This alert discusses the small business loan components of the recent coronavirus stimulus package signed into law on Friday March 27, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The alert focuses on how such provisions may be helpful for larger companies seeking to assist companies in their supply chain.
For additional information please contact any member of Baker McKenzie's North America Transactional Groups.
Protecting Your Supply Chain Financial Support for Small Businesses under the CARES Act
On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide financial assistance to individuals and businesses impacted by the coronavirus pandemic. Among other financial support programs, $359 billion in federally backed loans is available under the CARES Act to assist small businesses through the Small Business Administration (SBA). These loans can be used to pay for items such as utilities, rent, mortgages, and payroll, as well as disaster relief, and the procedures to apply for these loans are expected to be finalized within 15 days.
Many large corporations have small businesses as key components in their supply chain. As the coronavirus pandemic continues and additional geographic regions and industries are impacted, weak links in these supply chains are expected to emerge. As a result, these corporations have a strong interest in supporting the key members of their supply chain, including through assisting them in securing financial support under the CARES Act. In addition to the loan programs summarized below, corporations large and small are expected to benefit from the removal of limitations on net operating losses, the $454 billion in general economic loans and employee retention credits also present in the CARES Act.
Paycheck Protection Program Loans
The CARES Act expands the ability to obtain loans under Section 7(a) of the Small Business Act through a new $349 billion Paycheck Protection Program. Under the program, small businesses are eligible for loans to cover payroll, salaries, commissions, health care costs, mortgages, rent and utility payments and interest on pre-existing debt obligations. Loans cannot exceed 2.5 times the average monthly payroll cost during the prior year to the loan date, are capped at $10 million and have a maximum annual interest rate of 4%. These loans do not require collateral, personal guarantees or any recourse to equity holders and are available through June 30, 2020, to borrowers meeting program criteria. Loan fees are waived, as are the SBA's prior limitations on demonstrating funds are otherwise not available. The maximum loan term is ten years. A business is not eligible to receive these loans if it receives an SBA economic injury disaster loan for the same purpose.
Small Business Size Tests
Businesses with 500 or fewer employees that were operational on February 15, 2020, are eligible to participate in the program. Businesses with more than 500 employees in certain industries may also be eligible to participate under applicable SBA size standards.
The size standards are applied on an affiliate basis in accordance with existing SBA affiliation rules, except for hospitality and restaurant businesses, franchises and recipients of Small Business Investment Company investments. For these exempted businesses, the 500-employee size threshold is measured on a location-by-location basis.
Some private equity sponsors and venture capital firms have criticized the application of the SBA affiliation rules to their portfolio companies, which individually may have fewer than 500 employees but which may become ineligible to participate in the program based on their common controlling ownership.
It should also be noted that businesses that participate in joint ventures with other companies or that have minority investors may also find that they are subject to the SBA’s affiliation rules, which are complex and can be triggered in numerous situations not involving 50% or greater ownership.
It is uncertain whether the anticipated SBA implementing regulations (described below) will address the concerns that have been raised regarding the application of the SBA affiliation rules to determine eligibility to participate in the program.
For an initial eight week period after an SBA loan is made, the loan may be forgiven to the extent it is used to cover payroll costs, interest payments on mortgages (not including prepayments or principal), rent and utilities. Businesses must retain their employees and pay them at least 75% of their prior-year compensation in order for their loan forgiveness not to be subject to deductions.
The amount of a loan that may be forgiven is ratably reduced if the average number of full-time equivalent employees during the eight week forgiveness period is less than the average number of employees during the period from February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020. The small business borrower is able to choose which period to compare.
To encourage employers to rehire workers laid off due to the coronavirus pandemic, employers that rehire previously laid off workers will not be penalized for having a reduced payroll at the beginning of the forgiveness period. If, during the period from February 15, 2020 through April 26, 2020, there is a reduction in the number of full-time equivalent employees or their compensation and the employer eliminates the reduction by June 30, 2020, the amount of loan forgiveness is determined without regard to the reduction.
To apply for SBA loan forgiveness, businesses must submit documentation regarding the eligible uses of loan funds, the amount to be forgiven and any other documentation deemed necessary by the SBA Administrator. The SBA will purchase any loan forgiveness amounts from its certified lenders, and this canceled indebtedness will not result in taxable income to the small business borrower.
For principal amounts that exist after any loan forgiveness, small businesses may defer payment of remaining principal, interest and fee balances for at least six months and up to one year.
Economic Injury Disaster Loans or EIDL Loans
In addition to the Paycheck Protection Program, the CARES Act also provides funding for up to $10 billion in economy injury disaster loans (EIDL). Such loans are designed to be quickly deployed with advances up to $10,000 distributed as soon as three days after application. The SBA's website now shows a simplified EIDL application process with a reduced number of forms that initially need to be submitted (an application form) and a supporting information form.
The SBA is required to issue implementing regulations within 15 days after the enactment of the CARES Act (April 11, 2020).
Loans under the program will be made by over 800 SBA-certified lenders. A list of the 100 most active Section 7(a) lenders is available on the SBA's website. The SBA also offers a lender match online referral tool to assist small businesses in contacting SBA-certified lenders. It is expected that participating lenders will await the issuance of implementing regulations by the SBA before accepting loan applications under the program. The CARES Act also permits the SBA Administrator and Secretary of the Treasury to certify additional lenders to join the program, if required.
Further information on the CARES Act and Coronavirus Pandemic Impacts
For additional information with respect to the financing programs to be provided by the Treasury Department and the Federal Reserve to non-banks such as corporate borrowers, see the Baker McKenzie client alert. If you would like to draw from our other global resources developed by Baker McKenzie on the CARES Act and COVID-19, please visit our Coronavirus Resource Centre.