Hoteliers and Restaurateurs: How Forgivable are Your PPP loans?
5.5.20 | Berdon Industry Insights – COVID-19 Update
As you know by now, a Paycheck Protection Program (“PPP”) loan can be forgiven in whole or in part if the borrower uses the proceeds for forgivable purposes and in accordance with the guidelines established by the U.S. Small Business Administration (“SBA”).1 However, the various restrictions placed upon the forgivability of the loan require hotel and restaurant owners to take a closer look as to how likely (or unlikely) this loan is to be forgiven.
A borrower is eligible for loan forgiveness equal to the amount spent during the eight-week period after the loan proceeds are received for:
- Payroll costs (including salaries, wages, commissions, and tips up to $100,000; leave benefits; health care benefits; retirement benefits; and state and local payroll taxes)
- Interest payment on any mortgage originated prior to February 15, 2020
- Payment of rent on any lease in force prior to February 15, 2020
- Payment on any utility for which service began before February 15, 2020
The SBA determined that loan forgiveness requires at least 75% of the loan amount to be spent on payroll costs and no more than 25% on other eligible expenses (mortgage interest expense, rent and utilities). The SBA imposed this restriction as a mechanism to promote employment retention, even though it was not initially in the CARES Act. If you do not use 75% of the total PPP funds received on payroll costs, then the amount forgiven will be reduced based upon the amount used towards payroll.
Example: If you receive a PPP loan for $1,000,000 and use $300,000 towards payroll costs, then up to $400,000 may be forgiven (which includes up to $100,000 of mortgage interest expense, rent and utilities — maintaining the required 75% payroll/25% other costs ratio required by the program). The remaining $600,000 of the loan proceeds, which is not forgiven, will have a maturity of two years and carry an interest charge of 1% per annum, so long as those funds are spent on the other permitted purposes by June 30, 2020.2
Other Important Restrictions
In addition to the restriction to use no more than 25% of the loan proceeds for non-payroll expenses, the following events can also trigger a reduction in the amount of loan forgiveness:
- A reduction in Full-Time Equivalent (“FTEs”) employees, which is determined by comparing the average number of FTEs during the eight-week period to the lesser of the average number of FTEs for the period January 1, 2020 to February 29, 2020 or for the period February 15, 2019 to June 30, 2019.
- A reduction in employee pay level by more than 25% for those making less than $100,000/year, which is determined by comparing earnings during the eight-week period to amounts earned during the first quarter of 2020.
According to the current guidelines, reductions in head count and pay level that occur from February 15, 2020 to April 26, 2020 may be disregarded for purposes of reducing the forgiveness amount so long as the reductions are eliminated before June 30, 2020.3
Concerns Impacting Hotels and Restaurants
SBA statistics issued on April 16, 2020 state that approximately 8.9% of loans approved at that point went to businesses in the accommodation and food services industry. These borrowers are now struggling to fully avail themselves of the forgiveness feature since the requirements do not align well with businesses such as hotels and restaurants that have either been shut down due to shelter-in-place orders or essential business restrictions imposed by health and government officials. In addition, many are operating as a mere shell of their former selves by offering limited hotel services or by restaurants solely providing take-out and delivery services.
The services currently provided by these hotels and restaurants require skeleton staffs as compared to fully operational levels. To reach the 75% minimum threshold, some hoteliers are hiring staff back to take advantage of the down-time to rewrite their property’s Standard Operating Procedures for a post-COVID-19 world in order to establish potentially new check-in procedures or to create new common area guidelines and best practices. Restaurants might be looking to use the time to cross-train employees or get to special projects that they never seem to have the time to complete, including new ones such as the implementation of new food preparation and handling guidelines for the reopening of their establishments. However, full levels of employment may not be necessary to work on these types of tasks and some hotel or restaurant owners might then look to hire back staff for no-show jobs or to work minimal hours just to be able to meet the forgiveness requirements. If that decision is made, then they would be in the highly likely position of terminating a number of these employees after the eight-week period (or shortly after the June 30th reduction restriction date). Borrowers need to be careful to not end up in a position where they paid these workers for unproductive work and then find themselves potentially not qualifying for forgiveness because not enough were rehired or the SBA issues new guidance along the way which negatively affects a borrower’s projected forgiveness calculations.
