The Department of Justice has already started investigating and even filed charges against individuals who acquired Paycheck Protection Program (“PPP”) loan funds under false pretenses.  In most of the cases charged so far, the individuals all claimed to have employees at various businesses when in fact there were allegedly no employees working for any of the businesses.  These cases are just the tip of the iceberg.  Once the dust settles, and Congress evaluates the amount of money loaned, more enforcement initiatives will surely follow.

As such, it is important that borrowers make sure that they are in compliance with all requirements of the PPP, including eligibility and the loan amount calculation.  Although there are few certainties with the PPP, applicants can at least substantiate their processes for determining their eligibility and loan amount, thereby minimizing the risk that the Small Business Administration (“SBA”) denies loan forgiveness or imposes any penalties for false certifications.

The CARES Act provides that to be eligible, the applicant must either be a qualifying “small business concern” or “business concern” as defined in the Act.  An applicant also must have been in operation on February 15, 2020 and had employees for whom it paid salaries and payroll taxes or must have paid independent contractors.  Sole proprietors, independent contractors, and self-employed individuals may also be eligible for PPP loans.

The basic size tests for eligibility are:

  1. A “small business concern” that satisfies the small business size standard for the industry in which the applicant is primarily engaged and, combined with its affiliates, satisfies the size standard designated for either the primary industry of the applicant alone or the primary industry of the applicant and its affiliates, whichever is higher;
  1. A “small business concern” that satisfies the SBA’s “alternative size standard”; or
  2. For all other applicants eligible under the CARES Act, a “business concern,” qualifying 501(c)(3) nonprofit organization, 501(c)(19) veteran organization, tribal business concerns, or other business concerns, that employ, when combined with their affiliates, not more than the greater of (i) 500 employees whose principal place of residence is in the United States; or (ii) the maximum number of employees permitted by the applicable SBA’s size standard for the primary industry in which the applicant is primarily engaged.

The SBA requires small business concerns to count every employee of the applicant and all domestic and foreign affiliates of the applicant, regardless of full-time or part-time status.  The existing SBA regulations on 7(a) loans do not limit employees to only employees who reside in the United States.

On May 18, 2020, the SBA released an Interim Final Rule concerning the Treatment of Entities with Foreign Affiliates under the PPP.  According to the new rule, all employees of affiliates are to be counted for purposes of determining if the SBA’s employee size standards are met for purposes of PPP eligibility.  The principal place of residence of the employee is not relevant for purposes of this headcount.  If an applicant, together with its domestic and foreign affiliates, does not meet the Existing SBA Size Tests or the CARES Act Size Test, it is not eligible for a PPP loan.  Because there was confusion based on prior guidance, the SBA agreed that this rule would not apply to borrowers who applied for their PPP loan prior to May 5, 2020 and did not include non-U.S. employees in their headcount determinations.

Determining the Amount of the PPP Loan

Once an applicant has determined it is eligible for a PPP loan, it must then calculate the maximum amount of the loan for which it is eligible.  The amount of the loan is limited to the lesser of (i) $10,000,000 or (ii) 2.5 times an applicant’s eligible “payroll costs” plus the amount of any Economic Injury Disaster Loan (“EIDL”) originated on or after January 31, 2020 being refinanced with PPP proceeds (less the amount of any advance received under an EIDL).  An applicant must only consider its own payroll costs and not those of its affiliates, even though it had to consider its affiliates’ employees when determining eligibility.  “Payroll costs” are defined as:

  1. Salary, wage, commission, or similar compensation;
  2. Payment of cash tips or equivalent;
  3. Payment for vacation and parental, family, medical, or sick leave;
  4. Allowance for dismissal or separation (e.g. severance pay);
  5. Health insurance premiums and other payments for provision of healthcare benefits;
  6. Retirement benefits; and
  7. State/local taxes on employee compensation.

The required exclusions include:

  1. Any compensation for each individual employee in excess of an annual salary of $100,000 as prorated for the Covered Period (between February 15, 2020 and June 30, 2020);
  2. Federal taxes for payroll, railroad retirement, and income;
  3. Compensation of each employee with a principal residence outside United States;
  4. Qualified sick and family leave wages where credit is allowed under Families First Coronavirus Response Act.

Permissible Uses of PPP loan funds

Borrowers are permitted to use PPP loan funds for payroll costs, interest on mortgage, and other debt, rent, and utilities (provided the mortgage, other debt, rent, and utilities are in place or in service before February 15, 2020).  Proceeds that are used for permissible uses between February 15, 2020 and June 30, 2020 that are not forgiven will become a loan.

It is still unknown what will happen if borrowers use loan proceeds other than for the permitted uses identified by the CARES Act.  The first Interim Final Rule states that “[i]f you use PPP funds for unauthorized purposes, SBA will direct you to repay those amounts.  If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud.”

Risks of Accepting a PPP Loan

  • Audits and interviews by government regulators and/or CARES task force
  • Subpoenas from Office of Inspector General
  • Fines
  • Restitution
  • Criminal prosecution
  • Disgruntled employee could bring a qui tam (whistleblower) action

Practical Tips to Ensure Compliance

  • Application. Make sure you understand the questions on the application and that your answers are accurate.  Make sure to record your rationale for your responses.  Particularly, record your rationale and analysis of how you calculated the loan amount.
  • Record keeping: Organize and keep all records related to the application, use of the loan proceeds, steps taken to secure funds, and any advice received in obtaining the funds. Keep those records for a minimum of two years.
  • Use of Funds: Deposit loan proceeds in a separate bank account. Use the account for permissible expenses and document all expenses.

Consult a Professional: If you are contacted by a law enforcement agency regarding your PPP application or use of funds, hire a lawyer before responding to the inquiry.