The following information supplements our prior note on May 5 and is provided as a courtesy based on available public information; however, it is not intended nor should it be used as a substitute for appropriate accounting and legal counsel specific to your individual situation. Congress may pass new legislation and the Small Business Administration (SBA) may issue additional guidance that could change the process and calculation of loan “forgiveness.”
The Small Business Administration (the “SBA”), in consultation with the Department of the Treasury, released on May 15 the long awaited Paycheck Protection Program (the “PPP”) Loan Forgiveness Application (SBA Form 3508) and the related detailed instructions (collectively, the “Forgiveness Application”). Then on May 22nd, the SBA released two interim final rules (“IFRs”) addressing the forgiveness process of the PPP. One interim final rule (“IFR”) focuses on loan review procedures and related borrower and lender responsibilities, such as SBA reviews of individual PPP loans. The other interim final rule provides details on loan forgiveness, including eligible payroll and non-payroll costs, reductions to the loan forgiveness amount based on reduced employees or compensation, and documentation requirements.
The combination of these rules shifts the burden of PPP Forgiveness on to borrowers with a heavy documentation burden to obtain forgiveness of PPP loans. The SBA has made it clear it is the borrower’s responsibility for ensuring accuracy, completeness and legitimacy with new Certification requirements. Freedom Bank’s role will be to collect the Forgiveness application from borrowers and obtain the documentation supporting the calculation components.
To be frank, if the application process seemed difficult to you as a borrower, then the forgiveness process appears to offer an entirely new level of additional complexity. The long-awaited forgiveness guidance released by Treasury has become a source of disappointment and frustration for lenders and borrowers alike. However, keep in mind that Congress continues to make efforts to secure significant changes and in fact this afternoon, by a vote of 417-1, the House of Representatives has passed H.R. 1701, The PPP Flexibility Act. The Act will:
While the proposed changes are welcome, Congress has not yet addressed the need to simplify the forgiveness process for borrowers and to alleviate the significant logistical and operational burden on PPP lenders. Absent such Congressional intervention, we are left with the 30+ pages of Forgiveness Rules that include an 11-page forgiveness application form with supporting schedules.
The Forgiveness Application is composed of four sections: (1) the PPP Loan Forgiveness Calculation Form; (2) PPP Schedule A; (3) the PPP Schedule A Worksheet; and (4) the (optional) PPP Borrower Demographic Information Form. All Borrowers are required to submit the Loan Forgiveness Calculation Form and Schedule A to the bank (as well as supporting documentation).
In the press release announcing the Forgiveness Application, the SBA states that the application includes “several measures to reduce compliance burdens and simplify the process for borrowers.” However, the application’s instructions are in prose and hard to follow.
The SBA has expanded on some of the definitions that have been used in interim final rules and frequently asked questions (“FAQs”) since the PPP began.
Employees: The form does not provide much clarity on the term “employees” used in determining the number of employees later in the calculation portion of the form. However, the SBA states that the forgiveness reduction calculation uses Full Time Equivalents (“FTEs”) set at 40 hours a week later in the forgiveness calculation portion of the form. The form is silent on how Borrower’s should count employees when they do not use the traditional 40 hour week.
Covered Period: The forgiveness period is listed as eight weeks. This period is determined as 56 days from the date of the PPP loan distribution date. We saw earlier this week that the HEROES Act wishes to extend this period to 24 weeks. There is no mention of any potential extension of the Covered Period.
This form now gives borrowers an option to calculate payroll costs using an “alternative payroll covered period”, if that alternative method better aligns with borrowers’ regular payroll cycles. Borrowers with a biweekly (or more frequent) payroll schedule may elect to calculate eligible payroll costs using the eight-week (56-day) period that begins on the first day of their first pay period following their PPP loan disbursement date (the “Alternative Covered Period”)
Rent and Mortgage expenses: The SBA clarifies that rent and mortgage expenses include both real and personal property. This allows borrowers to include payment besides leases for real property. The original definition was ambiguous as to whether or not it only covered real property leases.
