April 07, 2020

Below is a high-level overview of the most relevant provisions of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) and related legislation, guidance and considerations for private equity sponsors and their portfolio companies.

Please note that this is in summary form and does not purport to cover all of the terms of the CARES Act or other applicable legislation that may be of interest, and there is additional nuance to a number of the issues raised below that we are happy to discuss. Importantly, given the pace at which the CARES Act was passed, and the pace with which additional guidance is being issued, there remains significant ambiguity, even with some of the matters identified below. The situation remains dynamic and we expect further material developments in the coming weeks as the rules and regulations implementing the CARES Act evolve.

Availability of Small Business Loans under the CARES Act

The CARES Act provides $349 billion in funding for the U.S. Small Business Administration (the “SBA”) loans under a new Paycheck Protection Program (“PPP”) that supplements the SBA’s existing 7(a) loan programs. The CARES Act relaxes certain SBA loan eligibility criteria to expand the availability of relief for small businesses through the PPP and allows loan forgiveness in some circumstances. Key features and considerations relating to PPP loans under the CARES Act are set forth below.

  • Eligibility: In general, businesses with 500 or fewer employees are eligible for PPP loans. However, some business with greater than 500 employees may be eligible:
    • Certain industries are subject to higher thresholds under existing SBA standards that remain in place under the PPP (see SBA Table of Small Business Size Standards Matched to NAICS Codes). 
    • Businesses that are assigned a North American Industry Classification System code beginning with 72 (the accommodation and food services industries) and do not have more than 500 employees at any individual physical location are eligible.

  • Affiliation Rules: Subject to limited exceptions, the SBA’s existing affiliation rules appear to remain in effect (with the Treasury recently clarifying which sections of the Code of Federal Regulations apply for PPP Loans). These rules require that a potential applicant for a PPP loan aggregate all of their employees with all of the employees of all affiliated businesses for purposes of determining whether the applicable employee number limit is satisfied. The  SBA defines “affiliation”  very broadly.      
    • Important Note for Portfolio Companies: As a result of the affiliation rules, unless one of the specific exceptions described below is available (or Congress or the Treasury takes action to expand the eligibility for PPP loans, which has been the subject of significant lobbying effort in recent days), portfolio companies are unlikely to qualify once their employees have been aggregated with the employees of all affiliated portfolio companies. The Treasury published an interim final rule regarding affiliation on April 3, 2020 (the “Affiliation Interim Final Rule”), which addressed some ambiguities in the application of the affiliation rules under the CARES Act but did not take further steps (such as waiving the affiliation rules altogether) to make PPP loans available to portfolio companies. Among other things, the Affiliation Interim Final Rule has signaled a focus on counting employees whose principal place of residence is the United States.
    • Exceptions to Affiliation Rules: The CARES Act provides that the affiliation rules will not be applied for the following: 
      • Businesses with not more than 500  employees that are assigned a North American Industry Classification System  code beginning with 72 (the accommodation and food services industries);
      • Businesses operating as a franchise that is assigned a franchise identifier code by the SBA; and 
      • Businesses that receive financial assistance from a small business investment company, or SBIC.
  • Key Terms: Key terms of the PPP loans include the following:
    • The maximum loan amount will be 2.5 times the average total monthly payroll cost during the trailing one-year period, subject to a cap of $10 million. There are certain limits on what compensation can be included as payroll cost. For example, the portion of compensation of employees that exceeds $100,000 is excluded. 
    • Neither collateral nor a personal guarantee is required to receive a PPP loan. 
    • Proceeds can be used for expenses such as payroll costs, mortgage interest, rent payments and utilities. 
    • Loan forgiveness can be secured for the sum of payroll costs, mortgage interest, rent payments, and utility payments for the eight-week period after the loan is disbursed, subject to reduction based on decreases to the business’s employee headcount or employee salaries. Due to anticipated high subscription rates for PPP loans, no more than 25% of the loan forgiveness amount may be with respect to non-payroll costs. 
    • Based on the interim final rule implementing the PPP,  which was published on April 2, 2020, (the "Implementing Interim Final Rule"), PPP loans will have a 1.0% interest rate and two-year maturity, and payment can be deferred for six months. 
    • There is some ambiguity as to the scope of “credit elsewhere,” but historical credit elsewhere requirements that were applicable to SBA 7(a) loans are being waived for PPP loans.

