Federal Reserve Chairman Jerome Powell announced on May 19, 2020, before a Senate Committee that the Main Street Lending Program (Program) is anticipated to be launched around the end of May. Prospective borrowers should be preparing for making loan applications with participating lenders when the Program commences.
As described in our earlier Alert available here, the Federal Reserve and the U.S. Department of Treasury are making available up to $600 billion in new financing for eligible small and mid-sized businesses. Unlike loans under the Paycheck Protection Program (PPP) which, subject to certain conditions, are forgivable, loans under the Program are not forgivable. These loans must be repaid, may require collateral arrangements satisfactory to the lender, and impose on borrowers a number of restrictions, including the prohibition of dividends and stock repurchases as well as significant compensation increases for highly compensated executives. The Program is designed to provide secondary market liquidity for Program loans, with each lender retaining a portion of each loan it originates and the Federal Reserve providing liquidity for lenders by purchasing loan balances not retained by lenders.
It is important to understand that simply meeting the Program’s criteria is no assurance that a borrower will actually receive a loan. These loans will be negotiated between the lender and the borrower. As described in the Federal Reserve’s FAQs, “Eligible Lenders will apply their own underwriting standards in evaluating the financial condition and creditworthiness of a potential borrower.”
The Program, as currently revised, is comprised of three separate facilities:
• Main Street New Loan Facility to facilitate new loans to eligible businesses (New Loans);
• Main Street Expanded Loan Facility to facilitate the extension of already existing loans for eligible businesses (Expanded Loans); and
• Main Street Priority Loan Facility, similar to New Loans, but increases the amount eligible lenders will retain of eligible loans to 15% (Priority Loans).
What Prospective Borrowers Are Eligible for a Program Loan?
To be eligible to borrow under the Program, the prospective borrower must:
• be a permitted business established prior to March 13, 2020;
• have been formed under the laws of the United States, one of the several states, the District of Columbia, any of the territories and possessions of the U.S., or an Indian Tribal government;
• not be an Ineligible Business (as defined herein);
• either (a) have 15,000 or fewer employees, or (b) have 2019 annual revenues of $5 billion or less, or both;
• have significant operations, and a majority of their employees, based in the United States; and
• not have participated in the Primary Market Corporate Credit Facility (PMCCF) or received specific support pursuant to the Coronavirus Economic Stabilization Act of 2020 (such as loans and loan guarantees to air carriers).
How Does the Program Define a Business?
A “business” means an entity that is organized for profit, including a partnership, a limited liability company, a corporation, an association, a trust, a cooperative or a joint venture with no more than 49% participation by foreign business entities. It is not clear if a sole proprietorship would qualify as a business. This definition is the same definition as a “business concern” for purposes of SBA loans, except the SBA includes in its definition “individual proprietorship.” Whether this omission was intentional is unclear.
A “business” also includes certain tribal concerns owned in whole or in part by Indian tribal governments.
Not-for-profit entities are not eligible borrowers under the Program, because in the Federal Reserve's view, such entities do not generate EBITDA. However, the Federal Reserve’s FAQs did signal that such borrower eligibility criteria and Program loan eligibility metrics for not-for-profit entities may be reconsidered. Other forms of organizations may be considered for inclusion as a business at the discretion of the Federal Reserve.
What is an Ineligible Business?
The following types of businesses are not eligible to receive Program loans:
• financial businesses primarily engaged in the business of lending, such as banks, finance companies, factors and life insurance companies;
• certain passive businesses owned by developers and landlords that do not actively use or occupy the assets acquired or improved with the loan proceeds (except Eligible Passive Companies under 13 CFR §120.111);
• businesses located in a foreign country;
• businesses deriving more than 1/3 of gross annual revenue from legal gambling activities;
• businesses engaged in any illegal activity or any pyramid sale distribution plans;
• private clubs and businesses which limit the number of memberships for reasons other than capacity;
• government-owned entities (except for businesses owned or controlled by a Native American tribe);
• loan packagers earning more than 1/3 of their gross annual revenue from packaging SBA loans;
• businesses with an “associate” who is incarcerated, on probation, on parole, or has been indicted for a felony or a crime of moral turpitude;
• businesses in which the lender, or any of its “associates,” owns an equity interest;
• adult entertainment businesses;
• businesses that have previously defaulted on a federal loan, or businesses owned or controlled by an applicant or any of its “associates” which previously owned, operated, or controlled a business which defaulted on a federal loan;
• businesses primarily engaged in political or lobbying activities; and
• speculative businesses (such as oil wildcatting).
