In response to the COVID-19 pandemic, Congress recently passed, and President Trump signed, the Coronavirus Aid, Relief, and Economic Security Act, known as the CARES Act. Described in the media as the “largest emergency aid package in U.S. history,” this unprecedented $2.2 trillion economic rescue package promises to “deliver a tidal wave of cash to individual Americans, businesses and health care facilities.” The legislation, spanning 335 pages in its single-spaced version, provides much-needed relief to businesses in several areas, as this summary discusses.
Small Business Loans
The Small Business Administration (SBA) already had a number of loan programs for small businesses, including the 7(a) Loan Program and the Economic Injury Disaster Loan (EIDL) Program. The CARES Act appropriates substantial additional money to support those programs and loosens some of the normal qualification requirements, expanding the pool of eligible recipients to include certain businesses and organizations that otherwise would not be considered “small” and would, thus, not normally be eligible for the programs.
1. 7(a) Loan Program
Section 1102(b) of the CARES Act now authorizes commitments of $349 billion for the 7(a) Loan Program, which was already the SBA’s most common loan program. Under the SBA’s normal rules, to qualify for a 7(a) loan, an entity generally must be a small, for-profit business located in the United States that needs credit and is unable to find it elsewhere (13 C.F.R. Part 120, Subpart A).
Now, under section 1102(a) of the CARES Act, for the period of February 15 through June 30, 2020, in addition to “small” business concerns, any business concern, nonprofit organization, veterans organization, or tribal business concern can receive a loan of as much as $10 million under this program if the concern or organization employs 500 or fewer employees, or a higher number if that higher number is permitted under the SBA size standards. In other words, a concern or organization can qualify for a 7(a) loan either if it is already considered “small,” as defined by the SBA’s size standards using the employee or annual receipts cap dictated by the concern’s or organization’s specific North American Industry Classification System (NAICS) code, or a concern or organization can qualify if it has 500 or fewer employees. The CARES Act, thus, appears to expand the category of concerns and organizations eligible to receive a 7(a) loan to include concerns or organizations that would otherwise not be considered “small” under the SBA’s size standards. A concern or organization in an industry with a NAICS code that utilizes an employee cap of less than 500, for example, would be eligible for a loan under the CARES Act even if it exceeded its NAICS code employee cap if the concern or organization still had fewer than 500 employees. Also eligible would be a concern or organization in an industry with a NAICS code utilizing an annual receipts cap and that concern or organization had annual receipts greater than the applicable standard but the concern or organization had fewer than 500 employees. For purposes of the 7(a) Loan Program, an “employee” includes individuals employed on a full-time, part-time, or other basis. Sole proprietors, independent contractors, and self-employed individuals are also eligible for 7(a) loans.
“Affiliation” Rules Still Apply
While the CARES Act expands the number of concerns and organizations that are eligible for 7(a) loans, concerns and organizations must still be mindful of the SBA’s “affiliation” rules. The SBA’s affiliation rules dictate that if two or more entities are related through common ownership or control, the number of employees (or the annual receipts) of those entities will be aggregated for purposes of determining whether the entities are individually eligible for an SBA loan. There are several different scenarios in which the SBA will find that entities are “affiliates.” As an example, if two concerns are subsidiaries of a third concern and the two concerns are determined to be controlled by the third concern, then the SBA will calculate the number of employees employed by each individual concern by referencing the number of employees employed by all three concerns in the aggregate. Accordingly, if each concern individually employed 500 employees and one of the subsidiaries wanted to apply for a loan, the SBA would calculate that concern’s total employees by adding the 500 employees employed by each of its sister/parent concerns, would find that the applicant concern employed 1,500 employees, and would likely find the applicant concern ineligible.
Exceptions to “Affiliation” Rules for Certain Industries
There is, however, now a special rule for businesses in the “Accommodation and Food Services” sector (Sector 72) of NAICS. Examples of businesses in that sector are hotels, motels, casinos, restaurants, and bars, etc. Businesses in NAICS Sector 72 with more than one physical location can qualify for loans if they employ 500 or fewer employees per physical location. Moreover, section 1102(a) of the CARES Act expressly waives the SBA’s affiliation rules (13 C.F.R. 121.103) for NAICS Sector 72 businesses for the period of February 15 through June 30, 2020. The CARES Act also expressly waives the SBA affiliation rules for franchises and any business concern that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act of 1958. With the waiver of the “affiliation” rules by the CARES Act, a higher number of businesses will now qualify for 7(a) loans.
What Can CARES Act SBA Loans Be Used for?
