On April 2, 2020, the Small Business Administration (SBA) issued an unusual interim final rule (the Rule) providing further detail regarding Paycheck Protection Program loans (PPP Loans) authorized under the CARES Act. The Rule will take effect immediately upon publication in the Federal Register. However, SBA may revise the Rule based on public comments submitted within 30 days after publication. SBA relied on Section 1114 of the CARES Act to issue the Rule without following the usual notice-and-comment procedure.
Much of the Rule covers old ground, adding some explanatory language around eligibility provisions, methods of calculating loan amounts and similar issues. Manatt will address these provisions in a separate alert and focus here on aspects of the Rule important to lenders and brokers of PPP Loans.
Another Change to the Interest Rate, Without Essential Details
The interest rate on PPP Loans continues to be a moving target. The CARES Act calls for an interest rate “not to exceed 4 percent,” but Treasury on March 31 issued an information sheet setting the rate at 0.5%. The Rule changes the rate again, to 1%, without specifying important details such as interest accrual method and amortization. Lenders will be reluctant to make loans without these details. Furthermore, the 1% rate will deter many lenders from risking their limited capital and will effectively eliminate their ability to make more loans by selling loans into secondary private markets. We understand that many participating banks already have decided to limit their lending to current customers due to the economics.
Rules for New Lenders Will Limit Participation
The Rule explains who can make PPP Loans. The good news is that federally insured depository institutions and credit unions not currently approved to make SBA loans are basically preapproved to participate, together with “any Farm Credit System institution that applies the requirements of the Bank Secrecy Act (“BSA”) or functionally equivalent requirements.” (This assumes no pending formal enforcement action or Troubled Condition designation from their primary federal regulator.) These institutions need only file a CARES Act Section 1102 Lender Agreement (SBA Form 3506), which is a new form not yet released as of this writing.
The bad news is that many nonbank lenders, including fintechs, appear to be excluded as a practical matter. The Rule provides that “any depository or non-depository financing provider” will be approved if it:
- “originates, maintains and services business loans or other commercial financial receivables and participation interests”,
- “applies the requirements under the BSA as a federally regulated financial institution, or the BSA requirements of an equivalent federally regulated financial institution”, and
- “has been operating since at least February 15, 2019 and has originated, maintained and serviced more than $50 million in business loans or other commercial financial receivables during a consecutive 12 month period in the past 36 months, or is a service provider to any insured depository institution that has a contract to support such institution’s lending activities in accordance with 12 U.S.C. § 1867(c) and is in good standing with the appropriate Federal banking agency.”
Some prospective participants, including nonbank lenders and fintechs, may not qualify as financial institutions subject to the BSA’s strict compliance regime. If they don’t already have appropriate BSA/AML compliance procedures in place, they may have to implement them to satisfy the second requirement described above. In any case, careful analysis of the lender’s business platform must be undertaken to determine whether an adequate BSA/AML compliance program is in place to mitigate the risk of regulatory action.
Most Lenders Unable to Obtain PPP Loans Themselves
Existing SBA rules prohibit certain financial services firms from obtaining SBA loans. It was not clear whether the CARES Act superseded these restrictions, but the Rule resolves that ambiguity by providing that it does not. Importantly, the SBA affirmed that the exclusions from obtaining an SBA-guaranteed loan for banks, finance companies, investment companies, factoring companies and “companies whose stock in trade is money” apply to PPP Loans, and therefore certain businesses may not qualify. This would seem to encompass many marketplace lenders, merchant cash advance firms and other alternative lenders, many of whom are startup companies in need of help. There are limited exceptions, however. For example, mortgage servicing companies and mortgage companies that sell their loans within 14 calendar days of loan closing are eligible. We can assist small financial services firms in determining whether they are eligible to apply for a PPP Loan.
Underwriting and Documentation
The Rule sets out a streamlined underwriting procedure for PPP lenders. Underwriting requirements are limited to (i) confirming receipt of the borrower certifications in the loan application form issued by Treasury, (ii) confirming receipt of information demonstrating that a borrower had employees for whom the borrower paid salaries and payroll taxes on or around February 15, 2020, (iii) confirming the dollar amount of average monthly payroll costs for the preceding calendar year by reviewing the payroll documentation submitted with the borrower’s application, and (iv) following applicable BSA compliance procedures.
The Rule does not address the form of loan documentation, and no standard forms such as loan agreements have been released as of this writing. We view this as a major impediment to the commencement of lending, as lenders will be reluctant to use unapproved forms, and the absence of approved standardized forms will impair whatever private secondary market activity might be feasible given the economics of PPP Loans.
Reliance on Borrower Documentation and Certifications
The Rule reiterates that lenders may rely on borrower certifications and documentation. Lenders need not conduct any verification if the borrower submits documentation supporting its request for loan forgiveness and attests that it has accurately verified the payments for eligible costs. The Rule states that the administrator will hold harmless any lender that relies on such borrower documents and attestation from a borrower.
