CARES Act Paycheck Protection Loan Program: From the Secured Lender Perspective

By David W. Morse, Esq.

On March 27, 2020, Congress approved the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”).  The CARES Act includes extensive provisions to address the current public health crisis, including provision for $349 billion of commitments for general business loans under Section 7(a) of the Small Business Act (15 U.S.C. 636(a)) through June 30, 2020. Title I of the CARES Act, titled “Keeping American Workers Paid and Employed Act,” sets out the terms for the “Paycheck Protection Program.”  The Paycheck Protection Program substantially expands the existing loan program of the Small Business Administration under Section 7(a) of the Small Business Act.

As a result of the changes to Section 7(a) under Section 1102 of the CARES Act, the Paycheck Protection Program is a potential source of interim financing during the current crisis to assist many businesses that are borrowers from asset-based lenders and other secured lenders, recognizing that some lenders may want to consider obtaining loans under the program themselves or even becoming lenders qualified to provide loans under the program.

Set out below is a summary of certain elements of the Paycheck Protection Program, together with points for the secured lender to consider when its borrower seeks a loan under the program 

As a preliminary matter, there are three significant points to note about the program, subject to further qualification and details outlined below:

  • the Paycheck Protection Program significantly expands who can borrow under Section 7(a) to generally make most business concerns with less than 500 employees eligible;
  • the loans are to be made by existing qualified SBA lenders and the statute contemplates that additional lenders may get qualified, but there is likely to be some time required for banks and other SBA lenders to ramp up to provide such loans, however it will not require going to the SBA;
  • the program includes the forgiveness of the loans up to an amount equal to 8 weeks of payroll costs and other specified costs of a business to the extent the loan proceeds are used to pay such amounts.

In addition to seeing how SBA lenders will establish their requirements for the loans under the Paycheck Protection Program, the Small Business Administration is required to provide guidance on loans under the program within 30 days of the enactment of the statute, so there will still be further developments.

Expansion of Eligible Borrowers

Section 1102 of the CARES Act amends Section 7(a) of the Small Business Act to expand the eligible recipients for loans from only “small business concerns” under current SBA rules to any business concern so long as it employs not more than 500 employees (subject to the SBA establishing a different standard for a specific industry).   

The CARES Act also expands the program to make sole proprietorships, independent contractors and self-employed individual eligible for loans, as well as nonprofit organizations described in Section 501(c)(3) of the Internal Revenue Code, veterans organizations described in Section 501(c)(19) of the Internal Revenue Code and Tribal business concerns, in each case subject to the requirement that it not have more than 500 employees.

An eligible recipient applying for a program loan is required to make a good faith certification of the following:

  • that the uncertainty of current economic conditions makes the loan request necessary to support the ongoing operations of the recipient,
  • that the funds will be used to retain workers and maintain payroll and make mortgage payments, lease payments and utility payments,
  • that the recipient does not have an application pending for a loan under the program for the same purpose and duplicative of amounts being applied for, and
  • during the period from February 15, 2020 to December 31, 2020, the recipient has not received amounts under the loan program for the same purpose and duplicative of amounts applied for.

In determining the number of employees of a business concern, an “employee” includes individuals employed on a full-time, part-time or other basis.

Section 7(a) of the Small Business Act includes a requirement that employees of affiliated companies be counted for purposes of determining whether a business satisfies the requirement of having less than 500 employees.  If affiliated companies collectively have more than 500 employees then they are not eligible.

Section 121.103 of 13 CFR (which is titled “How does SBA determine affiliation?) says that concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists. The SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships, in determining whether affiliation exists.

Lender Note.  The determination by the SBA as to “affiliation” can be quite fact intensive so it may be worthwhile in any given instance for the borrower to review the regulation and its circumstances.  This has been an issue for joint ventures, private equity firms and family offices that may own and control a portfolio of companies, and may mean that the program is not available for some sponsor-backed asset-based borrowers.

The legislation does say that these rules of “affiliation” are waived with respect to eligibility for a covered loan to: (i) any business concern with not more than 500 employees that is assigned a NAICS code beginning with “72”—which is for businesses in “Accommodations and Food Services”, (ii) any business concern operating as a franchise that is assigned a franchise identifier code by the SBA and (iii) any business concern that receives financing assistance from a Small Business Investment Company.

