On April 24, 2020, the President approved an additional funding package to replenish loans small businesses are eligible to apply for through the Paycheck Protection Program (PPP). On the same day, the Department of the Treasury released added PPP guidance by way of an Interim Final Rule that substantially changes the landscape for hedge funds and private equity firms intending to submit applications for the Small Business Administration’s (SBA) PPP loans by expressly stating these businesses are considered ineligible for participation in the program.

Hedge Funds and Private Equity Firms PPP Loan Application Being Denied

Interim Final Rule Disallows PPP Loans for Hedge Funds and Private Equity Firms

The stance of the Interim Final Rule – which negates both the related sections of the CARES Act and prior guidance issued by the Treasury – is that because hedge funds and private equity firms are mainly involved in “investment or speculation”, Congress’ original intent was for these types of businesses to be excluded from applying for and receiving PPP loans. The Interim Final Rule guidance is more in keeping with regulations previously established by the SBA prior to the COVID-19 outbreak, which rendered hedge funds and private equity firms ineligible to receive 7(a) loans.

Portfolio Companies May Still Be Eligible for PPP Loans

The updated guidance further clarifies that portfolio companies are permitted to apply for and can obtain a PPP loan as long as they are not deemed to be an affiliate under SBA loan affiliation rules (for a definition of affiliates, refer to the SBA guidelines). To establish eligibility, the onus lies with the portfolio company to undertake an analysis of the sponsor to determine whether or not it must be classified as an affiliate of the private equity firm.

If an eligible portfolio company chooses to submit an application for a PPP loan, it must certify that the loan is essential to support ongoing operations during the time of COVID-19.

Employee Stock Option Plans, Not Subject to Affiliation Rules

Under the PPP, an affiliation does not result from a business’s participation in an employee stock option plan (ESOP) and is thereby still able to participate in the PPP loan program.

No PPP Loans for Businesses in Bankruptcy

If a business was in bankruptcy proceedings either at the time it submitted its PPP loan application or at any time before it received PPP funds, the borrower is obligated to contact the lender to disclose that information and to cancel any pending application. If the business fails to take either of these courses of action, they may be subject to action by the SBA for obtaining a PPP loan for unauthorized purposes.

Repayment of Loan Funds for Ineligible Businesses

If a hedge fund, private equity firm, or other small business had already applied for and received PPP loan funds before the Interim Final Rule was released but is now deemed ineligible under the guidance, the business is obligated to pay back the monies received. A limited safe harbor allowance will be made if the PPP loan is repaid before May 14, 2020. It will be assumed that hedge funds and private equity funds which had previously applied for a PPP loan certified their need as essential and submitted an application in good faith, utilizing the language in the CARES Act as a guideline. Should an ineligible borrower retain the funds, they may be subject to enforcement by the SBA, although specific penalties have yet to be formally communicated.

To avoid potential complications associated with ineligible businesses claiming PPP loans, be sure to read the PPP application thoroughly before submitting it, or consult with your Untracht Early advisor to review the terms of eligibility and whether or not they apply to your business.