Agents Assisting Borrowers
The Rule states that agent fees must be paid by the lender out of fees the lender receives from the SBA. Agents (which includes brokers) may not collect fees from the borrower or be paid out of loan proceeds. The total amount that an agent may collect for assistance in preparing an application for a PPP loan (including referral to the lender) may not exceed: (i) 1% for loans of not more than $350,000, (ii) 0.5% for loans more than $350,000 and less than $2 million, and (iii) 0.25% for loans of at least $2 million.
Secondary Market Sales
The Rule indicates that SBA will issue guidance regarding any advance purchase for loans sold in the secondary market.
SBA Purchase of PPP Loans
The Rule states that a lender may request that the SBA purchase the expected forgiveness amount of a PPP Loan or pool of PPP Loans seven weeks after the loan is made. In order to submit a loan or pool of loans for advance purchase, a lender is required to submit a report to the SBA requesting advance purchase with the expected forgiveness amount. The report must include the Paycheck Protection Program Application Form (SBA Form 2483; revised and now “final”) and any supporting documentation submitted with such application; the Paycheck Protection Program Lender’s Application for 7(a) Loan Guaranty (SBA Form 2484) and any supporting documentation; a detailed narrative explaining the assumptions used in determining the expected forgiveness amount, the basis for those assumptions, alternative assumptions considered and why alternative assumptions were not used; any information obtained from the borrower since the loan was disbursed that the lender used to determine the expected forgiveness amount, which should include the same documentation required to apply for loan forgiveness, such as payroll filings, canceled checks and other payment documentation; and any additional information the administrator may require to determine whether the expected forgiveness amount is reasonable. The Rule states that the administrator is required to purchase the expected forgiveness amount of the PPP Loan or pool of loans within 15 days of the date on which the administrator receives a complete report that “demonstrates that the expected forgiveness amount is indeed reasonable.”
This is a surprising list of required support for forgiveness. It is unclear what the lender is to do in order to support the detailed narrative that is required or what assumptions a lender should or should not use in determining the expected forgiveness amount. Furthermore, it is particularly uncertain how a lender can be sure that the report it submits will demonstrate that the expected forgiveness amount is “indeed reasonable.” Finally, there is no discussion of what happens if the administrator determines that the forgiveness amount is not reasonable and how that relates to the provisions of the CARES Act and the Rule that hold harmless any lender that relies on borrower documents and attestations. For the next two years, until the SBA guarantee kicks in, lenders may be left to collect “stub loans” at 1% interest from borrowers with whom they have little customer relationship.
Current SBA rules regarding when companies are deemed to be affiliates of each other (and therefore whether or not the companies can count their employees separately for purposes of PPP eligibility) are having a significant impact on companies with venture capital or private equity financing. If a borrower has an affiliate, the number of employees used for counting whether it qualifies for a loan must include the affiliate’s employees, and all the employees of companies of which the affiliate is an affiliate. Affiliate status is presumed for any owner of 50% of the voting stock. Affiliation can be found for lower levels of ownership based on a facts and circumstances analysis including whether an investor has restrictive covenants/negative control voting power, the relative voting power compared with other investors, and other factors. The PPP Loan form requires disclosure of any 20% owners.
The terms of the investments made by venture capital or private equity funds can lead to a finding that each portfolio company of the fund is an affiliate of the others. This is a particularly acute issue for startup companies in the tech industry. For example, a large investor would be affiliated with a portfolio company, and all affiliate portfolio companies would serve to knock each other out of the program, despite the fact that many portfolio companies are otherwise deserving small businesses. House Speaker Nancy Pelosi and Rep. Ro Khanna have written to Treasury Secretary Steven Mnuchin and SBA Administrator Jovita Carranza asking for relief from the SBA affiliation rules for startups. Significantly, the Rule confirms that the SBA plans to promptly issue additional guidance regarding the affiliation rules, and we are aware of other bipartisan momentum to plug this gap.
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The Rule provides welcome additional guidance regarding the Paycheck Protection Program, but there remain numerous issues that seem likely to prevent the $349 billion in aid from reaching small businesses anytime soon. We will continue to monitor developments and provide updates. If you have questions, please contact:
- Neil S. Faden, Partner, Corporate and Finance, at email@example.com or 212.830.7181.
- Richard S. Hartunian, Partner, Investigations and White Collar Defense, at firstname.lastname@example.org or 212.790.4520.
- Brian S. Korn, Partner, Manatt Financial Services, at email@example.com or 212.790.4510.
- Craig D. Miller, Partner, Manatt Financial Services, at firstname.lastname@example.org or 415.291.7415.
- Scott M. Pearson, Partner, Manatt Financial Services, at email@example.com or 310.312.4283.
- William T. Quicksilver, Partner, Corporate and Finance, at firstname.lastname@example.org or 310.312.4210.
- Charles E. Washburn, Jr., Partner, Manatt Financial Services, at email@example.com or 310.312.4372.
- Jonathan H. Lemberg, Counsel, Venture Capital / Emerging Companies, at firstname.lastname@example.org or 415.291.7402.
- John A. Kimble, Associate, Manatt Financial Services, at email@example.com or 310.312.4251.
- Veronica Lah, Associate, Corporate and Finance, at firstname.lastname@example.org or 310.312.4130.