When the Paycheck Protection Program (the “PPP”) was enacted as part of the federal $2.4 trillion bailout program, Coronavirus Aid, Relief, and Economic Security Act, the terms of the program looked fairly clear; there were few restrictions on how PPP loan proceeds could be used (for a basic discussion of the PPP click here). Now, as we delve into this issue and new guidelines continue to be published, it becomes clear serious restrictions do exist. If you don’t timely spend the money on approved expenses, you won’t have all or a portion of your loan forgiven (but you’ll still have two years to pay it back). If you spend too much of your loan on unapproved items, your loan could be called at the end of 2020. And if you are guilty of fraud, personal liability and even jail time are possible. So let’s be clear on how to spend this money.
75% of the Loan Must Be Spent on Payroll Costs
The new SBA Interim Final Rule (the “IFR”) (click here for link to text) clearly states 75% of the proceeds of the loan must be used for payroll costs and only 25% for “Other” purposes such as rent and utility payments (for a discussion of what is “payroll” and what is “other purposes” click here). If compliance is not reached by December 31, 2020, the loan could be called and repayment demanded immediately. Given the formula used to derive the loan amount -2.5 times average monthly payroll– this compliance should be easy for on-going businesses.
While “payroll purposes” is defined, issues may still arise. If you make an honest mistake, which seems understandable given the constantly changing landscape we face regarding these new laws, you’ll likely only lose some forgiveness of the loan. But if you intentionally use the 75% for non-payroll items, that is fraud. Most importantly, this is a criminal act and jail time is possible. Also, the SBA can pierce the corporate veil and require repayment from a shareholder, member or partner, even though loans up to $200,000 do not require personal guarantees.
Calculating Forgiveness of the Loan
The law states that amounts used for appropriate purposes during the first eight weeks after the loan is made will be forgiven. No further requirements are written into the law. The IFR however, require at least 75% of the amount forgiven must have been used for payroll costs during that eight week period. This means the amount used for non-payroll costs during the first eight week period can be no more than one third of the amount used for payroll costs (25% is one third of 75%). Therefore, if the borrower doesn’t use the full 75% for payroll, the borrower can’t use the full remaining 25% for “Other” costs.
Furthermore, as has been well reported, the law includes other restrictions on the amount forgiven. These restrictions reduce the amount forgiven based on reductions in headcount of the borrower and individual employee pay reductions of more than 25%. These reductions are applied to the amount of payroll costs that could be forgiven. This in turn reduces the amount of “Other” costs allowed. For example, if a borrower claims it paid $100,000 in payroll costs but due to headcount and individual pay rate reductions, the borrower lost $10,000 of forgiveness, the payroll expense would now be $90,000. In turn, the 25% for “Other” costs will be based on $90,000, not $100,000, so the maximum forgiveness of “Other” expenses will be one third of $90,000 ($30,000) not one third of $100,000 ($33,333).
When your lender audits how you spent your funds, which we expect to happen within a few months after your eight week period ends, make sure your presentation/analysis complies with these rules. If you have any questions, check with qualified legal counsel.
Brody and Associates will continue to closely monitor this issue and keep our readers informed.
The subject matter discussed in this article can be very technical. It is an evolving area of law and very fact specific. Our goal here is to simply alert you to some of the key issues involved. We urge you to seek competent legal counsel before applying these ideas to your specific situation. Brody and Associates stands ready to discuss your particular needs