Interest: Covered expense includes both real estate and personal property mortgage interest payments.
Utilities: The utilities definition is now “payments for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access.” This definition is more expansive for borrowers and lenders on what can be included under utilities. Borrowers are required to submit documentation verifying the existence of such obligations prior to February 15, 2020. What documentation is required to prove transportation expense obligations, for example, remains unclear.
The authorized representative of the borrower must sign additional certifications. These certifications include confirming the accuracy of the Forgiveness Application, accuracy of the supporting documents and proper use of PPP funds. The borrower must acknowledge potential government enforcement if funds were misused or for falsehoods in the application or supporting documents. The form asks the borrower to check a box if the borrower, together with its affiliates, received PPP loans with a principal amount in excess of $2 million. The borrower does not need to include affiliates that were not otherwise waived (15 U.S.C. 636(a)(36)(D)(iv)).
Eligible payroll costs includes either payroll costs incurred or payroll costs paid during the forgiveness period. Payroll costs incurred but not paid during the Borrower’s last pay period of the Covered Period (or “Alternative Covered Period” described below) are eligible for forgiveness if paid on or before the next regular payroll date. The borrower must be sure not to count any payroll cost twice using these methods.
Eligible non-payroll costs must be paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, which can be outside the Covered Period.
The form includes a step by step worksheet for calculating the forgiveness amount. Please refer to the form for the steps. It is possible that the forgiveness amount will not be in line with what borrowers were anticipating based on SBA guidance to date. Borrowers are expected to use Schedule A and the Schedule A Worksheet to complete the Forgiveness Application. The SBA states that, in lieu of the Schedule A worksheet, borrowers can obtain an equivalent report from their payroll system or payroll processor—but borrowers would still need to use the worksheet to determine if they meet the FTE Reduction Safe Harbor described below. The bank will require these worksheets in order to process the Forgiveness Application.
The Forgiveness Application formalizes a safe harbor for borrowers whose number of FTEs as of June 30, 2020 equal the number of FTEs as of February 15, 2020. Specifically, the Borrower is exempt from the reduction in loan forgiveness based on FTE employees described above if both of the following conditions are met: (1) the borrower reduced its FTE employee levels in the period beginning February 15, 2020, and ending April 26, 2020; and (2) the Borrower then restored its FTE employee levels by not later than June 30, 2020 to its FTE employee levels during the pay period that included February 15, 2020.
The safe harbor is separate from the FTE reduction exception when (i) the borrower has made a good-faith, written offer to rehire an employee that was rejected by such employee, or (ii) employees were fired “for cause”, voluntarily resigned, or voluntarily requested a reduction in hours and were replaced. These FTE reductions do not reduce the borrower’s loan forgiveness.
As mentioned above, the Schedule A Worksheet should be completed by borrowers or a borrower may use an equivalent report from their payroll processor or system. In either event, the SBA will require:
The FTE is set at 40 hours, and each employee is capped at 1.0 FTE. The Borrower may also state each employee that works 40 hours or more at 1.0 and any that work fewer hours as .5 as a simple alternative—but some forgiveness may be sacrificed for taking this option.
It is worth noting that the instructions for the Schedule A Worksheet are longer than the instructions for the actual application.
The last page of the Forgiveness Application consists of an optional demographic information form. It is unclear why borrowers would want to provide this additional information. This form itself may be quite burdensome. Requested information includes demographic information for “Principals,” which includes the 20% or more equity owners, trustors, key employees of the borrower as well as officers and directors if the borrower is a nonprofit. This form also asks for the veteran status, gender, race and ethnicity of each Principal. Remember, at this time and based on current guidance from the SBA, submission of this form is optional.
