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Borrower Insights For Maximizing PPP Loan Forgiveness

Mike Miller and Kathryn Hesman
Law360
June 2020
As businesses that have received funds under the Coronavirus Aid, Relief and Economic Security, or CARES, Act's Paycheck Protection Program execute their COVID-19 survival strategies, it is important that these survival strategies are designed to take advantage of PPP's defining feature for borrowers: loan forgiveness. 

The PPP provides that loans made under the PPP may be forgiven if the borrower meets certain criteria for the use of the PPP loan proceeds and maintenance of employee headcount and compensation levels.

The forgiveness regime is governed by Section 1106 of the CARES Act, as supplemented by Small Business Act and the U.S. Department of the Treasury interim rules and guidance, the long and short form forgiveness applications released by the SBA and updated as of June 16, and the Paycheck Protection Program Flexibility Act, or PPPFA, which was signed into law June 5. 

Based on guidance issued as of June 24, this article will summarize for entity borrowers (i.e., not sole proprietors or independent contractors) the permitted forgivable uses of PPP funds, the process of applying for PPP loan forgiveness, and best practices for maximizing PPP loan forgiveness. It is important to note that as further SBA or Treasury guidance is issued, the analyses presented herein may become outdated or inaccurate.

Forgivable Uses of PPP Funds

Paramount for borrowers to understand is that simply meeting the eligibility requirements for PPP loans and using the proceeds of PPP loans for permitted uses does not mean that the PPP funds are forgivable. Forgivable permitted uses are limited to a separate subset of business expenses. PPP funds used for permitted uses that are not forgivable must be repaid, but repayment terms remain favorable to borrowers.

Generally. The forgivable portion of PPP funds is calculated by determining the sum of qualifying forgivable expenses minus any forgiveness reductions, each of which are described in turn below.

To be forgivable, the forgivable expenses must, depending on the category of forgivable expenses, consist of either costs incurred and paid, or simply costs incurred, during the covered period.

The covered period is the period from the date that the PPP loan was originated to the earlier of (1) 24 weeks following the loan disbursement date and (2) Dec. 31. If a borrower received a PPP loan prior to June 5, it can elect to have its covered period be the initial eight-week period set forth in the pre-PPPFA CARES Act. 

The four categories of forgivable expenses are as follows.

1. Payroll Costs

Payroll costs consist of the following types of compensation payable to U.S.-based employees:

  • Salary, wages, commission and tips;
  • Vacation, parental, family, medical or sick leave;
  • Severance-type payments;
  • Payments required for provision of group health insurance, including insurance premiums;
  • Retirement benefits, including employer contributions to defined benefit or defined contribution plans;
  • The employee portion of Federal Insurance Contributions Act and income tax;
  • Payment of state and local taxes on employee compensation; and
  • Bonuses and hazard pay.

The calculation of payroll costs is reduced by the amount of compensation of an employee exceeding a prorated annual salary, excluding noncash benefits, of $100,000 and certain wages that are eligible for tax credits under the Families First Coronavirus Response Act.

Payroll costs specifically do not include the employer's share of Federal Insurance Contributions Act, which is equal to 7.65% of the employee's wage, or the employer's share of income taxes, but the PPPFA provided that borrowers with amounts forgiven are eligible for payroll tax deferral — 50% until the end of 2021, with the remaining 50% until the end of 2022.

For payroll costs specifically, the forgiveness application created an alternative payroll covered period, which is the eight-week period — or 24-week period if elected through the PPPFA — that begins on the first day of the first pay period following the loan disbursement date, the alternative payroll covered period, to be used at the election of the borrower, but only specifically for payroll costs and the employee-related forgiveness reductions discussed below.

Forgivable payroll costs have to be incurred during the covered period or alternative payroll covered period, depending on the borrower's election, but such payroll costs may be paid on or before the next regularly scheduled payroll date after the conclusion of the covered period or alternative covered period, as applicable.

2. Interest on Certain Mortgage Obligations

Payments of interest incurred and paid with respect to a mortgage that is a liability of the borrower and secured by real or personal property, which mortgage was incurred in the ordinary course of business prior to Feb. 15, are forgivable expenses. Payments with respect to principal and any prepayments have been specifically identified as unforgivable.

3. Certain Rent Payments

Payments of rent under a lease that was entered into before Feb. 15, that are paid during the covered period or incurred during the covered period and paid on or before the next regular billing date, even if that billing date falls after the covered period, are forgivable expenses. 

4. Certain Utility Payments

Payments for a service for the distribution of electricity, gas, water, transportation, telephone or internet access service, which service began prior to Feb. 15, and are incurred or paid during the covered period, or incurred during the covered period and paid on the next regular billing date after the covered period are forgivable expenses. 

Reduction of Forgivable Amount

Even if all PPP funds are used on forgivable expenses, borrowers can still be left with unforgiven amounts based on three types of forgiveness reductions set forth below.

1. Nonpayroll Cost Use Reduction

The PPPFA requires that at least 60% of the loan forgiveness amount be attributed to payroll costs. If nonpayroll costs comprise more than 40% of the use of PPP funds, the forgivable amount will be reduced proportionately. 

2. Full-Time Equivalent Employees Reduction

The forgivable amount will be reduced by a percentage based on employee headcount reductions that occur during the covered period. This percentage is calculated by taking the borrower's average number of full-time equivalent employees, or FTEs, per week during the covered period and dividing it by, at the borrower's option, either (1) its average number of FTEs per month from Feb. 15, 2019 to June 30, 2019, or (2) its average number of FTEs per month from Jan. 1 through Feb. 29.