7(a) loans provided pursuant to the CARES Act may be used to pay for the following costs:(i) payroll; (ii) group healthcare benefits, and insurance premiums; (iii) salaries and other employee compensation; (iv) mortgage interest; (v) rent; (vi) utilities; and (vii) interest on loans incurred before February 15, 2020. To the extent the loan proceeds are used for one of these purposes, the CARES Act provides that the SBA will have no recourse against any individual, shareholder, member, or partner of an eligible recipient of a covered loan for nonpayment of the covered loan. The SBA regulations relating to 7(a) loans in general also state that loan proceeds may be used for purposes such as inventory, supplies, raw materials, working capital, and to refinance certain outstanding debts. The CARES Act is meant to expand on the 7(a) Loan Program and, indeed, states that loans provided pursuant to the CARES Act may be used for the purposes outlined in the CARES Act in addition to the allowable uses generally provided by the 7(a) Loan Program.
Potential Limitations on CARES Act SBA Loans
In order to receive a 7(a) loan under the CARES Act, however, an applicant is required to certify that the funds “will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments.” There, thus, remains an ambiguity as to whether a recipient of a loan pursuant to the CARES Act can actually use the proceeds for one of the uses permitted by the general 7(a) Loan Program unless doing so is for the purpose of “retain[ing] workers and maintain[ing] payroll or mak[ing] mortgage payments, lease payments, and utility payments.” Additionally, 7(a) loan proceeds generally cannot be used to refinance an unsecured or under-secured loan, meaning that the loan cannot be used to pay any creditor in a position to sustain a loss causing a shift to the SBA of all or part of a potential loss from an existing debt. A borrower also cannot use 7(a) loan proceeds to purchase a portion of a business or a portion of another owner’s interest. However, generally under the 7(a) Loan Program, one or more current owners may use loan proceeds to purchase the entire interest of another current owner, or a borrower can purchase ownership of an entire business. Again, it is unclear whether this remains true in the context of 7(a) loans received pursuant to the CARES Act.
Interest Rate and Debt Forgiveness on CARES Act SBA Loans
The interest rate on loans provided pursuant to the CARES Act cannot exceed 4%. A recipient of a loan made pursuant to the CARES Act is also eligible for debt forgiveness in an amount equal to the sum of the following costs incurred and payments made during the eight-week period following (and beginning on) the date of the origination of the loan: (i) payroll costs; (ii) any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation); (iii) any payment on any covered rent obligation; (iv) any covered utility payment.
The loan forgiveness amount will be reduced by a calculation that takes into account the recipient’s reduction in full-time equivalent employees or the recipient’s reduction in excess of 25% of the salary of an employee making less than $100,000. If, however, the reduction in the number of employees or the reduction to an employee’s salary occurred during the period beginning on February 15, 2020, and ending on the date that is 30 days after the enactment of the CARES Act, and the loan recipient eliminates the reduction in full-time equivalent employees and any reduction to employee salaries by June 30, 2020, then the amount eligible for loan forgiveness will not be reduced.
2. EIDL Program
Section 1107 of the CARES Act appropriates $10 billion for emergency EIDL grants and Section 1110 expands or waives several requirements for the program. The SBA’s EIDL Program already provides up to $2 million in disaster business loans to cover both physical disasters and economic injuries. The current regulations state that a small business is eligible for an EIDL if it is “located in a declared disaster area and suffered substantial economic injury as a direct result of a declared disaster” (13 C.F.R. 123.300). The SBA’s standard rules define a substantial economic injury as an injury “such that a business concern is unable to meet its obligations as they mature or to pay its ordinary and necessary operating expenses.” Normally, a business is not eligible to apply for an EIDL if it is able to obtain credit elsewhere.
The CARES Act implements some important changes to the EIDL Program. Specifically, Section 1110 of the CARES Act:
- Provides for EIDL assistance to small business concerns, private nonprofit organizations, small agricultural cooperatives, and “eligible entities.” (An eligible entity is a business, cooperative, business owned through an employee stock ownership plan, or tribal small business concern with 500 or fewer employees, and a sole proprietorship);
- Waives the rules relating to personal guarantees for grants and loans of not more than $200,000, waives the requirement that an entity be in business for at least a year (as long as it was in business by January 31, 2020), and waives the requirement that an entity be unable to obtain credit elsewhere;
- Allows the SBA to approve an applicant for an EIDL based solely on a credit score without the need to provide tax returns or use alternative methods to determine ability to repay a loan; and
- Permits SBA to provide $10,000 emergency grants to applicants for EIDLs to meet immediate allowable business expenses, such as paid employee sick leave, payroll, rent or mortgage, increased costs because of interrupted supply chains, and repayment of obligations otherwise not payable because of revenue losses. (This $10,000 grant does not need to be repaid, even if the loan is eventually denied).
The CARES Act does not provide for forgiveness of EIDL loans as it does with loans under the 7(a) Loan Program. The CARES Act does provide, however, that EIDL loans made during the covered period can be refinanced as part of a 7(a) loan.
Small businesses considering their options for keeping afloat during this crisis should seriously consider seeking loans from SBA-approved lenders. The CARES Act has provided the SBA loan programs outlined in this article with substantial funds to support the business community in these challenging times.
If you have questions about whether your business might qualify for either of these loan programs or about any related issues, please feel free to contact Aron C. Beezley, Patrick R. Quigley, or Lisa Markman.