On May 15, 2020, the Small Business Administration (SBA), in consultation with the Department of the Treasury, released the Paycheck Protection Program (PPP) Loan Forgiveness Application accompanied by detailed instructions. The newly released application and instructions provide key definitions and calculation instructions that clarify some of the most frequently asked questions about how borrowers can obtain full loan forgiveness.

The PPP, created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, provides low-interest, forgivable loans to small businesses affected by the COVID-19 pandemic. The PPP’s popularity stems from the fact that the full amount of the principal is forgivable provided the borrower maintains the average number of full-time equivalent employees (FTE) and full wages paid to each employee. If a borrower does not maintain its average number of FTEs or the wages of any employee, the forgivable amount is reduced.

Employers that were able to obtain PPP loans have been grappling with a host of questions about how to comply with the loan’s complicated provisions and the uncertainty about how the loan forgiveness provisions would be implemented. This situation has been exacerbated by limited and frequently changing Interim Final Rules and FAQs issued by the SBA.

The PPP Loan

PPP loans are intended to assist small businesses with retaining employees during the COVID-19 emergency. Loan proceeds can be used only for specified purposes: payroll costs, rent, mortgage interest (not including any prepayment or payment of principal), utilities and interest payments on debts incurred before February 15, 2020, and refinancing an SBA Economic Injury Disaster Loan made between January 31, 2020 and April 3, 2020. Payroll costs consist of compensation to employees, including salary, wages, commissions or similar compensation; cash tips or the equivalent; payment for leave; allowance for separation or dismissal; payment for employee benefits including group health care coverage and insurance premiums; retirement contributions; and payment of state and local taxes assessed on the compensation of employees. 

Forgivable expenses are narrower than permitted expenses and include only payroll costs, mortgage interest (not including prepayment or payment of principal) on a mortgage that is a liability of the borrower incurred in the ordinary course of business before February 15, 2020, payments of rent on a lease in force before February 15, 2020, and utility payments for services that began before February 15, 2020.

The first iteration of guidance from the SBA suggested that borrowers would be required to spend at least 75% of loan proceeds on payroll costs as a threshold condition to obtain any amount of forgiveness. Subsequent guidance and the forgiveness application indicate that this will not be the case. Instead, not more than 25% of any amount forgiven may be attributable to non-payroll costs.

The CARES Act specifies that the amount that can be forgiven must be for costs “paid and incurred” during the eight-week period beginning with the date loan funds are disbursed (Covered Period). The forgiveness application appears to change this rule as it instructs the borrower to include cash compensation paid or incurred during the Covered Period. Therefore, although the statutory provisions appear to prohibit forgiveness of any payment incurred before the Covered Period, such as retroactive pay or accrued vacation, the loan application indicates that such amounts are eligible for forgiveness. Similarly, the forgiveness application appears to permit prepayment of compensation, which may allow borrowers additional flexibility in using loan proceeds.  The forgiveness application also allows borrows to choose an Alternative Payroll Covered Period, beginning on the first day of the first pay period following the date disbursement of loan funds.

Calculating Loan Forgiveness

The PPP loan is potentially forgivable up to the entire principal balance. The amount of forgiveness will be reduced in two ways. If the borrower’s average FTEs per month during the Covered Period is reduced relative to the average FTEs per month during either February 15, 2019 to June 30, 2019 or January 1, 2020 to February 29, 2020 (at the borrower’s election), then loan forgiveness is reduced proportionally. Forgiveness will also be reduced to the extent the total salary or wages (of any employee who made less than an annual rate of $100,000 for all pay periods in 2019) is reduced greater than 25% during the Covered Period. This reduction is measured relative to the total salary or wages of the employee during the most recent full quarter during which the employee was employed prior to the Covered Period. Prior to the issuance of the forgiveness application and instructions, no guidance explained how FTEs should be calculated, how total salary or wages should be calculated, or how the most recent full quarter would be defined.