The borrower's number of FTEs are calculated by evaluating each employee, including part-time employees, and dividing the average number of hours paid to such employee per week by 40 and rounding to the nearest tenth, with the maximum for each employee being one.

The forgiveness application contains an alternative method for calculating FTEs, to be used at the borrower's election, which just assigns one FTE to each employee that works at least 40 hours per week, and assigns 0.5 of an FTE to any employee who works less than 40 hours. 

Exceptions From FTE Reduction

The forgiveness application specifically excepts the following from the FTE reduction calculation:

  • Any positions for which the borrower made a good faith, written offer to rehire an employee, who was an employee of the borrower on Feb. 15, during the covered period, which offer was rejected by the employee and the borrower was unable to hire similarly qualified employees for such unfilled positions on or before Dec. 31;
  • Any positions for which the borrower made a good faith, written offer to restore any reduction in hours, at the same salary or wages during the covered period, which was rejected by the employee; and
  • Any employees who during the covered period that (1) were fired for cause, (2) voluntarily resigned, or (3) voluntarily requested and received a reduction of their hours.

These exceptions only apply if the relevant position was not filled by a new employee.

Safe Harbors From FTE Reduction

Borrowers can remedy potential forgiveness reductions due to the FTE reduction in certain limited circumstances.

  • Restore prior levels of FTEs: If a borrower reduced its number of FTEs at any time from Feb. 15, to April 26, but restores its FTE levels by Dec. 31 to the levels in the pay period that included Feb. 15, the FTE reduction will not be applied. 
  • Documented inability to return to prior level of activity: If a borrower reduced its number of FTEs during the covered period and can document that it is unable to return to the same level of business activity at which it was operating before Feb. 14, directly or indirectly due to compliance with guidance issued by specific federal agencies related to standards for sanitization, social distancing or worker or customer safety requirements related to COVID-19, the FTE reduction will not be applied.

3. Salary and Wage Reduction

The forgivable amount will be reduced by the amount of any reduction in salary or hourly wage of employees that exceeds 25% of the total salary or hourly wage of such employee during the most recent full quarter during which the employee was employed before the covered period, excluding employees who received, during any single pay period during 2019, wages or salary at an annualized rate of $100,000 or more.

To the extent a reduction exceeds 25%, the reduction to the forgivable amount would be calculated on a dollar-for-dollar, employee-by-employee basis. 

Safe Harbor From Salary and Wage Reduction

If a borrower reduced its employee annual salaries or hourly wages below the 25% floor at any time from Feb. 15 to April 26, it can eliminate such salary reduction by Dec. 31, and the salary and wage reduction will not apply. 

Different rules, which are not discussed here, may apply for qualifying seasonal employers, employers of tipped workers. Further, interim final rule No. 6 limits the maximum forgiveness amount to $20 million for a corporate group of businesses that is majority owned, directly or indirectly, by a common parent.

Forgiveness Application Process

Borrowers are required to apply directly to their lender for forgiveness using the forgiveness application prior to the date that is ten months following the end of the covered period.

The forgiveness application can be submitted on either (1) the general Form 3508, which includes two mandatory parts to be submitted — the forgiveness calculation form and the PPP Schedule A, or (2) a new short Form 3508EZ, which is for use by borrowers that will not be subject to any forgiveness reductions.

Guidance has indicated that recipients of PPP loans in excess of $2 million will be audited by the SBA prior to forgiveness, while adding that all recipients will be subject to SBA spot-checks. The forgiveness application specifies required documentation for each category of forgivable expense — both to be submitted with the forgiveness application and to be maintained by the borrower — and requires certain certifications by the borrower.

A borrower may apply for forgiveness prior to the end of its covered period if such borrower has used all PPP funds for which it is requesting forgiveness.

Best Practices to Maximize Forgiveness

Borrowers can take steps to maximize their forgivable amounts and maintain flexibility when new regulations, guidance or commentary is disseminated, including the below recommended best practices.

Amend loan documents.

The recently passed PPPFA provided for a number of borrower-beneficial changes to the initial PPP loan framework. Borrowers should reach out to their lenders to amend their loan documents to reflect these changes as the PPPFA does not, automatically, incorporate these changes into any loan documents with lenders.

Use separate accounts.

Borrowers should segregate PPP funds into bank accounts separate from their normal operating accounts, allowing borrowers track and document specific uses for forgiveness purposes.

Keep great records.

Borrowers should closely review the documentation requirements in the forgiveness application and ensure that they keep organized and easily accessible records of required documentation.

If a borrower may wish to avail itself of a safe harbor or exception to a forgiveness reduction, it should keep records of any qualifying events, e.g., the termination of an employee for cause, the inability to rehire an employee or employees with substantially similar qualifications or applicable federal guidance or regulations directly or indirectly affecting such borrower's ability to maintain business activity. 

Manage headcount.

If any FTE headcount or compensation changes are contemplated during the covered period, borrowers should prepare a comparison analysis among its headcount and compensation levels (1) pro forma giving effect to such contemplated changes, and (2) during the periods contemplated by the salary and wage reduction and FTE reduction.

Once such analysis is prepared, borrowers can calculate any resulting forgiveness reduction and make a decision as to whether to proceed with such changes considering their impact on the forgivable amount. 

When in doubt, be conservative.

Borrowers that are basing their projections on PPP forgiveness should prioritize the use of PPP funds on expenses that are most clearly forgivable expenses, remembering to avoid other actions that could cause Forgiveness Reductions. 

Monitor new guidance.

The Treasury updates its CARES Act guidance website frequently. Borrowers should maintain consistent communication with their advisers to distill the impact of the future guidance on the any actions or plans that borrowers are executing.