The CARES Act – Implications for Fund Managers
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or “Act”), signed into law by President Trump on March 27, 2020, includes among its approximately $2.2 trillion in economic stimulus programs a series of measures designed to provide economic support to eligible businesses. These measures include, among others, broad eligibility for low-interest loans and loan forgiveness, tax credits and deferral of tax payments.
Managers of funds investing in illiquid assets, such as real estate funds, infrastructure funds, private equity funds or distressed debt funds, and managers of funds investing in liquid assets, such as hedge funds or commodities funds, manage more than just the assets under their control. They also are running a business, with revenues coming from management fees, performance fees and other sources, and an expense ledger covering employee payroll, rent, utilities, insurance and many other expenses. While many Fund Managers are focused on how to use available government programs to help their investments, Fund Managers should not overlook the availability of benefits to help their own businesses weather the coronavirus crisis and related economic downturn. This bulletin focuses on programs available for Fund Managers themselves.
Key benefits for eligible businesses under the CARES Act include the following:
• Eligibility for Emergency SBA Loans for Small/Midsize Businesses (500 or Fewer Employees): Under the CARES Act’s Paycheck Protection Program (“PPP”), most businesses that (i) were in operation (and paying employees or independent contractors) as of February 15, 2020, and (ii) have 500 or fewer employees (including full-time, part-time, and certain other employees) may be eligible for loans under the Section 7(a) loan program administered by the Small Business Administration (“SBA”) in an amount up to the lesser of $10 million or two-and-a-half times the average total monthly payroll costs from the prior year (subject to a $100,000 annual per-employee cap). As described below, if the loan proceeds are used for the purposes permitted under the PPP, all or a portion of the loan may be forgiven. The portion of the loan not forgiven will have a maturity of two years and bear interest at a rate equal to 1.0% per annum. Repayment of the loan will be deferred for six months following the date of disbursement of the loan and the loan may be prepaid at any time without penalty. Eligible applicants need not pledge collateral or provide a personal guarantee. However, they must self-certify, among other things, that (i) current economic uncertainty makes the loan necessary to support the ongoing operations of the business; and (ii) the loan will be used for permissible enumerated purposes. The loan proceeds may be used for payroll (including paid leave), health-insurance premiums, retirement benefits, interest on mortgage debt, rent, utility costs and interest on other debt obligations.
Subject to certain limitations, a Paycheck Protection Program loan is eligible for forgiveness — effectively converting it into a grant — to the extent it is used for payroll expenses (not to exceed $100,000 of annualized compensation per employee) or rent, utility or mortgage interest payments during the eight-week period following origination of the loan. The SBA has clarified that not more than 25% of the forgiven amount may be for non-payroll costs. The amount of loan forgiveness may be reduced if, on or after February 15, 2020, the borrowing business lays off employees, or reduces the compensation of employees earning less than $100,000 a year by enumerated amounts. However, a business is eligible for relief from certain loan-forgiveness-reduction penalties if it rehires the laid off employees, or restores their compensation to required levels, by June 30, 2020.
On April 2, the SBA issued a final interim rule on the implementation of the Paycheck Protection Program. On April 3, the PPP began accepting loan applications through participating lenders.
Observation: During the “covered period” (February 15, 2020 – June 30, 2020), virtually all businesses, including fund management businesses, with 500 or fewer employees, as well as sole proprietors, self-employed workers and independent contractors, will be eligible for loans. As a result, many entities that previously did not qualify for an SBA Section 7(a) loan will be able to obtain a PPP loan.
Observation: Fund management businesses are often operated through multiple entities, such as a management company, registered investment adviser, general partner of a fund, etc. In many cases these entities will be aggregated for purposes of determining how many employees the business has.
Observation: The entity within the fund management business that is eligible to receive a loan under the Paycheck Protection Program is the entity or entities that have employee payrolls.
Observation: Fund management businesses often have employees located in foreign jurisdictions, such as the U.K., Hong Kong or Cayman. The compensation paid to these foreign employees is not included in the calculation of “payroll costs” under the PPP.
Observation: In calculating the number of employees of the Fund Manager’s business for purposes of SBA loans, the SBA guidelines currently require that affiliated entities, including portfolio companies, may have to be included. For example, a private equity firm with 60 employees that manages a fund that owns three portfolio companies, each with 150 employees, would be treated as having 510 employees for this purpose (60 plus 3 x 150). The SBA’s interim final rule states that the SBA intends to promptly issue additional guidance with regard to the applicability of affiliation rules to PPP loans. However, as of the time of this bulletin, no such change has been officially announced. Affected Fund Managers should continue to monitor this issue.
Observation: An eligible business may borrow only once during the program, and thus should consider applying for the maximum loan amount for which it is eligible.
• Eligibility for Federal Loans for Larger Businesses (501-10,000 Employees): Businesses with between 501 and 10,000 employees will be eligible for available federal loans at rates not exceeding 2% per year (with no payments due or accrual of interest for the first six months). Such businesses must certify that, among other things, (i) the loan is necessary to support its ongoing operations, and (ii) the business will use the funds to retain at least 90% of its workforce at full compensation and benefits until at least September 30, 2020, and will not outsource or offshore jobs for a specified time period. Loan forgiveness is not available under this program.
Observation: This program is suited for larger, institutional investment managers; asset managers that are part of a larger organization; or fund managers whose portfolio company affiliates aggregate to more than 500 employees. As a result, many entities that otherwise would not qualify for a PPP loan will be able to participate in this new program.
Observation: Fund Managers that are part of a larger institution or complex should consult with other parts of their institutions to allow for a coordinated decision on program choices and applications.