  • Application Process: Participating SBA lenders were permitted to accept applications for PPP loans as of April 3, 2020, but we understand that many lenders were not prepared to accept or process applications on that date and may take several days to get fully up and running. We recommend that eligible companies seeking to apply for PPP loans work with their existing lenders to the extent those lenders are participating in order to streamline the process and avoid unnecessary timing delays. As part of the application process, applicants  will need to gather supporting information regarding their payroll costs and will be required to make a number of good faith certifications set forth in the PPP application form.  Participating SBA lenders may have their own application processes that applicants will also need to consider. 

  • Additional Information: 
Availability of Title IV Emergency Business Loans under the CARES Act
Title IV of the CARES Act provides the Secretary of the Treasury $500 billion of funding to make emergency loans and other financial support available to businesses in specific industries that have been hard hit by the COVID-19 pandemic (such as airlines), including at least $454 billion that has been earmarked for businesses across industries that do not otherwise receive adequate economic relief under the CARES Act (such as those that may be ineligible for PPP loans). Certain considerations relating to the $454 billion of emergency relief loans available to businesses across all industries are set forth below.

  • Key Terms: The terms of these emergency relief loans are subject to the discretion of the Secretary of the Treasury, and we expect additional information to become available as the Treasury and Federal Reserve release guidance and regulations implementing the program are adopted. Notably, the CARES Act provides that these loans will not be forgivable.

  • Restrictions on Borrowers: Businesses receiving these emergency relief loans would be subject to a number of restrictions during the term of the loan, and in certain instances for a period of time after the loan has been paid in full, which in many cases may make these loans unattractive to portfolio companies. These restrictions include a prohibition on making distributions with respect to common equity, a prohibition on repurchasing publicly traded equity of the company or a parent company, and limitations on compensation for individuals whose compensation exceeded $425,000 in 2019 (with additional limitations for those whose compensation exceeded $3 million).

  • Mid-Sized Business Loans: As part of this relief loan program, the Secretary of the Treasury is also directed to implement a mid-sized business lending program providing financing to lenders who will make direct loans targeted at businesses with 500-10,000 employees. The timing for implementation of this program is uncertain, but we expect additional information to become available. Borrowers of mid-sized business loans would be subject to similar restrictions relating to distributions and repurchases, as well as additional restrictions relating to workforce retention.

  • Additional Information: 
    • Separately, the Federal Reserve announced on March 23, 2020 that it would be implementing a “Main Street Business Lending Program” to support lending to eligible small and mid-sized businesses. As with the mid-sized business loan program, we expect additional information to become available.
    • It is worth noting that the Treasury has issued guidance relating to the airline-specific loan programs under Title IV which states that borrowers of those loans must be unable to reasonably obtain credit elsewhere (though it is unclear whether 20% owners of an applicant would be required to provide financial support, as was the case with historical SBA “credit elsewhere” requirements). It is fair to assume that other Title IV loans may be subject to a similar credit elsewhere requirement.
Payroll Tax Relief
The CARES Act provides for the temporary deferment of certain employer payroll taxes and provides eligible employers with a refundable payroll tax credit for certain qualifying wages.

  • Delay of Payment of Employer Payroll Taxes: The CARES Act defers the payment of the social security component of employer payroll taxes (OASDI) owed on wages in the period beginning March 27, 2020 and ending December 31, 2020. The CARES Act provides that 50% of the deferred taxes are due December 31, 2021 and the remaining 50% are due December 31, 2022. This deferral does not apply to any employer who has received loan forgiveness with respect to a PPP loan. It is currently unclear whether penalties and interest could apply if loan forgiveness is subsequently sought and received.
  • Employee Retention Credit: The CARES Act provides eligible employers with a refundable payroll tax credit equal to 50% of “qualified wages” (including certain health plan expenses) paid to employees from March 13, 2020 through December 31, 2020.
    • Eligibility: An eligible employer is an employer engaged in a trade or business in 2020 for which, during the applicable calendar quarter, either (x) the operation of that trade or business is fully or partially suspended due to a governmental order limiting commerce, travel, or group meetings due to COVID-19 or (y) gross receipts for the calendar quarter are reduced to less than 50% of gross receipts for the same calendar quarter in 2019, until the calendar quarter following the quarter in which gross receipts reach at least 80% of the same quarter in 2019.
    • Qualified Wages: An employer determines its “qualified wages” based on the size of the employer’s workforce. For employers with more than 100 full-time employees, qualified wages are wages paid to those employees not providing services due to circumstances described in (x) and (y) above. For employers with 100 or fewer full-time employees, qualified wages cover wages paid to all employees during any applicable quarter with circumstances described in (x) or (y) above.
    • Credit Caps: The employee retention credit is capped at $5,000 per employee for all calendar quarters during the period in the aggregate (i.e., not per quarter). An employer’s ordinary business expense deduction for wages paid is also reduced by the amount of the employee retention credit. The credit is not available for the companies receiving PPP loans.
Tax Burden Relief for Businesses
The CARES Act temporarily eases the impact of several provisions of the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The most relevant of these changes include the modification of net operating losses and the increase in the amount of allowable interest expense deduction.

