Paycheck Protection Program: Bumpy start, updated rules

April 7, 2020

The Coronavirus Aid, Relief, and Economic Security Act’s Paycheck Protection Program (PPP) got off to a turbulent start last week. The program relies heavily on private lenders to supply Small Business Administration (SBA)-backed loans to smaller businesses struggling due to the economic impact of the coronavirus. However, lenders were having their own problems handling the crush of applicants, and some were apparently requiring applicants to complete the lender’s own loan forms. Then overnight at week’s end, the SBA tossed into the stew an updated employer affiliation rule – designed to determine whether an employer is disqualified from applying for a program loan due to affiliation with other employers – and an updated application form, SBA Form 2483 (opens a new window).

As we begin the first full week of the PPP loan program, let’s take stock of where the program sits today, who may apply, what the loans may be used for, and when they may be forgiven.


The PPP offers nearly $350 billion in SBA-guaranteed, and often entirely forgivable, loans of up to $10 million each to small businesses to help keep them afloat during the current economic downturn.

Lockton comment: Although many applicants won’t qualify for the full $10 million, the $349 billion earmarked for loans will be disbursed on a first-come, first-served basis, and each applicant may apply only once, so the SBA encourages applicants to apply for what they believe is their maximum permissible loan amount.

The first-come, first-served warning is well taken. If every applicant received the full $10 million, the loan pool would be limited to 34,900 businesses. According to SBA data there are 30.2 million small businesses in the U.S.

Eligible businesses

Eligible businesses include for-profit as well as nonprofit businesses, veterans’ organizations and tribal businesses (nonprofit, tax-exempt businesses have typically not been eligible for SBA business loans).

Sole proprietorships, independent contractors and other self-employed individuals may also apply.

The businesses must have been in operation prior to Feb. 15, 2020, and, generally, cannot have more than 500 employees (including part-time employees) whose principal place of residence is in the U.S.

On the upside, there are exceptions to the size standard (opens a new window), allowing some larger businesses to apply, based on the size of their receipts relative to others in their industry. On the downside, there are newly updated “affiliation” rules (opens a new window) that require some, but not all, applicants to aggregate their employee counts with others, potentially disqualifying the applicant based on size. Those affiliation rules are broader and more subjective than the IRS’s controlled group rules. See the “Affiliation appendix” at the end of this alert for more detail on that analysis.

Lockton comment: Some entities get a free pass under the PPP loan program’s 500-or-fewer employee rule or the affiliation rules, or both. For example:

1. For any business assigned a North American Industry Classification System code beginning with 72 (opens a new window) (generally, hotels, motels and food service businesses, such as restaurants, caterers, taverns etc.), even if the company has more than 500 employees, it can request a loan if it employs no more than 500 at any given physical location. In the event a business in this classification has 500 or fewer employees, but another entity in its corporate family tree would normally be aggregated with it when counting employees, the business does not apply the affiliation rules (for example, a pair of separately incorporated brother-sister hotel properties, each with 500 or fewer employees but together more than 500).
2. A franchise assigned a franchise identifier code by the SBA can ignore the affiliation rules, as can any business that receives financial assistance from a small business investment company licensed under section 301 of the Small Business Investment Act of 1958.
3. Religious organizations do not receive a complete waiver under the affiliation rule, but the relationship of one faith-based organization to another is not considered an affiliation if the relationship is based on a religious teaching or belief or otherwise constitutes a part of the exercise of religion. This waiver will allow many smaller churches to potentially qualify for loans even though they are part of a larger convention or association of churches.

Amount of a PPP loan

Loans are intended to help the applicant retain employees and maintain operations through at least June, and so are generally based on a look-back calculation of the applicant’s average monthly payroll costs over a given period. For all but the newest businesses, the look-back period is the 2019 calendar year.

Lockton comment: If the applicant is a seasonal employer, it can use the period Feb. 15 (or, at its election, March 1) to June 30, 2019. If the applicant is new and was not in business during that latter window, it uses its average monthly payroll costs over the first two months of this year.