The term “associates of a business means (i) an officer director, owner of more than 20% or key employee of the business, (ii) any other entity in which one or more individuals referred to in (iii) above owns or controls at least 20% of the business, or (iv) any individual or entity in control of or controlled by the business.
Prospective borrowers must consider these eligibility criteria for itself and, where applicable, its associates and affiliates.
How Are Employees Counted?
To be eligible, the borrower must meet at least one of the following two conditions: (a) the borrower and its affiliates have 15,000 employees or fewer, or (b) the borrower and its affiliates have 2019 annual revenues of $5 billion or less. The Federal Reserve’s FAQs describe how to count the number of the borrower’s employees.
The borrower must count as employees all individuals employed on a full-time, part-time, seasonal or otherwise employed persons, including employees obtained from a temporary employee agency, professional employee organization or leasing concern, but excluding volunteers and independent contractors. Part-time and temporary employees are counted the same as full-time employees.
The number of employees is the average of the total number of persons employed by the borrower and its domestic and foreign affiliates for each pay period over the twelve months prior to obtaining the Program loan. If the borrower has not been in business for twelve months, the average number of employees is used for each of the pay periods during which it has been in business.
If a borrower has acquired an affiliate or been acquired as an affiliate during the twelve-month period prior to the loan, the number of employees include the employees of the acquired or acquiring concern. This aggregation applies for the entire twelve-month period, not just the period after the affiliation arose.
The employees of a former affiliate are not counted if affiliation ceased before the date used for determining size. This exclusion of employees of a former affiliate applies during the entire twelve-month period, rather than only for the period after which affiliation ceased. However, if a business has sold a segregable division during the twelve-month period, the employees used in determining size status will continue to include the employees of the division that was sold.
Do the SBA Affiliation Rules Apply to Counting Employees?
Yes. To determine eligibility, a prospective borrower’s employees are calculated by aggregating the employees of the borrower itself with those of the borrower’s affiliated entities in accordance with the affiliation test set forth in 13 CFR §121.301(f). Therefor the same issues under the SBA’s affiliate rules that plagued the PPP, apply in this Program. Although the Program has a much larger 15,000 employee limit compared to the PPP 500 employee limit, prospective borrowers still need to go through the exercise to determine (i) the borrower’s affiliates and (ii) such affiliates’ employees.
Under these rules, entities are “affiliates” of each other when one controls or has the power to control the other, or a third party controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists.
As a general rule, a business is an affiliate of an individual or entity that owns or has the power to control more than 50% of the business’ voting equity, as if all stock options and convertible securities have been exercised or converted (unless extremely remote). If no one has such voting control, persons who control management of the business are deemed to control the business, depending on facts and circumstances.
Venture capital-backed borrowers need to consider the minority equity holder rule, which states such equity holder may be in control of the borrower if that equity holder has the ability, under the borrower’s charter “to prevent a quorum or otherwise block action by the board of directors or shareholders.” Borrowers should look at these “protective provisions” and, if applicable, whether they can be modified to stay under the Program’s employee or revenue limit.
How Are Revenues Determined?
A borrower that does not meet the employee requirement may still be eligible if the borrower’s 2019 revenues were $5 billion or less. When calculating revenues, the calculation must include the borrower’s affiliates’ 2019 annual revenues. The definition of “affiliates” is the same as when calculating the number of employees.
The Federal Reserve’s FAQs allow prospective borrowers to use either of the following methods to calculate 2019 annual revenues:
• such borrower’s and its affiliates’ annual “revenue” per its 2019 GAAP audited financial statements; or
• such borrower’s and its affiliates’ annual “receipts” for the fiscal year 2019, as reported to the Internal Revenue Service (the FAQs use “receipts” as defined in 13 CFR §121.104(a)), or
• if such borrower or any of its affiliates does not yet have available audited financial statements or annual receipts for 2019, the borrower or such affiliate should use its most recent audited financial statements or annual receipts.
What Should Prospective Borrowers Do Next?
Prospective borrowers should prepare in advance of the launch of the Program to try to avoid the initial logjam that frustrated initial PPP borrowers. This includes an assessment of the borrower’s eligibility under the Program, current cash needs and availability of existing credit (currently outstanding and undrawn) and the benefits and risks of taking on a Program loan.
Tarter Krinsky & Drogin is ready to assist to determine prospective borrowers’ eligibility under the Program and other U.S. government programs. The above summary is current as of May 19, 2020.
Attorney Advertising. The information contained in this Legal Alert provides a general summary of the topics covered and is not intended to be and should not be relied upon as legal advice. You should consult with your legal counsel for advice and before making legal, business or other decisions.
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