  • Modification of Net Operating Losses: The TCJA (i) eliminated the ability of taxpayers to carry back a net operating loss (“NOL”) to prior tax years and (ii) limited the use of an NOL carry forward such that it could reduce no more than 80% of a subsequent year’s taxable income (the “80% Cap”). The CARES Act modifies the TCJA’s elimination of carryback NOLs such that NOLs generated in a tax year that begins in 2018, 2019 or 2020 may be carried back for up to five years prior to the tax year in which an NOL is generated to claim refunds of federal income taxes paid during such carryback period. Additionally, the CARES Act removes the 80% Cap for taxable years beginning before January 1, 2021, thereby allowing NOLs to fully offset taxable income in years 2018 and 2019 (which were previously limited by the TCJA) and 2020.

  • Increase in Allowable Interest Expense Deduction: Under the TCJA, a taxpayer’s interest deduction cannot exceed 30% of the taxpayer’s adjusted taxable income. Under the TCJA, adjusted taxable income roughly equates to (i) EBITDA for taxable years through 2021, and (ii) EBIT for taxable years beginning in 2022. For taxable years beginning in 2019 and 2020, the CARES Act increases the amount of allowable interest expense deduction from 30% to 50% of a taxpayer’s adjusted taxable income. The CARES Act also allows a taxpayer to elect to use 2019 adjusted taxable income when calculating its 2020 limitation.
    • Special Treatment for Partnerships: The increase from 30% to 50% does not apply to partnerships. However, unless a partner elects to not do so, 50% of the excess business interest of the partnership which is allocated to a partner for 2019 is treated as being paid to or accrued by such partner for such partner’s taxable year beginning in 2020 and is not subject to the business interest deduction limitation imposed by the TCJA. The remaining 50% is carried forward pursuant to existing law.

  • Refundable AMT Credit for Corporate Taxpayers: The TCJA repealed the alternative minimum tax (the “AMT”) for corporate taxpayers and provided that any AMT credits generated prior to the TCJA that were previously eligible to be carried forward are refundable in tax years 2018 through 2021. For each tax year from 2018 to 2020, a taxpayer was generally allowed a refund of 50% of the taxpayer’s remaining available AMT credits in the applicable year, and the remaining AMT credit balance would be refundable in 2021. To illustrate, if a taxpayer had $10 million of accrued AMT tax credit carryforwards, $5 million would be refundable in 2018, $2.5 million would be refundable in 2019, $1.25 million would be refundable in 2020 and the remaining $1.25 million would be refundable in 2021. The CARES Act accelerates the availability of carryforward AMT credits and provides that a corporate taxpayer may (i) utilize 50% of its pre-TCJA AMT credit in 2018 and the remaining 50% in 2019 or (ii) elect to utilize the entire available AMT credit in 2018. Under the CARES Act, corporate taxpayers with available AMT credits may request a tentative refund to be paid within 90 days, if applicable.

  • Suspension of Excess Business Loss Limitations for Non-Corporate Taxpayers: Under the TCJA, non-corporate taxpayers cannot deduct any “excess business losses” for any tax years beginning after December 31, 2017 and before January 1, 2026. An excess business loss is a taxpayer’s loss attributable to its trades or businesses in excess of $250,000. The aggregate trade or business loss taken into account for a taxpayer’s excess business loss includes such taxpayer’s allocable share of losses from flowthrough entities such as partnerships and S corporations. Since an excess business loss cannot be deducted in the year itis generated, it is treated as an NOL carryforward for a subsequent tax year. Under the CARES Act, business loss limitations are suspended and are only effective for taxable years beginning after December 31, 2020 and before January 1, 2026. This change is retroactive and effective for tax years beginning after December 31, 2017. Taxpayers may amend prior tax returns to take advantage of the suspension of this limitation.