The new IFRs make it clear that Borrowers must complete and submit the SBA Form 3508 Loan Forgiveness Application (or a lender equivalent, each referred to as the “Forgiveness Application”) to receive loan forgiveness. Lenders must review the application and make the initial decision regarding loan forgiveness within 60 days from receipt of a complete application. If the lender determines that the borrower is entitled to forgiveness for some or all of the amount requested, the lender must submit a request for payment from the SBA at the time the lender issues its decision. Lenders are responsible for determining whether borrowers are not eligible for some or any of the requested forgiveness amount. The IFR also states that “[t]he general loan forgiveness process...applies only to loan forgiveness applications that are not [specifically] reviewed by the SBA prior to the lender’s decision on the forgiveness application.” More substantial details regarding the loan forgiveness process are outlined in the second IFR, as described below.
The IFR ratifies much of what was released in the Forgiveness Application, including clarifying that payroll costs paid or incurred during the eight consecutive week covered period are eligible for forgiveness. Payroll costs are considered paid either on the day that paychecks are disbursed or when the borrower originates an ACH credit transaction. Incurred payroll costs must be paid on or before the next regular payroll date after the end of the covered period. The eight-week period is either the period starting on the date the loan was disbursed or the “alternative payroll covered period” as previously defined in the Forgiveness Application and now formally adopted.
In what should come as some relief to borrowers, the IFR clarifies that the SBA will follow the CARES Act in broadly defining the term “payroll costs” provided that an employee’s total compensation does not exceed $100,000 on an annualized basis. Accordingly, borrowers will now be able to count short term hazard pay and bonuses for forgiveness.
Owner-employees and self-employed individuals are subject to a cap on the amount of loan forgiveness equal to the lesser of 8/52 of 2019 compensation or $15,385 per individual in total across all businesses. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit, and owner-employees by the amount of their 2019 employee cash compensation and retirement and health care contributions made on their behalf. General partners are capped by the amount of their 2019 net earnings from self-employment (reduced by claimed Section 179 expense deduction, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235.
As with payroll costs, eligible non-payroll costs include expenses that are either paid or incurred during the covered period—provided incurred expenses are paid on or before the next regular billing date. The rule clarifies that borrowers may seek forgiveness for non-payroll expenses incurred prior to the covered period if paid in the covered period, e.g., when a borrower pays the May electricity bill in June when the covered period also began in June. The SBA reiterates that advance payments of interest on mortgage obligations and principal on mortgage obligations are not eligible for forgiveness under any circumstances—presumably, this restriction would apply to rent as well.
Much of the IFR covers curtailing a borrower’s loan forgiveness amount based on reductions in full-time equivalent employees or in employee salary and wages during the covered period. We strongly advise borrowers and lenders to carefully review how the statutory forgiveness reduction formulas work and consult with their accountants and advisors.
This IFR provides additional clarity on how borrowers can avail themselves of the safe harbor when an employee declines an offer for rehire or to restore the employee’s reduction in hours. In order to meet the safe harbor requirements, there is a new requirement that the borrower informs the applicable state unemployment insurance office of any employees who rejected offers of reemployment within 30 days of rejection of such offers. In addition to this reporting requirement, borrowers must show that they made a good faith, written offer to rehire a recently fired employee (or to restore hours/wages), that the offer was for the same salary or wages and number of hours, that the offer was rejected by the employee, and that the borrower has maintained records documenting the offer and its rejection.
As provided in the Forgiveness Application, a reduction in full-time equivalent (FTE) employees during the covered period reduces the forgiveness amount by the same percentage as the percentage reduction in FTE employees. Borrowers can choose from four reference periods in calculating the relevant number of FTE employees. It is admirable that the SBA and Treasury are seeking to provide borrowers with flexibility regarding the reference period, but the complexity is likely to cause significant borrower confusion.
Because the CARES Act does not define the term “full-time equivalent employee,” the SBA, in consultation with the Secretary of the Treasury, determined that full-time equivalent means an employee who works 40 hours or more, on average, each week. Borrowers are required to document their average number of FTE employees during the covered period and their selected reference period. Borrowers have two options for calculating full-time equivalency: (1) calculate average number of hours a part-time employee was paid per week during the covered period, or (2) elect to use a full-time equivalency of 0.5 for each part-time employee. Due to the complexity and number of calculations required, many borrowers may elect for the second option—unfortunately this may lead many borrowers to qualify for less than the full potential forgiveness amount.