Amount and Terms of Program Loans

Lender Note.  If a borrower obtains a loan under the Paycheck Protection Program, unless the credit agreement already includes a category of permitted indebtedness that applies to such a loan, the secured lender will need to consent to the debt. And, even if the credit agreement already includes a “basket” that would permit the loan, the lender and borrower may not want to use the capacity under such basket if it is limited for purposes of the loan. The willingness of a lender to consent to any debt requires that the lender know the terms and conditions of the debt so it knows what in fact it is consenting to and as important, for the lender to determine any conditions to such consent.

The legislation does not set out all of those terms of the loans—some aspects of the loan will presumably be set by the institution that makes the loan, and by the regulations that are to be issued by the SBA, but it does set out key terms.  And, the secured lender will need to consider the significance of the critical part of the program with respect to loan forgiveness discussed below in establishing any requirements it has to permit the debt.


During the covered period (which is from February 15, 2020 to June 30, 2020), the maximum amount of the loan may be the lesser of:

  1. the sum of: (i) 2.5 times the average total monthly payments by the applicant for “payroll costs” incurred during the 1-year period before the date on which the loan is made (with some modification to this period for a “seasonal employer" and in certain other circumstances), plus (ii) the amount of SBA Economic Injury Disaster Loans being refinanced under the program, if any; or
  2. $10 million.

“Payroll costs” is a defined term that includes:

  • payment of any compensation with respect to employees that is a salary, wage, commission or similar compensation,
  • payment for vacation, parental, family, medical or sick leave,
  • allowance for dismissal or separation,
  • payment required for group health care benefits, including insurance premiums,
  • payment of retirement benefits and other items.

But it does not include:

  • compensation of an individual employee in excess of an annual salary of $100,000,
  • taxes imposed or withheld under chapters 21, 22 or 24 of the Internal Revenue Code during the covered period,
  • taxes or any compensation of an employee whose principal place of residence is outside of the United States,
  • qualified sick leave or family leave wages for which credit is allowed under the Families First Coronavirus Response Act.


The legislation says that a lender under the program is required to provide an “impacted borrower” a complete deferral of payments of principal, interest and fees on a loan under the program for a period of not less than 6 months and not more than 1 year.  The statute says that each eligible recipient that applies for a covered loan is to be considered an “impacted borrower.”

Interest and Fees

A loan under the program is to bear interest at a rate not to exceed 4%.  The statute says that all fees are waived.  It also says that there are no prepayment penalties for any payment made on a loan under the program.


If a loan has a remaining balance after reduction based on the loan forgiveness amount under Section 1106 of the CARES Act (discussed below), the remaining balance may have a maximum maturity of 10 years from the date on which the borrower applies for loan forgiveness under Section 1106.

Lender Note:  While the statute refers to the maximum maturity it does not indicate whether there may be shorter maturity.  Consequently, the secured lender to a borrower obtaining a program loan will want to see what the maturity to its borrower will actually be and determine how that may fit with the cash flow available for repayment of the debt.

Of course, if the entire balance of the loan is forgiven, the maturity date will not be applicable.


While under the Section 7(a) SBA program, collateral and/or personal guarantees are generally required, the Paycheck Protection Program expressly eliminates this requirement. Under the Paycheck Protection Program, no personal guarantees or collateral are to be required.

As a result, the secured lender will not need to consent to any liens or deal with any intercreditor issues that might have arisen otherwise. 

The statute goes further stating that “notwithstanding the waiver of the requirement for personal guarantees or collateral,” the SBA will have no recourse against any individual shareholder, member or partner of an eligible recipient of a covered loan for non-payment of any covered loan except to the extent that such shareholder, member or partner uses the covered loan proceeds for purposes not authorized under the statute.

Permitted Uses

Under Section 1102, during the covered period (which is from February 15, 2020 to June 30, 2020), in addition to the allowable uses under Section 7(a) of the Small Business Act, the recipient of the loan may use the proceeds for: 

  • payroll costs,
  • costs related to group health care benefits during periods of paid sick, medical or family leave and insurance premiums
  • employee salaries, commission or similar compensation,
  • payments of interest on any “mortgage obligations” (which does not include any prepayment of, or payment of, principal on a mortgage obligation),
  • utilities, and
  • interest on any debt obligations that were incurred before the covered period.

