Treasury Provides Material PPP Update for Hedge Funds and PE Firms

On April 24, 2020, the Department of Treasury (“Treasury”) issued a new interim final rule (the “Interim Final Rule”) and guidance, which materially changes portions of the existing guidance on the paycheck protection loan program (“PPP”) in a way meaningfully detrimental to hedge funds and private equity funds in particular. You can find our previous client alerts on the program here. The material terms of the Interim Final Rule are as follows:

• Hedge funds and private equity firms are no longer eligible for PPP loans. The accompanying guidance takes the position that hedge funds and private equity firms are “primarily engaged in investment or speculation” and therefore allegedly are not the intended beneficiaries of the program. This new guidance directly and materially contradicts previous Treasury guidance and the plain text of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). Although the prohibition explicitly applies to hedge funds and private equity firms, other businesses should consider whether they are “primarily engaged in investment or speculation” such that they would be ineligible for a Small Business Administration (“SBA”) Section 7(a) loan, as such businesses may also be — or may later be alleged to be — ineligible for a PPP loan.

• Businesses that are ineligible for PPP loans that have already received a PPP loan must promptly repay the funds. If a hedge fund, private equity firm or other ineligible business applied for a PPP loan prior to April 24, 2020 (when the rule was issued), and received a PPP loan, such business will be granted a limited safe harbor if it repays the PPP loan amount before May 7, 2020. Businesses that fit into this safe harbor will be deemed to have made their certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the [business]” in good faith and because of a misunderstanding or misapplication of the CARES Act and existing guidance. There is no specific penalty for failing to make use of the safe harbor period to repay the PPP loan, but the implicit threat of enforcement hovers over non-compliant recipients.

• Portfolio companies of hedge funds and of private equity firms may still be eligible for PPP loans. However, an analysis of whether the sponsor will be deemed an “affiliate” of the portfolio company is required. If the sponsor is an affiliate, the portfolio company will only be ineligible for a PPP loan if, when aggregated with the sponsor and all other affiliates, the business would exceed the SBA standard size for its industry (as measured by number of employees or revenue, as applicable) and the SBA’s alternative size standard, a financial eligibility test.

If the sponsor is an affiliate, the portfolio company will only be ineligible for a PPP loan if, when aggregated with the sponsor and all other affiliates, the business would exceed the SBA standard size for its industry (as measured by number of employees or revenue, as applicable) or fail the financial eligibility test. The CARES Act does provide exemptions to the general SBA affiliation rules for applicants operating in the accommodation and food services industry, operating as a franchise, or receiving financial assistance from a Small Business Investment Company.

The Interim Final Rule cautions, however, that in addition to applying any applicable affiliation rules, all borrowers should carefully review the required certification on the PPP application form, which states that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations” of the borrower. There is still no guidance from regulators as to what satisfies that test.

• Businesses are deemed not to be affiliated with their employee stock options plans (“ESOPs”). For purposes of the PPP, a business’s participation in an ESOP does not result in affiliation between the business and the ESOP.

• Businesses that are the subject of a bankruptcy proceeding are ineligible for the PPP. Businesses currently in bankruptcy are ineligible for PPP loans. If bankruptcy proceeding is instituted after the date on which the business applies for a PPP loan but prior to the funding of the loan, the business has an obligation to notify the letter and cancel the PPP application.

Summary

The Treasury’s Interim Final Rule includes a number of material changes governing which businesses may be eligible for PPP loans. These changes affect hedge funds, private equity firms and those that are the subject of a bankruptcy proceeding. Ineligible businesses that have received a PPP loan are required to return those funds by May 7, 2020, and all borrowers should carefully review the required certification on the PPP application form.