement) will not be necessary for loans under the Paycheck Protection Program even for brands listed on the SBA Franchise Directory.
Advantageous Terms: Paycheck Program loans include many advantageous terms for borrowers. Terms include:
- Qualifying businesses are eligible for loans up to the lesser of 2.5 times their average, monthly “payroll costs” for the preceding year. Through December 31, 2020, the maximum 7(a) loan amount is increased from $5 million to $10 million.
- The program also expands the allowable uses of loan proceeds to include, for example, certain payroll costs, mortgage interest (but not prepayments), rent, utilities, and interest on existing debt.
- SBA will guarantee 100% of the loan amount through December 31, 2020. Thus, lenders are not expected to perform credit analysis of potential borrowers.
- The program does not require application fees, closing costs, collateral or personal guarantees. Also, there is no requirement to demonstrate that credit is unavailable elsewhere.
- Treasury and the SBA have specified that the interest rate for PPP loans will be fixed at 1.0%. Payments will be deferred for the first 6 months of the loan; however, interest will accrue over this period. The balance of the loan that is not (as further described above) will mature 2 years from the loan origination date, and there are no prepayment penalties or fees.
- All 7(a) loan payments under the Program (both principal and interest) are automatically deferred for the first six months.
- Borrowers will be required to make certain certifications, including that the loan is necessary due to economic conditions caused by COVID-19 and that they will use the funds to retain workers and maintain payroll, lease and utility payments.
Forgiveness for Certain Amounts:
- PPP loans may qualify for forgiveness for loan proceeds used to cover certain payroll costs, and most mortgage interest, rent, and utility costs during the 8-week period after the date the loan is made.
- The Department of Treasury and SBA issued rules providing that it is anticipated that no more than 25% of the forgiven amount may be for non-payroll costs.
- Loan forgiveness will be reduced if a borrower decrease full-time employee headcount or salaries and wages by more than 25% for any employees that made less than $100,000 annualized in 2019.
- In many cases, a borrower's loan forgiveness will not be penalized for a reduction in the number of employees or compensation between February 15, 2020 and April 26, 2020 if a borrower restores full-time employment and salaries by June 30, 2020. However, if stay-at-home orders remain in place through May and June (as some fear) and previously reduced payrolls are not increased during the 8-week period after the loan is made, a borrower may not qualify for 100% loan forgiveness even if it restores full-time employment by June 30, 2020.
- Borrowers must request forgiveness and submit documents to their lender verifying the number of employees and pay rates as well as payments for expenses that qualify for forgiveness. Lenders will have 60 days to make a decision on the forgiveness request.
Emergency EIDL Grants
Some small businesses may qualify for Economic Injury Disaster Loans (EIDL) under the existing SBA financial assistance framework. The CARES Act expands the definition of businesses eligible for the existing EIDL program and enhances several components of the program, including Emergency EIDL Grants.
What is an Emergency EIDL Grant?
In connection with an application for an EIDL (Section 7(b) program), an eligible business can request an advance of up to $10,000 to be funded within 3 days of the SBA's receipt of its application. This cash advance is to be used for certain expenses including maintaining payroll during business disruptions or substantial slowdowns and making rent or mortgage payments. An applicant is not required to repay the advance even if its loan application is ultimately denied.
Who else qualifies?
In addition to small business concerns, private nonprofit organizations, and small agricultural cooperatives that are typically eligible for this EIDL program, the CARES Act temporarily expands the program and now the following applicants may potentially be eligible:
- a business with no more than 500 employees;
- individuals who operate under a sole proprietorship, with our without employees, or an independent contractor;
- a cooperative with no more than 500 employees;
- an Employee Stock Option Plan with no more than 500 employees; and
- tribal small business concerns with no more than 500 employees.
Impacts on other requirements?
The Act temporarily waives the following rules and requirements for program loans made in response to the COVID-19 pandemic during the covered period:
- Rules related to personal guarantees on advances and loans of $200,000 or less.
- The requirement that an applicant be in business for the year preceding the disaster as long as the business was in operation on January 31, 2020; and
- The requirement that an applicant demonstrate that it is unable to obtain credit elsewhere.
The SBA may also approve certain EIDLs based solely on applicant credit scores or use other appropriate methods to determine an applicant's ability to repay.
Can a business participate in both loan programs?
Eligible borrowers under the Paycheck Protection Act (Section 7(a)) and the Emergency EIDL Program (Section 7(b)) may be allowed to receive loans under both programs so long as the purpose of such loans is not duplicated. In the event that the purpose of the loan is covered under both programs, eligible borrowers must decide whether to apply under Section 7 (a) or (b) based on the terms applicable to each loan category.
In addition to the financial assistance programs above, the CARES Act includes many tax provisions that may benefit your business, including for example, allowing taxpayers to take a deduction for Qualified Improvement Property immediately and certain enhanced net operating loss (NOL) rules, among other things. For more information on the tax implications of the CARES Act, please click here to download our CARES Act client alert.
We welcome the opportunity to discuss any of the items above with you.