The coronavirus pandemic is making a devastating impact on the global economy. In order to address the economic impact on US companies and employees, the US government on March 27 enacted the Coronavirus Aid, Relief and Economic Security Act (CARES Act) that included a $2 trillion relief package.
Many India-related companies, including leading technology and software-as-a-service (SaaS) companies, are incorporated as US companies. Many Indian companies have “flipped” their structure so that a US company is the parent holding company. In addition, many Indian companies have US subsidiaries. The CARES Act provisions may be relevant to all these companies.
There are two key features of the relief package: One, Economic Injury Disaster loans under 7(b) of the US Small Business Administration (SBA) loan program. Two, Paycheck Protection Program loans under 7(a) of the SBA loan program.
EID loans are tied to a specific dollar amount of damages suffered by the applicant’s business as a result of a declared disaster (in this case, the COVID-19 pandemic). In order to be eligible, the applicant needs to represent that its business has suffered economic injury. EID loans will be directly processed by the SBA.
Terms and conditions
The EID loan amount is up to $2 million and an applicant can request a non-refundable advance of up to $10,000. The interest rate is 3.75% for a 30-year term. EID Loans over $200,000 must be guaranteed by any owner having a 20% or greater interest in the applicant.
Loans under the PPP differ from EID loans in that they are not necessarily tied to the applicant being able to demonstrate a specific economic injury. Instead, the key intended purpose of the PPP loans is for the applicant to meet payroll requirements (although they may be also utilized for other qualifying purposes).
An amount of $350 billion has been allocated under the CARES Act for PPP loans. These loans will be processed and issued directly to the applicant (and guaranteed by the SBA) by US lending institutions.
Terms and conditions
The PPP loan program will allow businesses suffering due to the coronavirus outbreak to borrow money for a variety of qualified expenses related to employee compensation and benefits including payroll costs as well as mortgage and rent payments. Qualified expenses may also be forgiven for an eight-week period under the PPP loan program.
The CARES Act has expanded the number of businesses (including non-profits) that are eligible for SBA loans and raises the maximum amount for such a loan to 2.5 times the average total monthly payroll costs, or up to $10 million for a 10-year loan term period. The maximum interest rate is 4%.
Cross-border legal Issues
The two loans described above are for US business entities including C and S corporations, limited liability companies, limited partnerships, limited liability partnerships and sole proprietorships. However, several cross-border legal issues may arise.
Ownership of the business and use of funds
Foreign ownership of the US business does not in itself disqualify a US business from being an applicant. However, tax information authorization and financial statements must be provided by any person or entity owning more than 20% of the US business and for any owner who has 50% or more ownership in an affiliate business.
In addition, there are restrictions on the use of the funds. These restrictions mean that the use of funds should be for domestic US purposes and expenses. In addition, compensation for non-US based employees may not be used as the basis for a loan.
Under the Affiliation Rules, entities are deemed to be affiliates of each other if a business controls or has the power to control another or a third party (or parties) controls or has the power to control both businesses. Control may exist through ownership, management, or other relationships between the parties.
The CARES Act loans are for US businesses with less than 500 employees. The CARES Act continues to apply the SBA’s Affiliation Rules in determining the 500-employee cap. This calculation includes companies that have 500 employees or fewer across all “affiliates”. There are exemptions for hospitality businesses (hotels and restaurants) and franchise businesses.
The Affiliation Rules may capture shareholders who own more than 50% equity shareholding of an applicant and which therefore result in the applicant’s employee count being added to the employee count of the 50% equity shareholder. This could capture both downstream entities (US parent with a non-US subsidiary) and upstream entities (US subsidiary with a non-US parent) and result in the US entity deemed to be surpassing the 500-employee limit.
In addition, under the current SBA regulations, a US entity with minority investments (less than 50% equity stake) from venture capital and private equity funds or corporate investors could be deemed to be “affiliated” with its investors (and therefore required to aggregate its employee count with other companies in the fund’s portfolio) due to typical protective provisions (that is, negative control provisions) in venture capital transactions. There are several structures that may be utilized in order to mitigate the effect of the Affiliation Rules on eligibility.
US venture capital and private equity fund association groups have been lobbying the US Treasury and SBA to amend the Affiliation Rules. It remains to be seen whether such efforts will result in amendments being made to the CARES Act.
Shantanu Surpure and Chris Rasmussen are partners at Inventus Law in Silicon Valley.