  • Changes to Qualified Improvement Property Expensing: The CARES Act clarifies the classification of “qualified improvement property” (i.e., certain improvements made to the interior of non-residential real property), allowing qualified improvement property to be eligible for 100% bonus depreciation introduced under the TCJA. Previously, qualified improvement property had a 39-year depreciation period that made it ineligible for bonus depreciation. Since this amendment is retroactive to the enactment of the TCJA, qualified improvement property is eligible for bonus depreciation in the 2018 tax year, in addition to being eligible for bonus depreciation going forward (until bonus depreciation phases out under the TCJA, which begins in 2023).
Tax Payment and Filing Relief
In addition to the relief provided by the CARES Act (see above) and the Family First Coronavirus Response Act (see below), the U.S. Internal Revenue Service (the “IRS”) announced relaxed tax payment and taxpayer filing obligations.

  • Federal Income Tax Returns: The IRS is permitting taxpayers to defer filing their federal income tax returns and making federal income tax payments due April 15, 2020 to July 15, 2020 without incurring any interest or penalties. Any interest, penalty or additional tax with respect to such deferred federal income tax filings and payments will be calculated from July 16, 2020. This deferment does not apply to any tax payments or tax filings due after April 15, 2020 and does not apply to federal payroll taxes.
Family First Coronavirus Response Act (the “FFCRA”)
The FFCRA requires covered employers to provide their employees with expanded family and medical leave under the Family & Medical Leave Act (the “FMLA”) and paid sick leave for specified reasons related to COVID-19.

  • Covered Employers: Covered employers includes private employers who have fewer than 500 employees. The calculation of employees is made in accordance with the joint employer test under the Fair Labor Standards Act and the integrated employer test under the FMLA; as such, unlike the SBA loan eligibility guidelines discussed above, it is unlikely that a portfolio company’s employees would be aggregated with the employees of other portfolio companies.

  • Refundable Payroll Tax Credit: Under the FFCRA, employers are entitled to a tax credit against payroll taxes, in an amount equal to 100% of the qualified paid family and medical leave wages and paid sick leave wages for each calendar quarter, subject to certain caps:
    •  Cap on Credit for Paid Family and Medical Leave: The maximum credit amount for family leave payments required by the FFCRA is $200 per day per employee (and $10,000 in the aggregate per employee) for each employee who is unable to work because of a need to care for a child whose school or child-care facility is closed or child care provider is unavailable due to COVID-19.
    •  Cap on Credit for Paid Sick Leave: The maximum credit amount is $511 per day per employee for a total of 10 days for each employee who is unable to work because of COVID-19 quarantine or self-quarantine, or who has COVID-19 symptoms and is seeking a medical diagnosis. The maximum credit amount is $200 per day (and $2,000 in the aggregate, for up to 10 days) for an employee who is unable to work because the employee is caring for someone with COVID-19, or is caring for a child because the child’s school or child-care facility is closed, or the child care provider is unavailable due to COVID-19.

  • Additional Information:
Availability of Insurance
Many portfolio companies are assessing the possibility of using business interruption or other insurance in connection with COVID-19 related claims. Unfortunately, the CARES Act does not address insurance (even though it was discussed early on). Below are some considerations that may be relevant.

  • Government Responses: Certain states are trying to push through legislation that would force insurers to pay regardless of exclusions, but whether those efforts will provide a viable path for recovery remains unclear. There has also been some discussion around requiring insurance companies to pay for COVID-19 losses and having the federal government reinsure those losses, but it is not yet clear whether this will be pursued. 

  • A Few Quick Notes:
    • Most insurance policies have a blanket exclusion for communicable diseases that would exclude any claims related to COVID-19 or the shut-down of businesses caused as a result of the pandemic.
    • However, some policies (by some estimates, 10% -15% of policies) do not have this exclusion.
    • So far, insurers have seen claims lodged principally under two policies: (i) claims under property insurance and (ii) claims under pollution liability insurance (making the argument that the virus is a contaminant that is causing facilities to shut-down; some policies exclude this and others do not).
    • While a vast number of claims are being made to carriers, there has not yet been a general response from the industry, and carriers are still digesting all of the information. Unsurprisingly, many expect an aggressive push back from carriers in the first wave, though government pressure is starting to come to bear.

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