Avoiding (Additional) PPP Headaches – Considerations When Addressing PPP Loans Under Existing Loan Documents
While very attractive capital, the Paycheck Protection Program (PPP) loan program established pursuant to the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and its roll-out have caused headaches to program participants, from the scramble to submit and process applications before the funds dry up, to overwhelming demand for Phase 2 funds crashing the SBA’s platform, and to borrowers attempting to navigate the nuances of forgiveness without clarity on certain aspects of the rules. Notwithstanding any headaches, PPP loans provide borrowers support and liquidity to help weather the continuing COVID-19 pandemic and resulting economic downturn (unsecured, Small Business Administration (SBA) guaranteed loans on below-market terms may be eligible for forgiveness). While banks and other lenders have been generally supportive of their borrowers incurring PPP loans, lenders and borrowers should conduct a comprehensive review of the possible impact which consenting to a PPP loan may have in order to avoid additional headaches and “foot-fault” events of default.
This article outlines key considerations for both borrowers and lenders when documenting consents to a borrower’s incurrence of a PPP loan under existing loan documents.
Features of PPP Loans
PPP loans carry economic terms attractive to many borrowers, as well as restrictions on the use of proceeds and narrower requirements for loan forgiveness. Below are certain key terms and features which are relevant to existing lenders:
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Documented on SBA forms or SBA lender forms
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Two-year maturity
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1% interest
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Deferral of principal and interest payments for six months
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No origination fees payable by borrower
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Unsecured
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100% guaranteed by the SBA
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No required guarantors (other than the SBA)
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Use of proceeds must comply with the CARES Act and applicable SBA guidance, 1 including that 75% of the funds be used for “payroll costs” which are defined in the CARES Act and related SBA guidance 2
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Eligible for forgiveness up to 100% of the outstanding principal and accrued interest as long as (i) the proceeds are used for certain eligible purposes (which are more restrictive than the permitted use of proceeds) 3 within the eight-week period following the PPP loan’s funding and (ii) the borrower maintains existing employee count and payroll costs during such period.
Considerations under existing Loan Documents
Below is a summary of issues lenders and borrowers should consider when documenting consents to PPP loans under existing loan documents.
Negative Covenants. Lenders should review the negative covenant provisions under the existing credit documents and ensure (where appropriate) that the credit documents allow borrowers to incur additional debt under the PPP loan program.
Mandatory Prepayments. As PPP loans are not permitted to be applied to repay principal on mortgage loans or other indebtedness, to the extent that existing loan documents require the borrower to prepay certain existing debt with the proceeds (or a portion of the proceeds) of any new debt issuance (or, in many cases, debt not expressly permitted by the debt covenant in the loan agreement), such provisions should be carefully reviewed and expressly waived in connection with the PPP loan.
Impact on Financial Covenants and Ratios. Both lenders and borrowers should discuss and address the anticipated impact of PPP loans and any subsequent loan forgiveness on financial covenants and ratios (which may impact pricing and covenant basket availability) included in existing loan documents. While the CARES Act expressly excludes forgiveness of indebtedness in connection with PPP loans from taxable income, it is expected that PPP loan forgiveness will constitute income under GAAP. Accordingly, lenders and borrowers should consider not only excluding PPP loans eligible for forgiveness from debt for leverage ratio purposes (or adjusting covenant and ratio levels to address the impact), but also excluding any associated income in connection with loan forgiveness from EBITDA definitions (or adjusting covenant and ratio levels for any expected impact). It is also possible that for purposes of certain covenants, such as tangible net worth, a PPP loan will need to be treated differently if it is forgiven (by, for example, excluding amounts forgiven from tangible net worth).
Cash Management. Credit agreements often include two categories of cash management provisions: (i) requirements that deposit accounts be maintained with the lender or be subject to a deposit account control agreement, and (ii) requirements that collections or proceeds in deposit accounts be swept to an account maintained with the lender and, in some instances, used to pay outstanding borrowings. If this structure is in place, it could result in PPP loan proceeds being “swept” to the lender (intentionally or inadvertently) and applied to satisfy principal or other amounts on the existing indebtedness in violation of the CARES Act and applicable SBA guidance (except to the extent of payments of interest in certain instances). Additionally, it is advisable in most instances (and certain PPP lenders are requiring) that PPP loan proceeds be funded into a segregated deposit account to track the use of proceeds in accordance with the CARES Act. Any requirement to sweep any accounts receiving PPP loan proceeds or to obtain account control agreements over such accounts should be waived, but lenders should consider requiring that any such accounts be used only to receive and disburse PPP loan proceeds, cap the amount which may be on deposit in such accounts at any time, and require that the borrower close the account or cause it to be made subject to an account control agreement once the PPP loan has been repaid or forgiven.
