What Should a Borrower Do With PPP Loan Proceeds?

We have had a number of questions from clients with regard to how to use loan proceeds from a PPP Loan guaranteed by the Small Business Administration. We have also been asked whether a borrower may have made a mistake in applying for and receiving loan proceeds when the borrower may have had an alternative source of operating capital.

These questions are very appropriate. Congress acted quickly in appropriating funds to the SBA to make loans to small business through the PPP Loan Program. The SBA also acted very quickly in promulgating regulations and an application process for the program. Ordinarily, the rule-making process takes months and the process in this instance was compressed into the shortest possible time.

The regulations that were issued at the outset focused on eligibility for the PPP Loan program and little attention was focused on the issue of loan “forgiveness.” This is an important question for most borrowers because, if the loan proceeds are utilized properly the loan will be “forgiven” – which means that the borrower does not have to repay the loan. The loan becomes a grant from the U.S. taxpayer.

What if a Borrower had Access to Other Funding?

Additionally, borrowers are now asking if there was a risk in obtaining a PPP Loan if the borrower had another source of funds necessary to keep their business open.

The SBA issued guidance only late in the game with regard to the issue of the availability of other sources of liquidity and the impact on a borrower’s loan application. To the contrary, the SBA was directed in the authorizing legislation not to apply the “credit elsewhere” test. In all likelihood, the most recent release of guidance from the SBA was prompted by the loans made to large public companies which operate through local operating companies which qualified for the loan. These loans have drawn scrutiny from the press and from Congress.

Likely, if a loan was approved and funded prior to the issuance of the recent guidance from the SBA, a borrower with other sources of operating credit has limited risk that there will be a determination that the borrower was ineligible for the PPP Loan – although that risk is not non-existent. The application process required only that the borrower certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” If a borrower can legitimately make this statement at the time that the borrower applied for the loan then the borrower should be able to substantiate the economic justification for the loan.

The issue as to whether a PPP Loan was necessary is probably not going to arise unless and until a borrower seeks forgiveness of the loan. When borrowers under the PPP Loan program seek loan forgiveness after the funds have been expended, it is virtually certain that large loans will be scrutinized and carefully audited before a determination is made to forgive the loan. Also, the SBA has a history of retroactively revisiting situations where the agency expended funds resulting in large losses to the SBA – generally, by honoring a bank’s request that the SBA honor its financial obligations with respect to a defaulted loan.

Even after a loan has been forgiven it is not out of the question that the government may seek to claw back the funds made available to a borrower under the PPP Loan Program. It is to be anticipated that borrowers receiving large loans which seek loan forgiveness will almost certainly have the use of the loan proceeds carefully examined by the SBA.

What Needs to Happen for Loan Forgiveness?

If a borrower plans on seeking to have a PPP Loan forgiven the loan proceeds must be used in an amount of at least 75% of the loan for eligible payroll expenses. Remember, there is a $100,000 cap on compensation per employee and this would need to be pro-rated for the eight week forgiveness period. Up to 25% of the loan can be used for rent, mortgage interest and utility costs; but, as of this writing there is no guidance from the SBA as to what extent funds can be used. For example:

  • Can a business pay bonuses that were otherwise going to be paid (or not) but for the pandemic?
  • What about contributions to a 401(k) plan for its employees?
  • If an employer normally contributes to the plan each year, can it pay that during the eight week period so that the amount would qualify for forgiveness?
  • What if it does not but wants to contribute this year?
  • Can an applicant pre-pay rent, payroll costs or other eligible costs?

We will need to await further guidance from the SBA regarding these and other forgiveness matters.

If feasible, a borrower can ask the bank set up a separate account (if this goes on for a while there may be an additional round of stimulus funding). The borrower can transfer the entire proceeds of the PPP Loan into that account and then, when the borrower funds each payroll or other eligible cost, transfer the eligible portion of the PPP funds from that account to the borrower’s payroll or other operating accounts (keep in mind the cap per employee). If the loan proceeds are used cautiously, based upon what we know now, the loan should be forgiven which can be a huge boost to a borrower’s cash flow at the end of the year.

As of now we cannot forecast how much of a PPP Loan used for non-payroll (but otherwise “forgivable”) expenses will actually be forgiven. See the information below from the SBA:

How much of my loan will be forgiven? You will owe money when your loan is due if you use the loan amount for anything other than payroll costs, mortgage interest, rent, and utilities payments over the 8 weeks after getting the loan. Due to likely high subscription, it is anticipated that not more than 25% of the forgiven amount may be for non-payroll costs.

You will also owe money if you do not maintain your staff and payroll.

Number of Staff: Your loan forgiveness will be reduced if you decrease your full-time headcount.

 Level of Payroll: Your loan forgiveness will also be reduced if you decrease salaries and wages by more than 25% for any employee that made less than $100,000 annualized in 2019.

 Re-Hiring: You have until June 30, 2020 to restore your full-time employment and salary levels for any changes made between February 15, 2020 and April 26, 2020.

How can I request loan forgiveness? You can submit a request to the lender that is servicing the loan. The request will include documents that verify the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility obligations. You must certify that the documents are true and that you used the forgiveness amount to keep employees and make eligible mortgage interest, rent, and utility payments. The lender must make a decision on the forgiveness within 60 days.

It is important to know that while taxpayers will not have to recognize income if all or a portion of their PPP loan is forgiven, on April 30 the IRS issued Notice 2020-32 addressing the deductibility of expenses paid with forgiven PPP loan proceeds. This notice specifically states that no deduction is permitted if otherwise deductible expenses (such as payroll and rent) are paid with forgiven PPP Loan proceeds.

While there has been some discussion in Congress to change the law and permit taxpayers the double tax benefit of both the income exclusion and the corresponding deduction for the business expense, recipients of PPP loans should proceed expecting to owe Federal and State income taxes on the forgivable PPP loans. 

Should Some Companies Have Obtained PPP Loans?

As to the issue of whether a borrower with other sources of operating capital should have obtained a PPP Loan, there always is an element of risk that the SBA or the U.S. Attorney could deem that the response to the application question material and therefore an actionable misrepresentation.

However, unless a borrower received a large loan and utilized the loan proceeds for other than for payroll expenses a borrower can make the business decision to determine that the likelihood that there will be repercussions is probably a manageable risk, especially if the borrower can justify its need, notwithstanding its present financial condition.

Can the business justify its statement that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”? What does the business foresee in the next 3,6 9,12 months due to the conditions surrounding COVID and can it justify its need for the funds? If a business is truly concerned about its certification given the recent guidance issued and desires to avoid any risk, the borrower can repay the loan by May 7, 2020 without any repercussions, as some of the large public companies receiving PPP Loans did.

That said, we don’t know what we don’t know. The SBA was very late in providing any guidance with regard to these issues. We expect that we will have more guidance in the coming weeks and months.

Real estate and commercial lending attorney Arnie Spevack helps real estate developers and property owners, lenders, businesses, and individuals negotiate and close deals and resolve real estate disputes throughout the greater Washington, DC area. For more on PPP loans, contact him at 301-657-0749 or [email protected].