The loan is limited to 250% of the average monthly payroll costs over the look-back period, plus the amount of any SBA disaster loan the applicant received between Jan. 31 and April 3 of this year (but not the cash advance portion of the disaster loan, because the cash advance does not need to be repaid). The payroll costs considered include:

  • Salary, wages, commissions or similar compensation, including payment of cash tips and their equivalent, and including paid vacation, and parental, family, medical or sick leave, and severance pay.

  • Group health insurance premium payments and retirement plan contributions.

  • Payment of state or local tax assessed on the compensation of employees.

Lockton comment: The applicant must not include in its payroll cost calculation payroll costs for any one individual to the extent they exceed $100,000 in annual salary. Also excluded are FICA taxes imposed on the employer. Compensation paid to an employee whose principal place of residence is outside of the U.S. is also disregarded.

For example, assume the employer:

  • Took an SBA disaster loan of $30,000 on Feb. 15, and the loan included a $10,000 cash advance that does not need to be repaid.

  • Had annual payroll in 2019 of $1,500,000, including a total of $300,000 in compensation paid above $100,000 in compensation paid to several individuals with annual salaries in excess of $100,000.

The employer subtracts the $300,000 in compensation amounts for annual salaries in excess of $100,000, resulting in a net annual payroll in 2019 of $1,200,000. The average monthly payroll in 2019 was $100,000. Multiply this amount by 2.5, yielding a potential loan amount of $250,000. Add the $20,000 SBA disaster loan amount, net of the cash advance, for a total loan amount of $270,000.

The loan amounts are capped at $10 million. The lender is not allowed to demand a personal guarantee from the borrower or require collateral.

The interest rate for PPP loans is one percent.

The PPP loan may be used to pay for more than payroll costs

Although the main purpose of the PPP loan is to preserve wages for employees (thus, as we’ll see in a moment, loan forgiveness is compromised unless the vast majority of the loan proceeds are used to meet payroll costs), the loans may be used for more than just payroll costs. They may also be used to pay:

  • Payments of interest on any mortgage obligation (but not prepayment of or payment of principal on a mortgage obligation).

  • Costs related to the continuation of group healthcare benefits during periods of paid sick, medical, or family leave, and insurance premiums.

  • Rent (including rent under a lease agreement).

  • Utilities.

  • Interest on any other debt obligations that were incurred before Feb. 15, 2020.

  • Equipment and fixtures, working capital, inventory, and seasonal line of credit or refinancing debt, including an SBA disaster loan (if an SBA disaster loan was used to pay payroll costs, the PPP loan must be used to refinance that loan).

Free money: Loans are forgivable if used mostly for payroll, to retain employees and maintain wages

If PPP loan proceeds are adequately applied for their intended purpose, and employee and compensation levels are maintained, the loans effectively become grants. That is, the entire loan balance and accrued interest is forgiven.

To obtain maximum loan forgiveness, no more than 25% of the loan proceeds may be applied to mortgage, rent and utility payments over that eight-week period, under mortgages, leases and utility service agreements made prior to Feb. 15, 2020. The remaining 75% of the loan proceeds must be applied to payroll over the eight weeks following the loan. If more than 25% of the loan proceeds are used for purposes other than payroll, the total amount of loan forgiveness will be reduced.

Lockton comment: Any nonrepayable cash advance (up to $10,000) on an SBA disaster loan will be deducted from the loan forgiveness amount.

The loan forgiveness amount is subject to additional reductions depending on the extent to which the borrower reduced the number of its employees or their wages over a prior time period similar in length to the period for which the loan is intended to assist the borrower. The order in which these reductions occur is not clear. SBA is expected to issue additional guidance on that point, well before June 30.

To determine the size of the reduction due to employee furloughs and layoffs, multiply the maximum loan forgiveness amount by a quotient obtained by dividing:

1. The average number of full-time equivalent employees per month employed during the eight-week period commencing on the date of the loan by,
2. Either (a) the borrower’s average number of full-time equivalent employees per month for the period Feb. 15, 2019, through June 30, 2019, or (b) the average number of full-time equivalent employees per month employed from Jan. 1 through Feb. 28, 2020. The borrower may choose between (a) and (b), but seasonal employers must use (a).

Lockton comment: The average number of full-time equivalent employees is determined by calculating the average number of full-time equivalent employees for each pay period falling within a month. The CARES Act statute refers to full-time equivalent employees but does not define the term. Presumably it is intended to include actual full-time employees and fictional full-time employees comprised of part-time hours. Additional clarification from SBA on this point will be helpful.