Existing Subordination and Intercreditor Arrangements. Where a borrower’s capital structure also includes third party debt, corresponding covenant waivers may be needed from the third-party debt holders. In addition, senior lenders who also provide PPP loans to their borrowers should review subordination and intercreditor agreements to ensure that the PPP debt does not count towards any cap on the amount of senior debt under the applicable subordination agreement or intercreditor agreement.
Guarantor Acknowledgements. Whenever modifying loan documents, it is always a best practice to have guarantors and other third-party pledgors acknowledge the amendment or waiver and reaffirm their guaranty or pledge in light of the amendment or waiver.
Ancillary Loan Documents. Where the existing lender is also the PPP lender, parties should consider whether any loan documents, in addition to the primary loan agreement, may require modification (directly, or through an omnibus amendment or waiver). For example, dragnet clauses in security documents would have the effect of causing the PPP loan to be secured which would be inconsistent with the terms of the PPP loan program and could trigger indebtedness or mortgage taxes in certain jurisdictions.
Covenants regarding PPP Loans. Existing lenders may consider including in the terms of any consent or waiver affirmative covenants that require the borrower to provide notices or comply with the terms of the PPP loan program, including:
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Requiring that the borrower use the proceeds of the PPP loan solely for the allowable uses set forth in the CARES Act and applicable SBA guidance;
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Requiring that the borrower apply for forgiveness of the PPP loan (to the extent eligible) 4 on a timely basis (and provide documentation of such forgiveness to the lender upon the lender’s request);
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Requiring that the borrower provide copies of any notices received from the SBA in connection with the PPP loan; and
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Requiring the borrower to deliver the lender copies of any documentation executed in connection with the PPP loan (and represent that such copies are complete and correct), as well as copies of reports made to the SBA lender and any request for forgiveness.
Prepayments of PPP Loans. Existing lenders may consider prohibiting prepayments of PPP loans, but this could lead to unintended consequences if, for example, the borrower decides to return the PPP loan for, among other things, reputational or audit risk reasons. See, e.g., Paul Davis Fancher, Robert A. Friedel, and Scott R. Saks, Satisfying the “Need” Requirement for a Paycheck Protection Program Loan, TROUTMAN SANDERS LLP (April 27, 2020) (available at https://www.troutman.com/insights/satisfying-the-need-requirement-for-a-paycheck-protection-program-loan.html).
Cross-Defaults. Existing lenders should consider ensuring that any default under the PPP loan documents would be a default under the existing loan documents, which may require modifying the existing cross-default provision if the PPP loan falls below an existing threshold.
1 Permissible uses of PPP loan proceeds are limited to (i) payroll costs, (ii) costs related to continuation of group healthcare benefits, (iii) mortgage interest payments (but not prepayments or principal payments), (iv) rent, (v) utilities, (vi) interest payments on debt incurred before February 15, 2020 (but not principal payments on any such debt), and (vii) refinancing of SBA EIDL loans. See Business Loan Program Temporary Changes; Paycheck Protection Program, Small Business Administration, 85 Fed. Reg. 73 (April 15, 2020). Federal Register: The Daily Journal of the United States. Web. 15 April 2020.
2 “Payroll costs” generally include certain compensation to U.S. employees (and include, for an independent contractor or sole proprietor, compensation in the form of wages, commissions, income, or net earnings from self-employment); payments for vacation; parental, family, medical, or sick leave; certain severance payments; certain payments for employee health benefits and retirement; and payment of state and local taxes assessed on employee compensation. Payroll costs exclude, among other things, prorated annual compensation of any employee in excess of $100,000, certain federal employment taxes, and certain sick and family leave wages. See id.
3 Loan forgiveness will be equal to the “sum of documented payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities.” See id.
4 We have seen instances of lenders requiring borrowers to cause 100% of the loan to be forgivable. This may be challenging for borrowers facing continued uncertainty as, in addition to use of proceeds restrictions, borrowers may be compelled by economic realities to reduce employee headcount or payroll costs during the eight-week period following funding of the PPP loan, and either such action could render all or a portion of the PPP loan ineligible for forgiveness. Accordingly, we would advise against including any such requirements in amendments or waivers in connection with existing loan documents, or, alternatively, applying a commercially reasonable efforts standard.