Many Questions Still Remain
The PPP assumes operations are fully functional on the day the PPP loan proceeds are received, which is an unrealistic proposition. The underlying goal may be to shift those on the unemployment ledger over to company payrolls, but then what happens after the eight-week period? Payroll levels can’t be sustainable at that point if traffic flow is not approaching the level it was pre-COVID. Hiring back 75% to 100% of staff when only generating 25% to 50% of revenues doesn’t add up, especially when there are still so many questions about the economy and the country’s ability to return to normal business operations.
For instance, when will banquet business and corporate events return to full-service hotels, not to mention reasonable occupancy levels and room rates? What will be the occupancy restrictions imposed on restaurants and bars and how long will they be in effect? These questions, along with many others, are causing certain owners to evaluate if they might be better off staying closed until the economy recovers. Increasing payroll significantly with the intention of fitting into the PPP forgiveness parameters seems to be a risky proposition at this point.
Implementation guidance issued by the SBA regarding PPP loans has generally taken the form of interim final rules and FAQs. The SBA now seems to be shifting its focus away from the application process and towards the forgiveness calculations. One recent bit of guidance recently issued by the SBA helped to clarify how forgiveness would be adjusted for a situation such as:
What if my employees are making more on enhanced unemployment (especially tipped employees whose tips would be significantly reduced when the restaurant is closed or limited) and chose not to accept an offer to be re-hired?
In an FAQ dated May 3, 2020, the SBA stated that it intends to issue an interim final rule excluding laid-off employees whom the borrower offered to rehire (for the same salary/wages and same number of hours) from the CARES Act’s loan forgiveness reduction calculation. The interim final rule will specify that, to qualify for this exception, the borrower must have made a good faith, written offer of rehire, and the employee’s rejection of that offer must be documented by the borrower. Employees and employers should be aware that employees who reject offers of re-employment may forfeit eligibility for continued unemployment compensation.
Calls for More Clarity and Guidance
However, there is a pressing need for further clarification and guidance. The American Institute of Certified Public Accountants recently issued their own recommendations regarding the forgiveness process. One such recommendation is to start the eight-week period once operating restrictions are lifted, rather than the date loan proceeds are received. Other groups, such as the National Restaurant Association, are pushing to revise the 75% payroll cost restriction and to restore the 10-year loan repayments terms that were originally included in the CARES Act. Adjusting the payroll cost percentage downwards would certainly help urban areas such as Manhattan where out-sized rents comprise a much larger percentage of overall operating costs than in many other parts of the country. On April 27, 2020, the American Hotel and Lodging Association (“AHLA”) requested that the June 30th re-hire date be extended to December 31, 2020. If not, then as Chip Rogers, the President of the AHLA said, “… if you’re expecting hotels to pay employees now and then lay them off again, hoteliers are just going to say this loan isn’t worth it, and it doesn’t make any sense.” The AHLA is also asking for greater flexibility in the timing of PPP loan disbursements and forgiveness to coincide with the reopening and recovery for businesses.
Although many questions still remain, hotel or restaurant owners who have received PPP funding should take some comfort knowing that they were able to obtain a 1% unsecured loan in an incredibly difficult economic environment. However, if that same owner is not able to return to staffing levels that were maintained during the pre-pandemic days, then, based upon where we are in the process today, the PPP loan may not be as forgivable as was once believed.
For more information on this topic or any other matter related to the COVID-19 pandemic, please contact your Berdon Advisor.
Berdon LLP, New York Accountants
1 While the SBA has issued guidance on various aspects of the PPP, further guidance on loan forgiveness requirements and process is widely expected. This article is based on existing law and guidance, which may be impacted by future SBA pronouncements.
2 This is our “best guess” on how forgiveness would work under this fact pattern. Are we certain this is how the rules will ultimately operate? Unfortunately, no.
3 The head count and pay-level based reductions in forgiveness, and their potential cure, is another area where further guidance is critically needed.