The loan forgiveness amount is then further reduced dollar for dollar by the amount of any reduction in total salary or wages of any employee, from Feb. 15 to June 30, 2020, to the extent the reduction exceeds 25% of the total salary or wages paid to the employee for the most recent full quarter during which the employee was employed prior to Feb. 15, 2020.

Lockton comment: Thus, the loan forgiveness calculation allows leeway for some reduction in salary or wages for employees, without reducing the forgiveness amount.

Note that we’re only concerned here with reductions in salary or wages for employees who were paid less than $100,000 in annualized wages for all their pay periods in 2019.

The final step in the loan forgiveness amount calculation is to determine whether, by June 30, 2020, the borrower mitigated reductions in full-time equivalent employees or their salary or wages that caused a reduction in the forgiveness amount. If the number of full-time equivalent employees or their salary or wages were reduced between Feb. 15 and April 26, 2020, but by June 30, 2020, the employer has eliminated those reductions, the reductions do not trigger a reduction in the loan forgiveness amount.

Borrowers can request loan forgiveness after June 30, 2020. The SBA requires the request be accompanied by documentation reflecting the number of full-time employees and pay rates for relevant periods, as well as the payment of eligible mortgage, lease and utility obligations.

Decisions on the forgiveness amount must be made within 60 days. The amount of principal that is forgiven is not included in the borrower’s gross income for tax purposes.

The unforgiven: Repaying the PPP loan’s balance due

Any balance of a PPP loan that is not forgiven must be repaid over a two-year period with interest at a fixed rate of 1% per year. Repayment does not need to commence for a six-month deferment period.


For those employers lucky enough to successfully run the gauntlet of the PPP loan process before the available funds are exhausted, the program will serve as a lifeline to help keep their business afloat through the late spring. Employers will want to stay tuned for yet more help from Congress, as there is already talk of a second $2 trillion relief package in the offing.



Affiliation appendix

See the SBA affiliation guidance here (opens a new window).

The PPP is designed to rescue smaller businesses. The SBA’s affiliation rules are designed to prevent larger businesses from attempting to apply for loans simply because their operations are divided among multiple, smaller subsidiaries or other entities controlled by another.

Where two or more businesses are considered affiliated under these rules, their employee counts must be aggregated for purposes of determining whether the businesses are small enough to apply for a PPP loan.

Generally, businesses are affiliates of each other when one controls or merely has the authority to control the other, or a third party controls, or has the authority to control, both. Entities meeting any of the four tests below are considered affiliated for PPP purposes.

1. Ownership. The entity owns or has the power to control more than 50% of the other entity’s voting stock. But in addition, the SBA will deem a minority shareholder to be in control of an entity if that shareholder has the authority to prevent a quorum or otherwise block action by the entity’s board of directors or other shareholders.

2. Affiliation due to stock options, convertible securities and agreements to merge. Stock options, convertible securities and agreements to merge (including agreements in principle) are deemed to have a present effect on the power to control a business. However, mere agreements to open or continue negotiations towards the possibility of a merger or a sale of stock at some later date are ignored in an affiliation analysis. The SBA guidance provides additional detail regarding stock options, convertible securities and merger agreements.

3. Affiliation based on management. Where the chief executive or president, or other officers, managing members or partners who control an applicant’s management, also control the management of one or more other entities, the applicant and those other entities are considered affiliates.

Affiliation also exists where a single individual or entity that controls the board of directors or management of one business also controls the board of directors or management of one or more other businesses, even if only via a management agreement.

4. Affiliation based on identity of interest. Affiliation arises when there is an identity of interest between close relatives (spouse, parent, child or sibling, or the spouse of any such person) with identical or substantially identical business or economic interests, for example, where the close relatives operate businesses in the same or similar industry in the same geographic area.


Not legal advice: Nothing in this Alert should be construed as legal advice. Lockton may not be considered your legal counsel, and communications with Lockton's Compliance Services are not privileged under the attorney-client privilege.

Paycheck Protection Program: Bumpy start, updated rulesView alert (opens a new window)