CARES Act Loan Programs and Recent Development Considerations for Private Equity and Venture Capital Firms and their Portfolio Companies

We recently distributed an alert that provided a comprehensive description of the Phase 3 stimulus bill signed by the president on Friday, March 27 (the Coronavirus Aid, Relief, and Economic Security (CARES) Act). We thought it would be helpful to our private equity clients and their portfolio companies to highlight certain aspects of the loan programs and other relief included in the CARES Act and other recent stimulus legislation. Our alert can also be found here: COVID-19 Update: Financial Assistance Programs.

Expansion of the SBA 7(a) Loan Program — Paycheck Protection Program

Eligible Borrowers: Through June 30, 2020, qualifying businesses with fewer than 500 employees or, if applicable, the size standard in number of employees established by the SBA for the industry in which the entity operates, will be eligible to receive federally guaranteed loans under the new $349 billion Paycheck Protection Program (PPP).

• Affiliation Rule: Subject to additional guidance expected from the SBA in implementing the PPP, the SBA affiliation rules that aggregate a portfolio company with all other affiliates of a particular private equity sponsor for purposes of determining whether a potential borrower satisfies the maximum number of employees standard appear to apply. As such, this will generally prohibit an individual portfolio company that is itself under the 500-employee threshold (or relevant employee threshold for its particular industry) from participating in the PPP if the combined number of employees of all controlled portfolio companies and the management companies exceeds 500.
• However, portfolio companies in the accommodation and food services (NAICS Code 72) industries that have fewer than 500 employees per location, that operate as a franchise or that receive small business investment company loans are expressly exempted from the SBA affiliation rules and may be eligible for the PPP
• For borrowers that are eligible for the PPP, the program provides for loans up to the lesser of $10 million and 2.5x the monthly “payroll expenses” (which includes certain mortgage debt and rent) based on the 12 months preceding loan origination.

PPP Lenders: During the pendency of the COVID-19 national emergency, in addition to lenders previously approved by the SBA to provide Section 7(a) loans that may choose to opt in to the PPP, the CARES Act permits the Treasury Department and the SBA to designate additional qualified lenders to participate in the PPP.

• There may be opportunities to participate in the PPP as a lender, either by opting in (if already an approved Section 7(a) lender) or by being approved under the new criteria established by the CARES Act.

Additional implementation rules are expected as the PPP rolls out, and we will be closely monitoring how the affiliation rules (and the waivers in the CARES Act) are to be applied to the PPP.

Title IV Loan Programs

Title IV of the CARES Act, called the Coronavirus Economic Stabilization Act of 2020 (CESA), allocates $500 billion to make loans, loan guarantees and other investments to businesses, states and municipalities (BSM). Loans made pursuant to CESA are not subject to the size-based eligibility standards of the PPP or the use of proceeds restrictions. Loans under CESA are also not subject to forgiveness and will contain requirements that the borrower maintain 90 percent of its workforce (at full compensation and benefits) until Sept. 30, restore not less than 90 percent of its workforce to Feb. 1 levels no later than four months after the end of the COVID-19 national emergency, and not outsource or offshore jobs for the term of the loan, plus two years. In addition, loans under CESA may subject the borrower (and in some cases affiliates of the borrower) to restrictions on distributions, dividends and stock buybacks, as well as restrictions on executive compensation.

Loans to Companies in Specified Distressed Industries or that are Critical to National Security: Portfolio companies that operate in the passenger air or related businesses or the air cargo business may be eligible to participate in CESA’s $29 billion direct loan program or that operate businesses critical to maintaining national security may be eligible to participate in CESA’s $17 billion direct loan program, each of which is summarized here: COVID-19 Update: CARES Act Economic Stabilization Update. Direct loan determinations will be made, and such programs will be overseen, by the Treasury Department. It has been reported that the security-critical loan program is primarily intended for Boeing and other large defense contractors/manufacturers.

