Apr 16, 2020

Considerations Between the CARES Act Paycheck Protection Program and Loan Documentation


By James A. Dempsey, Esq.

The U.S. Congress approved the Coronavirus Aid, Relief and Economic Security Act on March 27, 2020 in response to the effect of the coronavirus pandemic on both the U.S. and world economies. The acronym known as the “CARES Act” has quickly become a very familiar term within the lending and financial community.


Not since the Great Recession of 2008-2009 has the lending community been required to become so quickly and deftly familiar with new laws, rules and regulations passed and/or promulgated in response to an economic crisis, and in the current situation, an economic crisis precipitated by a pandemic.

So, what issues should lenders consider when dealing with the CARES Act? First, under Section 1102 of the CARES Act, Section 7(a) of the Small Business Act (15 U.S.C. 636(a)) has been creatively expanded to set out terms and conditions for the newly minted Paycheck Protection Program and the loans provided thereunder (“PPP Loans”). The PPP Loans provide a potential alternate source of financing to borrowers that fall outside of the typical line of credit, asset-based or mortgage loan facility that a lender needs to address. There are a number of factors that come into play as to whether a borrower is “eligible” under the CARES Act for a PPP Loan that will not be detailed here because there are a number of Alerts on the SPSK website that provide a thorough and in-depth analysis of the CARES Act. Further, many lenders may have their own small business administration loan division that will certainly be impacted as they field numerous applications for PPP Loans, and it is likely under the circumstances that only customers of such lender will be considered for a PPP Loan.

Second, how do such PPP Loans potentially run afoul with incumbent credit agreements? The good news for lenders here (and specifically secured lenders) is that under the CARES Act and the Paycheck Protection Program, there will be no guarantees and more importantly, no collateral required by the Small Business Administration (“SBA”) to secure a PPP Loan—this is a vast departure from the standard SBA loan program guaranty and collateral requirements. As a result, a lender does not need to deal with intercreditor or lender-to-lender issues as to collateral or the priority thereof. The PPP Loan may, however, have an impact on whether such additional financing falls within the exception or permitted indebtedness basket that is typically found in a well-drafted loan agreement, note or mortgage.

It is not clear yet how the PPP Loans may be viewed from a financial point of view, but the lender and borrower should discuss how these loans affect an underlying credit document and how each party may want to categorize such financial accommodation. For instance, will the parties even want the PPP Loan to be deemed “permitted indebtedness” so as to count against other allowed indebtedness that a borrower may need to possibly have at its disposal to acquire equipment, machinery or even inventory? It is important to keep in mind that under the CARES Act, proceeds of a PPA Loan may be used for certain identified needs such as payroll and healthcare benefits. However, based on a borrower certification which is required as part of the application, proceeds are required to be utilized for specified purposes identified under 1102 of the CARES Act. Moreover, the PPP Loan may be forgiven under certain circumstances and needs to be factored into the discussion as well as the covered period under the program which currently runs from February 15, 2020 to June 30, 2020.

Consideration will also need to be given as to whether such loan has any impact on a borrower’s financial covenants, particularly, a leverage ratio. Borrowers may be anxious to have a PPP Loan placed outside of a financial covenant for obvious reasons. A lender should also consider added reporting requirements, continued evidence of use of proceeds, debt service and pricing information and perhaps even the opening of a separate account as to any PPP Loans. In any event, each of the parties to a financing arrangement will want to memorialize the PPP Loan and its impact on the underlying credit agreement by either a consent letter or if needed, some type of amendment or modification that specifically sets forth the lender and borrower’s agreement and understanding as to the impact of a PPP Loan on its financing arrangements. A lender should take the time now to touch base with its borrower and determine if a PPP Loan is contemplated.

The bottom line here--the credit community is dealing with an incredibly fluid and unprecedented situation as each day unfolds. The matters discussed in this Alert are just a few of the issues the current economic environment presents and what lenders should anticipate to stay ahead of the curve when their borrowers inform them of a potential PPP Loan.

Please feel free to contact any of our banking and finance attorneys at Schenck, Price, Smith & King, LLP to assist with any questions or concerns related to the CARES Act.

DISCLAIMER:  This Alert is designed to keep you aware of recent developments in the law.  It is not intended to be legal advice, which can only be given after the attorney understands the facts of a particular matter and the goals of the client.