• Eligibility for SBA Economic Injury Disaster Loans (“EIDL”) for Small Businesses: Under the SBA’s EIDL program, as expanded and modified by the CARES Act, businesses with less than 500 employees that were in existence as of January 31, 2020, are also eligible for emergency loans of up to $2 million at a 3.75% interest rate, subject to EIDL rules. The EIDL loans may be used for payroll, accounts payable and other debts that otherwise cannot be paid due to the impact of COVID-19.
Observation: Eligible businesses can receive checks for up to $10,000 within three days of applying for the loan — and need not repay the $10,000 (effectively converting it to a grant) if the loan application is later denied.
Payroll Tax Credit and Deferral:
• Employee Retention Payroll Tax Credit: Certain employers whose businesses are affected by COVID-19 may be eligible to receive a refundable payroll tax credit equal to 50% of qualified wages (including health benefits) up to $10,000 per employee for wages paid from March 13, 2020, through December 31, 2020. Because this credit offsets employment taxes, even eligible businesses with losses can take advantage of it. Employers that were carrying on a trade or business at the beginning of 2020, and either (x) have experienced a reduction in gross revenue of at least 50% in a calendar quarter in 2020 compared with the same calendar quarter of 2019 (a “Significant Revenue Decline”) or (y) had their operations suspended (in whole or in part) during the calendar quarter due to governmental orders restricting commerce, travel or the size of group meetings related to COVID-19 (a “Suspension of Operations”), are generally eligible for the refundable payroll tax credit for each employee on the payroll. For employers that experienced a Significant Revenue Decline, this tax credit ends after the quarter in which the business’s revenue exceeds 80% of its revenue from the same quarter in the previous year. For employers with more than 100 full-time employees, “qualified wages” are wages paid to employees when they are not working due to the COVID-19-related circumstances. For businesses with 100 or fewer employees, all employee wages qualify for the credit, whether the employer is open for business or subject to a shut-down order.
Observation: If the business receives a loan under the SBA’s Paycheck Protection Program, the business is not eligible for a payroll tax credit. Fund Managers should carefully weigh the benefits of both programs before choosing which one to pursue. However, the payroll tax credit can be claimed in conjunction with the payroll tax deferral described below.
Observation: For purposes of applying these provisions including determining whether a Fund Manager’s business has had a Significant Revenue Decline or a Suspension of Operations and how many employees the business has, all members of a group of entities that are treated as a single employer under Section 52(a) and (b) and Section 414(m) and (o) of the Internal Revenue Code of 1986, as amended, (i.e. entities that have common ownership of 50% or more, which are under common control or which are “affiliated service providers”) are treated as a single employer. This again raises the issue of whether a Fund Manager’s business is aggregated with portfolio companies owned by the funds that the Fund Manager controls. It is likely given the extremely broad definition of what constitutes a single employer for this purpose that portfolio companies and other related companies would be treated as a single employer for purposes of this provision.
Observation: Fund Managers who advise funds structured as “unaffiliated” for regulatory purposes should consult their counsel for advice regarding affiliation for purposes of determining a Significant Revenue Decline or a Suspension of Operations.
Observation: A Fund Manager’s revenue typically consists of management fees, performance fees and other income. Fund Managers also may have income with respect to capital invested in the fund or from a carried interest in the fund. Often these revenue streams are received by different entities, which may also have different ownership. For purposes of calculating whether there has been a Significant Revenue Decline, these fee structures should be reviewed carefully with counsel to determine which revenues should be included in the calculation in light of the treatment of affiliated entities as a single employer.
Observation: “Qualified wages” do not include amounts of paid sick leave and paid public health emergency leave that employers are required to provide pursuant to the Families First Coronavirus Response Act, although such amounts are generally eligible for a payroll tax credit pursuant to that legislation.
Observation: The credit can be claimed against amounts that have already been deposited in payroll accounts and, through an accelerated process, against wages for which amounts have not yet been deposited.
• Payroll Tax Deferral: Additionally, employers can defer payment of the employer portion of the 6.2% payroll tax due for the rest of 2020. Normally, employers are required to make payroll tax payments monthly or twice per month (although this time frame may be greatly reduced where substantial amounts are involved). The amounts not paid in 2020 will be due in two installments, on December 31, 2021, and on December 31, 2022. Employers who receive loans under the SBA’s Paycheck Protection Program (described above), are eligible for the payroll tax deferral.
Observation: If the business receives a loan under the SBA’s Paycheck Protection Program and the loan is forgiven, the business is no longer eligible for deferral of payment of payroll taxes and must deposit previously deferred payroll taxes. It appears, however, that employers can defer payroll taxes until the time of forgiveness.
Observation: This provision effectively provides employers an interest-free loan for payroll taxes. Subject to the exception noted above, all Fund Managers are eligible for this benefit and should take advantage of this payroll tax deferral program.
The SBA is in the process of rolling out regulations for the administration of its loan programs under the CARES Act. Businesses, including Fund Managers, that may be eligible for relief under the Act are therefore encouraged to stay closely abreast of regulatory and legislative developments.
At Stroock, we have established a multidisciplinary task force focused on coronavirus-related legal issues. Our aim is to provide holistic and proactive business guidance.
Please do not hesitate to contact us with any questions or concerns you may have during this period, including assistance drafting any documentation referred to herein.
For More Information:
 Loans under the PPP will be made by banks and guaranteed by the SBA, which has the full faith and credit of the US government.
 The CARES Act waives these affiliation rules for (i) any business with not more than 500 employees that is assigned an NAICS code beginning with 72 (generally, accommodations and food services), (ii) any business operating as a franchise that is assigned a franchise identifier code by the SBA and (iii) any business concern that receives financial assistance from a Small Business Investment Company. Fund Managers are unlikely to fit within any of these exceptions.
This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.