The loan application explains the calculation of FTEs. Each employee’s average weekly hours paid is divided by 40 and rounded to the nearest tenth. The maximum value for each employee is capped at 1.0. This method is contrary to the usual method of calculating FTEs in which the aggregate hours worked by all employees per week are divided by either 30 or 40 to obtain the total number of FTEs. As a result, the 1.0 FTE cap presents a new limitation in that any hours worked or paid over 40 in a week for any employee will not be counted. The application also permits borrowers to use a simplified calculation whereby each employee who works 40 or more hours per week is counted as 1 FTE and each employee who works less than 40 hours per week is counted as .5 FTE. Finally, this instruction clarifies that an FTE is calculated based upon hours paid rather than hours worked. This method is consistent with the purpose of the PPP—keeping workers paid and employed regardless of business closures resulting from stay-at-home orders.

The loan application also explains how a reduction in loan forgiveness due to a reduction to an employee’s salary or wages will be calculated. Because the Covered Period is eight weeks and a quarter is 12 weeks, this reduction provision caused much consternation for employers that discerned that the total wages during the Covered Period would immediately be 33% less than in the prior quarter, even if the employee made the same amount each week during both time periods. The forgiveness application clarifies that “total wages” means average weekly wages.

Borrowers also questioned the meaning of “most recent full quarter during which the employee was employed” prior to the Covered Period. This language suggested that an employer might have to consider the fourth quarter of 2019, for any employee who was not employed for the duration of the first quarter of 2020, such as employees who took vacation or leaves of absence. Alternatively, the most recent full quarter could simply apply to the 12-week period counting backwards from the start of the Covered Period. The loan application clarifies that the most recent full quarter means January 1, 2020 through March 31, 2020, but does not address how employers should calculate average wages for employees who were on leave or otherwise not employed for the full quarter.

Borrowers concerned about the impact of voluntary or for-cause terminations on FTEs can breathe a sigh of relief as well. The issue of inability to recall previously laid-off employees was addressed in guidance issued on May 13, 2020. An employer that makes a good-faith written offer to rehire a previously laid-off employee and documents the employee’s refusal of such an offer will not see a reduction to forgiveness based on a resulting reduction to FTEs. The loan application adds additional exceptions for employees fired for cause, those who voluntarily resign and those who voluntarily request and receive a reduction of their hours.

Safe Harbor Based on Restoring FTEs and Wages

The PPP provisions of the CARES Act include “second chance” language, deemed Safe Harbor provisions in the forgiveness application. Borrowers that experienced reductions in average FTE levels or wages between February 15, 2020 and April 26, 2020 must eliminate such reductions by June 30, 2020 to avoid reductions to loan forgiveness. The CARES Act language describes FTEs on an average basis during both the Covered Period and the reference period (the period chosen by the borrower for comparison of FTE levels). The CARES Act provisions also describe wages as “total wages.”  This language suggests that the elimination of FTE or wage reductions over the course of the Covered Period could not mathematically take place in a single day. As a result, it would make sense that the process of eliminating any reduction in these average amounts would have to begin well before June 30, 2020.

The application instructions, however, demonstrate that a borrower need only make the restoration as of June 30, 2020. It is unclear whether an employer that experienced reductions in FTEs could simply re-hire employees with schedules sufficient to match earlier FTE levels, or if such an employer would need to re-hire employees far enough in advance of June 30, 2020 to calculate employees’ average weekly hours paid—perhaps one week or one pay period. Similarly, an employer that reduced wages more than 25% during the Covered Period relative to the first quarter of 2020 can raise wages as of June 30, 2020 in order to avoid a reduction to forgiveness.

Further Guidance Expected

Borrowers should note that the SBA has been issuing guidance in the form of FAQs on an ongoing basis and is expected to issue an interim final rule on loan forgiveness in the near future. It is imperative to follow these updates as the PPP program guidance remains fluid.