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Editorial 9 MIN READ

PPP forgiveness and the February 15 line: who was actually in operation

The CARES Act drew a bright line at February 15, 2020, and the gray cases are where the audits live

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 8 sections
  1. What the statute actually says
  2. What "in operation" means in practice
  3. The Schedule C gap
  4. The EIN-without-payroll case
  5. The conversion and restructuring cases
  6. What the forgiveness reviewer will ask for
  7. What remains unclear
  8. Sources

PP loan forgiveness turns on one date more than any other: February 15, 2020. If your entity was in operation on or before that Saturday, you were eligible to borrow. If it was not, you were not, and the forgiveness reviewer reading your file this summer is going to ask how you prove it.

Forgiveness applications opened on August 10, 2020, through the borrower's lender. The question most founders did not think hard enough about in April is the question the SBA is asking now.

What the statute actually says

The Paycheck Protection Program was enacted as Section 1102 of the CARES Act, Pub. L. 116-136, signed March 27, 2020. The operative eligibility language sits in the amendments to Section 7(a) of the Small Business Act, specifically 15 U.S.C. § 636(a)(36)(D)(i), which extends eligibility to any business concern, nonprofit, veterans organization, or Tribal business that "was in operation on February 15, 2020" and had either employees for whom it paid salaries and payroll taxes or independent contractors paid via Form 1099-MISC.

The "in operation on February 15, 2020" phrase is the entire ballgame. The statute does not define it. SBA and Treasury have filled the gap through a sequence of interim final rules and the PPP FAQ document, which the agencies treated as operative guidance borrowers were expected to comply with as it was updated.

The First Interim Final Rule, published April 2, 2020, at 85 Fed. Reg. 20811, confirmed the February 15 cutoff and required that applicants "were in operation on February 15, 2020 and had employees for whom [they] paid salaries and payroll taxes or paid independent contractors." The FAQ document, updated continuously since April 3, then operationalized it. FAQ #1 through FAQ #3 established the baseline. FAQ #17 addressed the seasonal and new-business alternative payroll reference periods. FAQ #14 and later FAQ #63 addressed documentation for self-employed filers. Each of these sits on top of the February 15 line; none of them move it.

The hard edge: entities formed after February 15, 2020 are not eligible, full stop. A Delaware LLC with a Certificate of Formation stamped February 18 did not get a loan, should not have received one, and if somehow one was disbursed on a false application, forgiveness will be denied and the False Claims Act is on the table.

What "in operation" means in practice

The statute says "in operation." It does not say "had an EIN," "had filed a tax return," "had commenced business," or "had its first payroll." This ambiguity is where most of the borderline cases live.

SBA's working position, evident in the First Interim Final Rule, the FAQ, and the Form 3508 forgiveness application published May 15, 2020, is that "in operation" requires two things together: legal existence as of February 15, 2020, and some indicium of actual business activity as of that date. Actual business activity for an employer is typically evidenced by having paid salaries and payroll taxes (or paid contractors) at some point on or before February 15, or at minimum having had employees on payroll whose next paycheck fell after February 15 but whose employment relationship predated it.

For a self-employed Schedule C filer with no employees, FAQ #14 and FAQ #63 (and the separate Interim Final Rule for self-employed individuals published April 14, 2020, at 85 Fed. Reg. 21747) require that the filer have been "in operation" as of February 15 and have filed or "will file" a 2019 Form 1040 Schedule C showing self-employment income. That "will file" language was a concession to the fact that 2019 Schedule Cs were not always complete in April when applications were being cut. It is also the source of the first real gray case.

The Schedule C gap

Sole proprietors who were genuinely operating in 2019 but had not yet filed their 2019 Form 1040 when they applied for a PPP loan are in a defensible position. The agency explicitly contemplated this. The IFR for self-employed individuals accepts a draft or completed 2019 Schedule C as the basis for the loan calculation, and the borrower must submit it with the application.

The trouble is the Schedule C filer who was not actually in operation on February 15, 2020, but had revenue later in Q1 or Q2. There is a temptation, when assembling a draft 2019 Schedule C in April to support a PPP application, to treat incidental 2019 activity (one client in November, a $2,000 invoice) as a qualifying business. The SBA position, reflected in FAQ #14's repeated use of "in operation on February 15, 2020," is that the business itself must have existed and been operating on that date. A Schedule C showing $3,000 of 2019 revenue from a side project that petered out in December, from someone whose real income after February 15 came from a newly opened LLC, is a borrower with an eligibility problem the forgiveness reviewer can see from the filing dates alone.

The EIN-without-payroll case

A more common gray case: an entity that received an EIN in January or early February 2020, had no payroll before February 15, and ran its first payroll in March.