Since Section 1102 says that the program loans may be used for the purposes listed above “in addition” to the allowable uses under Section 7(a), in theory the loan proceeds could be used for other working capital purposes and refinance certain debts—subject to existing limitations and requirements under Section 7(a). However, based on the borrower certification required as part of the application for the loan, some of the loan proceeds would be required to be used for the specified purposes.

Lender Note. One key point here, as discussed below in more detail, is only loans used for specific purposes for an 8 week period may be forgiven.  So, the lender will need to understand how the loan proceeds are going to be used and over what period of time in order to know how much debt will be remaining after its borrower applies for forgiveness of the loan.  If the lender does not expect there to be any loan balance remaining because of the forgiveness feature of the program it will need to require that all of the proceeds be used for the specific purposes within the required time period.

Lender Note.  To the extent that the borrower has a revolving credit facility, the statute does not address how to identify that the interest is payable on debt obligations incurred before February 15, 2020, since the debt outstanding on or before February 15, 2020 (the beginning of the covered period) may have been paid down and the company received subsequent borrowings thereafter.  The secured lender may want to review its loan balances and payments received to determine if it can identify debt that was outstanding on or before February 15 and whether there is any interest on such debt that has not been paid.  Given the current date, this is unlikely, but theoretically possible under certain circumstances.

Program Lenders

A lender approved to make loans under the Small Business Act will have “delegated authority” by the SBA to make and approve the Paycheck Protection Program loans.  Section 1102 also says that the authority to make loans under the program may be extended to additional lenders determined by the SBA and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse and service loans under the program.

Applications for a loan are to be made directly to the lender, rather than to the SBA as is the case with the SBA’s Economic Injury Disaster Loan Program.

Lender Note.  Given that there will likely be a significant volume of requests for loans under this program it is reasonable to anticipate that the existing SBA lenders will be overwhelmed.  Since many asset-based lenders are banks with SBA units, the ability of the two units to coordinate on borrowers may be a positive development for prospective borrowers under the program, and helpful to those asset-based lenders in having their borrowers obtain access to the loans.  For those asset-based lenders that are not affiliated with banks approved under the Small Business Act, it may be desirable to establish contacts with such an approved institution.

A typical SBA loan under Section 7(a) can involve extensive documentation from the applicant and each SBA lender has its own process and requirements in this regard.  A key issue is how the SBA lenders will modify these procedures in order to facilitate the making of the loans under the new program. 

Loan Forgiveness

The real key to this program is the intention for loans made under the program to be forgiven--in effect turning a loan into a grant and relieving the borrower of the obligation to repay it, but only if the borrower can satisfy the criteria for such forgiveness.

As set out in more detail below, the amount of the loans forgiven will need to tie to the specific uses of the loan proceeds during the “covered period,” which is the period of 8 weeks after the loan is made.

Lender Note.  There are a few key points for the secured lender to consider:

  • The secured lender may want to include in any consent to the loan that its borrower comply with the requirements in the statute to obtain such forgiveness for at least some, if not all, of the loan.
  • Since the amount of the loan that is subject to forgiveness is only for the 8 week period beginning on the date of the loan, the secured lender needs to take into account whether the amount of the loan will be limited to the applicable costs for such 8 week period or if the loan is greater than such amount, how the borrower will repay the balance.

Under Section 1106(b), a borrower is eligible for forgiveness of indebtedness on a “covered loan” (that is a loan made under the Paycheck Protection Program before June 30, 2020) in an amount equal to the sum of the following costs incurred and payments made during the “covered period” (that is the 8 weeks from the origination of the loan):

  • payroll costs, which is a defined term under Section 1102 of the CARES Act as set out above,
  • any payment of interest on any “covered mortgage obligation” (which does not include any prepayment of, or payment of, principal on a covered mortgage obligation), which is defined as any indebtedness incurred in the ordinary course of business that is a liability of the borrower, is a mortgage on real or personal property and was incurred before February 15, 2020,
  • any payment on any “covered rent obligation”, which is defined as rent obligations under a lease in force before February 15, 2020,
  • any “covered utility payment”, which is defined as payment for electricity, gas, water, transportation, telephone or internet access for which service began before February 15, 2020.