Additionally, a reduction in an employee’s salary or wages in excess of twenty five percent results in a reduction of the loan forgiveness amount, unless an exception applies. The reduction calculations are performed on a per employee basis, not in the aggregate. If salary or wage reductions are restored to pre-February 15, 2020, levels, then the borrower may be exempt from any reduction in the loan forgiveness amount. To ensure borrowers are not double penalized, the salary/wage reduction only applies to the portion of the decline in salary and wages that is not attributable to the FTE reduction.
Employees that are fired for cause, voluntarily resign, or voluntarily request a reduction in hours, may be counted at same full-time equivalency level before the FTE reduction when calculating the FTE employee reduction penalty. As described in the next section, borrowers that avail themselves of this safe harbor must maintain records demonstrating that each such employee was fired for cause, voluntarily resigned, or voluntarily requested a schedule reduction.
The documentation obligations are significant. Incorporating the documentation requirements of the Forgiveness Application by reference, the IFR reiterates that borrowers must submit the required documentation in order to obtain forgiveness. Borrowers are required to submit all payroll, FTE, and non- payroll documentation used to complete the Forgiveness Application (or the lender’s equivalent of the application). Additionally, borrowers are required to maintain, and submit upon request by the SBA, documentation supporting the listing of each individual employee listed in the Schedule A Worksheet Tables 1 and 2 of the Forgiveness Application, documentation regarding any employee job offers and refusals, and documentation supporting the FTE Reduction Safe Harbor Worksheet.
As a final catch-all, borrowers must maintain “[a]ll records relating to the Borrower’s PPP loan, including documentation submitted with its PPP loan application, documentation supporting the Borrower’s certifications as to the necessity of the loan request and its eligibility for a PPP loan, documentation necessary to support the Borrower’s loan forgiveness application, and documentation demonstrating the Borrower’s material compliance with PPP requirements.” The retention period for such documentation is six years after the date the loan is forgiven or repaid in full and borrowers must permit authorized representatives of the SBA to access such files upon request.
The IFR starts with a sweeping statement that the SBA may review any PPP loan of any size, at any time, in the SBA’s sole discretion. Such review includes whether a borrower is eligible for the loan based on the provisions of the CARES Act, the rules and guidance available at the time of the borrower’s PPP loan application, and the terms of the borrower’s loan application. Additionally, the SBA may review whether a borrower calculated the loan amount correctly and used loan proceeds for the allowable uses specified in the CARES Act. Finally, the SBA may review whether a borrower is entitled to the claimed loan forgiveness amount. As stated in the first IFR, borrowers are required to maintain all required documentation for six years, and lenders are required to comply with the requirements for record retention established by their federal financial regulator.
It appears that the SBA intends to communicate with borrowers through the lenders, but the SBA may also request information directly from borrowers. The lender is responsible for contacting the borrower in writing to request additional information and to provide such information to the SBA when requested.
Borrowers may provide additional information in response to a review and the SBA will consider all information provided by borrowers in response to such inquiries. Failure to respond to the SBA’s inquiry may result in a determination that the borrower was ineligible for a PPP loan or that the borrower was ineligible to receive the loan amount or forgiveness amount claimed. If the SBA determines that a borrower was ineligible for the loan in the first place, the SBA will direct the lender to deny the forgiveness application. In addition to seeking repayment of the outstanding loan amount, the SBA retains the right to pursue “other available remedies.”
For all forgiveness applications, lenders are required to: (1) confirm receipt of the borrower certifications contained in the Loan Forgiveness Application; (2) confirm receipt of the documentation borrowers must submit to aid in verifying payroll and non-payroll costs; (3) confirm the borrower’s calculations on the Loan Forgiveness Application; and (4) confirm the borrower made the calculation on line 10 of the Loan Forgiveness Application. The SBA does reiterate that the borrower is responsible for providing an accurate calculation of the loan forgiveness amount.
