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CARES Act Paycheck Protection Program: What Franchisors and Franchisees Need to Know

On March 27, 2020, President Trump signed into law The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), a $2 trillion stimulus package to provide economic relief to individuals and businesses due to the effects of the COVID-19 (“coronavirus”) pandemic. Section 1102 of the CARES Act allocates a significant amount of federal funds to cover eight weeks of payroll and overhead expenses for small businesses through the Paycheck Protection Program. This client alert provides a summary of the key provisions and eligibility requirements of the Paycheck Protection Program for franchised businesses.

The Paycheck Protection Program

Under the Paycheck Protection Program, the Small Business Administration (SBA) will guarantee up to $349 billion in loans for small businesses of not more than 500 employees to maintain their payroll during the pandemic. These loans have very favorable terms, including loan forgiveness for eight weeks of payroll and overhead expenses, first payment deferral for six months, no collateral, no personal guarantees, no borrower or lender fees payable to the SBA, and 100% guarantee by the SBA. These features make the Paycheck Protection Program akin to an emergency grant program for small businesses to fund their payroll during the pandemic.

Small businesses may borrow up to $10 million, with interest not to exceed 0.5%, and maturity of two years, to fund payroll costs for full-time and part-time employees, as well as payment of tips, leave time, group health insurance benefits, and retirement benefits. Small businesses may also use the loan for state and local taxes attributable to employee wages, lease payments, and utilities and interest on mortgage payments.

The maximum loan amount is equal to 2.5 times the average monthly payroll costs for 2019. If the business was not in operation for the entirety of 2019, it should average for the time it was in operation. Under the Paycheck Protection Program, payments made on payroll costs, rent, utility, and mortgage interest in the 8 weeks following origination of the loan may be forgiven, however reductions in salary or layoffs may impact the amount eligible for forgiveness. Additionally, loan forgiveness will be limited for non-payroll costs.

Franchisee Eligibility: The Affiliation Test and the SBA Franchise Directory

Applicants with not more than 500 employees are eligible for Paycheck Protection Program loans.  Traditionally, the SBA has used an “affiliation” test to assess whether a business’s affiliates will be considered part of the same entity in order to determine eligibility (i.e., whether the entity is a small business concern or, in this case, has over 500 employees). According to the SBA, “[A]ffiliation exists when one business controls or has the power to control both businesses. Control may arise through ownership, management, or other relationships or interactions between the parties.”

The CARES Act contains a specific affiliation test exemption for franchised businesses seeking relief as part of the Paycheck Protection Program. Under the Paycheck Protection Program, a franchised business will not be aggregated with its franchisor and unrelated franchisees, for purposes of determining whether it has more than 500 employees, if the franchise has been assigned a franchise identifier code by the SBA.  The SBA assigns a franchise identifier code only to franchises listed on the SBA Franchise Directory. Hence, the franchise must be on the SBA Franchise Directory as a prerequisite for a franchisee to receive a loan under the Paycheck Protection Program.

In order to be listed on the SBA Franchise Directory, the SBA will conduct a separate “affiliation” assessment to determine eligibility (i.e., whether the entity is a “small business concern”). According to the SBA, “[A]ffiliation exists when one business controls or has the power to control both businesses. Control may arise through ownership, management, or other relationships or interactions between the parties.”

Franchisees may be deemed affiliated with their franchisors, or vice versa, where the franchisor exercises what the SBA deems to be significant control over the franchisee’s business. These controls may relate to, among other things, the franchisor’s step-in rights to manage day-to-day operations; the franchisor’s ability to hire, fire, or schedule the franchisee’s employees; and the franchisee’s freedom to transfer and sell the business.

A franchise system may submit its franchise agreement and Franchise Disclosure Document to the SBA for an affiliation determination. If the SBA does not find affiliation (i.e., control) as a result of the franchise agreement, the franchise system is added to the SBA Franchise Directory so that lenders can confirm that the franchisee is a “small business concern,” and therefore eligible for an SBA loan guarantee, even though it operates under a franchise agreement. As an alternative to submitting its franchise agreement, the franchisor may agree to use an SBA addendum to the franchise agreement, which removes the disqualifying control provisions from the franchise agreement, to bypass the affiliation determination and be added to the SBA Franchise Directory.

How To Apply?

Businesses may apply for the Paycheck Protection Program as early as April 3, 2020. The sample application form is available here. The Treasury Department and SBA expect a business will be able to apply for the loan and get approved on the same day. Polsinelli’s Global Franchise & Supply Network Group can assist franchisors with the process to register with the SBA. Members of the Group and the COVID-19 Response Team are available to advise businesses on eligibility for various federal and state COVID-19 relief efforts and to assist businesses in the application and filing processes.

© Polsinelli PC, Polsinelli LLP in California

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About this Author

Jan S. Gilbert Franchising Attorney Polsinelli Law Firm
Associate

Clients rely on Jan Gilbert for his strategic counsel in complex aspects of domestic and international franchising. With more than 30 years of experience, Jan advises start-ups and developed franchisors and franchisees on a wide variety of franchise relationship matters, including structuring franchise programs, federal and state regulatory issues, mergers and acquisitions, compliance issues and drafting development and area representative agreements.

Jan leverages his previous experience to negotiate both domestic and international agreements...

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