(updated May 8)
Much of the work for the loan is done. You made the easy decision to apply for the loan because you qualified and it is free money – an opportunity seemingly too good to believe and certainly too good to refuse. It is for many an opportunity to retain your employees at a time when your business might not otherwise be able to. For some, now it is time to make the tough decision; should I keep the loan?
The first article in this two part series focused on next steps after you obtained funding. With the guidance on who is eligible to accept the loan evolving, in this article we focus on new guidance to consider when deciding whether you should keep the loan.
Justifying the Loan
The loan terms you or your agent certified include the statement “Current economic uncertainty makes this loan request necessary to support ongoing operations.” Businesses obtaining over $2 million in loan proceeds should expect to have to explain how this criterion applies to their situation, following an announcement to that effect by Treasury Secretary Mnuchin. Smaller loan recipients should also be able to demonstrate how this subjective criterion applies if asked.
We know that “necessary” for meeting this criterion does not mean that a loan could not be obtained elsewhere. The law specifically removes the regular SBA standard requiring a lack of access to capital from other sources.
Must the business have already lost sales and liquidity to justify keeping the loan? One can make the argument that while there is no current liquidity issue, the aftermath of COVID-19 will damage the business at a later time and the loan is needed now because it will not be available later.
This good faith subjective criterion does not currently have anything close to a bright line definition. What we know is there must be need and documenting this need is strongly recommended.
The law was originally written with gaps as can happen when the enactment of a law is rushed. In this case it was rushed for the good reason of making funds available as soon as possible. To fill some of the gaps in this unclear part of the CARES Act, we have seen subsequent guidance, including frequently asked questions authored by the Small Business Administration.
What Shake Shack, Ruth’s Chris and the Los Angeles Lakers Have in Common
Following the letter of the law, many large and sometimes well financially positioned companies were legally applying for and receiving PPP loan funds. Since the program began we’ve heard from members of Congress, the Treasury Secretary and the SBA informing us that many loan recipients were violating the intent of the law by accepting funds.
We can reasonably surmise that the Lakers have been adversely affected financially by COVID-19, with the NBA season currently on hiatus and possibly prematurely over. However, Treasury Secretary Mnuchin specifically pointed to the Lakers and their $4.6 million PPP loan as an example of a company that the program was never intended for nor deserving of PPP funds. The Lakers along with Shake Shack, Ruth’s Chris and many other companies have returned their loans to make the funds available to other businesses.
The SBA addressed this issue in its published frequently asked questions, which includes the following:
Question 31: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?
Answer 31: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.
Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 14, 2020 (extended from May 7, the deadline date in this article when it was originally posted), will be deemed by SBA to have made the required certification in good faith.
Tax Benefits for Returning the Funds
The employee retention credit is not available to an otherwise eligible employer who keeps funds from the Payroll Protection Program. Sole proprietors without employees are not eligible for the employer retention credit, however, for the first time they can claim unemployment compensation based on the net profit from their business. But they can’t claim it on the same income used to generate a Payroll Protection Program loan.
The employee retention credit and unemployment compensation normally will not provide as much funds in the end as will a PPP loan that is forgiven. But eligibility is much more clear for the employee retention credit and unemployment compensation.
To Keep or Not to Keep?
The decision to return the funds was fairly easy for some bigger companies with much of the new guidance pointed at them. Combine that with the company’s name in the media garnering negative publicity that would have only gotten worse had they kept the funds, the decision to give it back was practically made for them.
But what about the little guy not in the spotlight who doesn’t now need the funds? Although the SBA’s question 31 recited above asks about the large companies, its answer applies to all companies. We are very close to May 14, 2020, and this question must be seriously considered now. Both civil and criminal penalties can be imposed in certain situations when funds are kept that should not have been. However, it is not clear what those situations are.
If your situation is one that does not see your company currently hurting and you don’t foresee a later COVID-19 related slide, you should consider consulting an attorney specializing in related matters as soon as possible to learn the company’s true exposure before making what may be a difficult decision.
Contact SDK’s Steven E. Warren, CPA, MBT, with any questions.