Lenders are expected to perform a “good-faith review, in reasonable time, of the borrower’s calculations and supporting documents concerning amounts eligible for loan forgiveness.” Other than clarifying that a minimal review of calculations based on a payroll report by a “recognized third-party payroll processor” is considered reasonable, the IFR provides no other clarity to give lenders any comfort on what will meet the “good-faith” standard of review. While the IFR stresses that lenders may rely on borrower representations, it also states that lenders are also responsible for working with borrowers when errors are identified in borrower calculations or supporting documents.
Once the lender has received a complete loan forgiveness application, it must issue a decision to the SBA within 60 days. Such a decision may take the form of an approval, in whole or in part, a denial, or a denial without prejudice due to a pending SBA review of the loan for which forgiveness is sought—this denial without prejudice only applies when specifically directed by the SBA.
If the lender decides to approve an application, in whole or in part, it must provide the SBA with the decision along with the following: (1) PPP Loan Forgiveness Calculation Form; (2) PPP Schedule A of the Loan Forgiveness Application; and (3) the optional Borrower Demographic Information Form (if the borrower submits it to the lender). Lenders are required to confirm that the information provided to the SBA accurately reflects the lender’s records for the loan and that the lender had made its decision in accordance with the requirements set forth in the IFR. The lender must request payment from the SBA at the time it issues its decision to the SBA. Subject to any SBA review of the loan or loan application, the SBA will remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, not later than 90 days after the lender provides its decision to the SBA.
When a lender determines that a borrower is not entitled to partial or full forgiveness, the lender must provide the SBA with the reason for its denial. In addition, the lender must provide the three items listed for an approved forgiveness application. The lender must also notify the borrower in writing that the lender has issued a decision to the SBA denying the forgiveness application, again in whole or in part. Borrowers may request that the SBA review the lender’s decision pursuant to the SBA’s discretionary loan review procedures.
As mentioned above, the SBA may begin a review of any PPP loan of any size at any time in the SBA’s sole discretion. The SBA will notify the lender in writing upon such a review and the lender must notify the borrower in writing within five days of receipt of the notice. Additionally, within five business days, the lender must submit the following: (1) the initial PPP loan application and all supporting documentation provided by the borrower; (2) the Loan Forgiveness Application, and all supporting documentation provided by the borrower; (3) a “signed and certified transcript of account;” (4) a copy of the executed note for the Triple P loan; and (5) “any other documents related to the loan requested by the SBA.” Note that all such documentation must be provided by the lender electronically to the SBA—no such electronic requirement exists for borrowers when submitting their documents to the lender.
We are pleased that Congress is considering much-needed reforms to the Paycheck Protection Program (PPP). Community bankers across the country have worked tirelessly to deliver PPP loans quickly and successfully on behalf of thousands of small businesses. PPP loans can be a lifeline for borrowers, if the terms for forgiveness are flexible and realistic, reflecting the complexity and variability of the current business environment. Unfortunately, the forgiveness rules and procedures outlined for small businesses and lenders are far too complex and onerous.
We are working with our state and federal trade groups to lobby for changes to amend and strengthen the PPP program and SBA rules so that it can more effectively achieve its goal. These recommendations include:
However, we are not waiting to see if there will be a legislative fix, but rather as we did during the origination process, we are designing a system internally based upon the current guidance described in this document to support and streamline the processing of Forgiveness Applications at Freedom Bank. We will largely rely on our talented team to work with you during this process, but we will be rolling out a worksheet and secure portal to facilitate the process.
While we certainly appreciate your desire to obtain forgiveness as soon as practicable, you should carefully follow the available guidance and only submit your Forgiveness Application when it is complete and you have assembled and organized all of the necessary supporting information. Submitting an incomplete application with unsupported entries will only delay the decision process which would be counterproductive for all involved. We will continue to monitor official SBA guidance and provide you with any material updates to help you during this evolving government process. If you have any questions in the interim, please contact your Relationship Manager at Freedom Bank.
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