BSM Loans: CESA establishes a $454 billion program to be used for loans and loan guarantees and other investments in programs or facilities established by the Federal Reserve for purposes of providing liquidity to the financial system that supports lending to eligible U.S. BSM that do not fall into any of the above categories. Amounts available under the BSM program may be increased by amounts not used in the specific distressed industries or security critical programs.

The BSM loan program will be composed of direct loans made by the Treasury Department subject to restrictions on stock buybacks, dividends and compensation for employees making more than $425,000 in total compensation. CESA also authorizes the Treasury Department to establish loan programs or credit facilities to provide financing to banks and other lenders that make direct loans to eligible midsize businesses. Prospective borrowers under the midsized business loan program administered through lenders will need to make certain certifications as we summarize in the Alert (including a certification that the uncertainty of economic conditions make necessary the loan request to support ongoing operations of the borrower, the borrower will maintain 90% of its workforce at full compensation and benefits until September 30, 2020 and the borrower intends to restore its workforce to not less than 90% of February 1, 2020 levels, at full compensation and benefits within 4 months of the end of the COVID-19 national emergency). Borrowers under the midsized business loan program may also be subject to the above-described compensation restrictions.

• The BSM loan program seems to require the direct loans from the Treasury Department to be secured, but it is unclear whether loans made by participating banks or other lenders (which receive funding from the Treasury Department under the BSM loan program) would need to be secured. In any event, we would expect many potential recipients to have existing senior secured debt facilities, and the CARES Act does not address whether proceeds would be available to refinance existing debt facilities or the terms of any intercreditor arrangements or subordination that may be required.
• As a general matter, we expect the CESA loans to be more available to portfolio companies than loans under the PPP.
• Opportunities may exist for private equity firms and portfolio companies involved in lending to participate in the forthcoming financing facility programs.

Specific details of each program and additional implementation guidance and regulations are expected in the coming days, and we will provide further details as they emerge.

Additional Considerations

Employment Considerations: Private equity firms and portfolio companies should take into account the following considerations when utilizing the below options to reduce expenses during this extraordinary period:

• Layoffs: Employers that permanently terminate employees may trigger severance obligations under existing employer plans, policies or agreements.
• Furloughs: Employers that temporarily lay off employees with an intention to recall the affected employees may agree to continue to provide benefits to such employees during the furlough period. Furloughs that extend for greater than six months can create complications under the Worker Adjustment Retraining and Notification Act. As such, if a furlough is expected to last more than six months, a permanent layoff may be more appropriate.
• Compensation Reductions: Employers that reduce salaries and wages across the board may make a flat-percentage reduction that applies to all employees, a graduated reduction that has a greater impact on more highly compensated employees or a limited reduction applicable to certain groups (such as for only salaried employees). Employers implementing a compensation reduction plan must comply with a variety of wage and hour laws to ensure that they meet minimum wage requirements and do not inadvertently convert exempt employees to nonexempt status. Additionally, in some states, advance notice of a compensation reduction must be provided in writing. Further, for executives with employment or other agreements, reductions could give such individuals the ability to terminate for “good reason” and receive severance, additional vesting or other rights. Employers should review any individual agreements to determine whether those provisions will be triggered and whether any actions, such as the consent of the affected employee, is needed to avoid triggering any good reason rights.

Note that implementing certain of these actions may impact a business’s ability to obtain relief under various provisions of the CARES Act.

In addition, the current business disruption as a result of the COVID-19 crisis will likely impact annual or long-term performance goals. For private equity firms and portfolio companies that have not yet set annual performance goals, they may consider waiting until there is less economic uncertainty to establish the metrics or explicitly reserve the right to adjust metrics for the impact of COVID-19. Private equity firms and portfolio companies that have already established metrics or are in the middle of a performance period should review and continue to monitor their goals to make sure they continue to provide the right incentives in the current environment. If a private equity firm or portfolio company has concerns regarding its cash flow, it should consider whether it has the flexibility to settle bonuses in equity.

Pension Relief: The CARES Act provides for limited funding relief for single-employer pension plans, allowing those plans to defer any minimum funding contributions (quarterly or annual) that are due in 2020 until Jan. 1, 2021 (at which time they will be paid with interest). For portfolio companies that sponsor a single-employer pension plan and are experiencing cash flow concerns, the ability to defer those payments for the next several months can provide additional near-term liquidity.