The SBA has not issued a bright-line rule here. The conservative reading of "in operation" plus the payroll eligibility screens in FAQ #3 and the application form itself suggests the following test. The entity must have legally existed on February 15. It must have had workers in the employment relationship on February 15, whether or not a paycheck had yet been issued to them. And it must be able to document that relationship with offer letters, signed employment agreements, contractor engagements, or the equivalent, dated on or before February 15, 2020.

An LLC formed in January 2020 that signed its first employee on March 3, 2020, did not have employees "for whom it paid salaries and payroll taxes" as of February 15. On the narrowest reading of FAQ #3 it was not eligible. Borrowers in this position who received loans based on projected payroll rather than February 15 payroll should expect a rigorous forgiveness review, and should be assembling the dated offer letters, the incorporation certificate, the lease, and any contemporaneous communications that show the business was a going concern rather than an idea on February 15.

The conversion and restructuring cases

The third gray zone, and the most common among founders who used Delaware as a reorganization venue, is the Q1 2020 restructuring.

A founder had an LLC that had been operating since 2018. In January or February 2020, they executed a statutory conversion, an F-reorganization, or a plain-vanilla domestication moving the business from the LLC to a newly formed C-corporation. The C-corp has a March 2020 formation date on its Certificate of Incorporation. The LLC has been paying payroll for two years.

SBA has not issued specific guidance on conversions in the context of PPP, but the operational reality is that successor-entity rules apply. If the C-corp is the legal successor of the operating LLC, carrying over the EIN or having an explicit IRS assumption of the prior EIN under Rev. Rul. 73-526 or Rev. Rul. 2008-18 depending on the mechanism, and the workforce and payroll continued without interruption, the "in operation on February 15, 2020" test is satisfied at the economic level. The reviewer will want to see the conversion documents, the board resolutions, the payroll reports that span the conversion date, and usually IRS correspondence confirming continuity.

If the founder instead dissolved the LLC, formed a new C-corp in March with a new EIN, and treated the old LLC as a historical footnote, the new C-corp has an eligibility problem no matter how much goodwill transferred across. This was a common Q1 scenario among venture-backed formations where the investor preferred a clean new cap table. Those borrowers should be working with counsel now on the forgiveness application, not in October when the decision letter arrives.

What the forgiveness reviewer will ask for

The SBA's Loan Forgiveness Application, Form 3508, published May 15, 2020, and the EZ variant, Form 3508EZ, published June 16, 2020, both require the borrower to certify that the information provided in the PPP application, including the eligibility representations, was "true and correct in all material respects." The lender, under the June 22, 2020 Interim Final Rule on forgiveness, is responsible for confirming receipt of the borrower's payroll documentation and reviewing the computations. The SBA retains authority under § 1106(g) of the CARES Act and the June 22 IFR to review any loan of any size at any time.

For the formation-date question specifically, a well-assembled forgiveness file should include:

Formation documents with the state filing date (Certificate of Formation, Articles of Incorporation, or the equivalent) dated on or before February 15, 2020. For entities formed earlier and later restructured, the chain of successor documents.

Payroll records demonstrating that employees were on the payroll across the February 15 date, or in the self-employed case, a 2019 Schedule C and evidence (bank deposits, invoices, 1099s received) that the self-employment activity was ongoing.

For gray cases, dated offer letters or contractor agreements pre-dating February 15, lease agreements, utility accounts, business bank account opening documents, and any other artifacts that show the business was functioning as a business rather than existing only on paper.

The borrower certification in Box 1 of Form 3508 is signed under the False Claims Act and under 18 U.S.C. § 1001. The penalties for a false certification are not abstract. The Department of Justice has already, in the first four months of the program, brought criminal charges against borrowers who misrepresented payroll, employee counts, and eligibility. The formation-date misrepresentation is the simplest fact pattern for a prosecutor to prove, because the state filing date is a public record.

What remains unclear

Two questions are still open as of August 2020.

The first is how SBA will handle loans under $2 million in the eligibility review. The June 22 IFR and FAQ #46, published May 13, 2020, created a safe harbor for the separate "economic necessity" certification for loans under $2 million, deeming them to have made the certification in good faith. That safe harbor is about necessity, not eligibility. A sub-$2-million borrower who was not in operation on February 15 is not protected. Whether SBA will in practice review the formation-date eligibility of smaller loans with the same rigor as the necessity certification for larger ones is the open question. Borrowers should not assume they will not.

The second is how the agency will treat the gray cases where the borrower has a plausible but not airtight February 15 operation story. The statute gives SBA broad discretion. The administrative record will likely be built case by case through forgiveness denials, SBA Office of Hearings and Appeals decisions, and eventually federal court review under the Administrative Procedure Act. The first wave of denials will probably land in Q4 2020.

The right posture for a borrower with a borderline eligibility story is to document the February 15 operation case now, while the records are warm, rather than after a denial letter arrives. The most persuasive forgiveness files will be the ones assembled by borrowers who treated the February 15 test seriously in April and have the contemporaneous paper trail to show it.

Sources

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