The amount of the loan that is forgiven is limited to the principal amount of it, which suggests that interest will still be required to be paid.

Under Section 1106(d) the amount of the loan forgiveness is to be reduced based on reduction in employees and payroll of the borrower (subject to rehiring).

A borrower applies for forgiveness at the end of the relevant period following various procedures set out in Section 1106 and the lender then has 60 days after the date the SBA lender receives the application for loan forgiveness to issue its decision on the application.

A borrower seeking loan forgiveness is required to submit to the SBA lender that is servicing the covered loan an application, which must include:

  • documentation verifying the number of full-time equivalent employees on payroll and pay rates for the applicable periods, including— (A) payroll tax filings reported to the Internal Revenue Service; and (B) State income, payroll, and unemployment insurance filings;
  • documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments;
  • a certification from a representative of the eligible recipient authorized to make such certifications that (A) the documentation presented is true and correct; and (B) the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments; and
  • any other documentation the SBA determines to be necessary.

The statute expressly provides that for tax purposes any amount which would be included in gross income for a borrower by reason of the forgiveness of the loan under Section 1106 is to be excluded from gross income.

Lender Note.  As part of its consent to the debt from the loan under the program, the secured lender may want to consider including as conditions and affirmative covenants that:

  • the company maintain the records required to be submitted for forgiveness in accordance with the statute,
  • the borrower will promptly at the end of the 8 week period after the loan is made submit its application for loan forgiveness,
  • the borrower regularly report to the secured lender on its use of the loan proceeds, the costs it is incurring that are being paid with the proceeds and the maintenance of the applicable records.

Relationship to SBA Economic Injury Disaster Loans

The CARES Act has not been the only legislation to be proposed or passed in response to the current public health crisis.  In fact, according to one source, as of March 27, 2020, there are 27 bills pending in Congress and three laws that have been enacted in connection with the coronavirus.  One of those three laws is the Coronavirus Preparedness and Response Supplemental Appropriations Act, which was enacted on March 6, 2020.  This legislation includes provisions for Economic Injury Disaster Loans to be made by the SBA.  While a review of that legislation is beyond the scope of this discussion, below are a comparison of some of its terms to the Paycheck Protection Program.

Unlike loans under the Paycheck Protection Program, Economic Injury Disaster Loans may be made only to businesses that qualify as “small businesses” under existing SBA rules.

A prospective borrower of a Economic Injury Disaster Loans must submit its application to the SBA, rather than to a private lender as is the case under the Paycheck Protection Program.

Eligible recipients of Economic Injury Disaster Loans may receive up to $2 million in loans to use for working capital and ordinary course expenditures, though the amount available to any business is tied to the actual economic injury sustained by that business resulting from the effects of COVID-19.

Eligible recipients must also show that they have exhausted all reasonably available funds at their disposal and have been unsuccessful in obtaining other third-party funding (which may include additional equity investment from significant owners) on reasonable terms, a requirement that is waived in the Paycheck Protection Program.

Under the terms of the Paycheck Protection Program, an Economic Injury Disaster Loans made during the period beginning on January 31, 2020 may be refinanced as part of a loan under the Paycheck Protection Program.


While there are still steps required for the implementation of the Paycheck Protection Program both from the lenders that will be making the loans and from the regulations to be issued by the SBA, a borrower from asset-based lenders and other secured lenders should be considering carefully how their needs would fit within the opportunity to access funds under the program, including determining the amount of the loans that such borrower could obtain, how much it would seek to have forgiven and the actual cash flow impact on its business, both in terms of having the loan proceeds available to it and in repaying any loans that would not be included within the scope of the loan forgiveness, if any.

At the same time, the asset-based lender or other secured lender with a borrower that may be seeking a loan should be considering whether its consent to such loan will be required under its loan documents and if so, any conditions that the lender may want to put on allowing a loan under the Paycheck Protection Program.

About the Author

David Morse photo
David W. Morse is member of Otterbourg P.C. and presently co-chair of the firm's finance practice group.  He represents banks, private debt funds, commercial finance companies and other institutional lenders in structuring and documenting loan transactions, as well as loan workouts and restructurings. He has worked on numerous financing transactions confronting a wide range of legal issues raised by Federal, State and international law.