Further discussion of the employee benefits-related provisions of the CARES Act can be found here: COVID-19 Update: Retirement Relief in the CARES Act.

Families First Coronavirus Response Act (FFCRA) Employment Considerations: The FFCRA, which includes the Emergency Paid Sick Leave Act (EPSLA) and the Emergency Family and Medical Leave Expansion Act (EFMLEA), goes into effect on April 1.

• The EPSLA and EFMLEA apply only to employers that have fewer than 500 employees at the time the employee’s leave under the FFCRA would begin.
  • Separate portfolio companies of private equity sponsors generally would not be aggregated for purposes of calculating coverage.
  • Separate subsidiaries under a holding company structure will be aggregated if they satisfy the integrated employer test, which balances factors including common management, interrelation of operations, centralized control of labor relations, and degree of common ownership or financial control.
• Covered employers must provide two weeks (80 hours) of paid sick leave (prorated for part-time employees), with benefits capped at $511 per day and $5,110 in the aggregate for those on leave because of their own health issues, and $200 per day and $2,000 in the aggregate for those needing to care for others. Qualifying reasons include employees affected by or caring for those affected by self-quarantining directives.
• The EFMLEA provides up to 12 weeks of leave only to employees who are unable to work or telework due to the need to care for a child under the age of 18 whose school or place of care is closed.
  • The first ten days may be unpaid, although a worker could choose to use other accrued leave (including that provided by the EPSLA).
  • For the balance of the EFMLEA leave, employers are required to pay employees two-thirds of their wages, with a cap of $200 per day and $10,000 in the aggregate.
• Covered employers may recoup the costs of provided EPSLA or EFMLEA leave through tax credits provided under the FFCRA.

Further discussion of the employment-related provisions of the EFMLEA can be found here: COVID-19 Update: Payroll Tax Credits for Paid Sick Leave and Child Care Leave Authorized for Eligible Employers with Workers Impacted by the COVID-19 Pandemic.

Tax Considerations: The following provisions enacted by Congress in the CARES Act and the FFCRA and actions taken by the Treasury Department can alleviate cash flow concerns for businesses:

• The Treasury Department has extended the deadline for income tax returns and income tax payments due on April 15 to July 15.
• Employers can delay without penalty depositing the employer’s share of Social Security taxes through Jan. 31, 2021, provided that (i) 50 percent of such amounts are deposited by Dec. 31, 2021, and (ii) the remaining 50 percent is deposited by Dec. 31, 2022.
• Employers may receive a refundable credit for sick leave and child care leave payments to employees under the FFCRA.
• Employers that undergo a significant decline in revenues or are forced to suspend operations by governmental order as a result of the pandemic may receive a refundable credit of up to $10,000 of “qualified wages” paid to each of its employees.
• The 2017 tax reform limitation imposed on the deductibility of net interest expense has been temporarily loosened for 2019 and 2020 by increasing the limitation to 50 percent (from 30 percent) of adjusted taxable income and allowing taxpayers to compute the 2020 limitation by reference to 2019 adjusted taxable income.
• The 2017 tax reform limitation imposed on the use of post-2017 net operating losses has been temporarily loosened by allowing a five-year carryback of losses generated in 2018-2020 and allowing all losses carried forward to pre-2021 taxable years to offset 100 percent (rather than 80 percent) of taxable income in such years.
• For participants in the PPP, any forgiveness of PPP loans will be excluded from income.

Further discussion of the tax-related provisions of the CARES Act can be found here: COVID-19 Update: Tax-Related Provisions of the CARES Act and COVID-19 Update: Payroll Tax Credits for Paid Sick Leave and Child Care Leave Authorized for Eligible Employers with Workers Impacted by the COVID-19 Pandemic.

We will continue to distribute alerts addressing issues related to the COVID-19 national emergency, including providing timely information on how the new legislation and accompanying regulations may affect your businesses.