Special Considerations for Restaurants and Franchised Businesses Under the CARES Act

While few sectors are likely to be spared from the economic consequences of COVID-19, the leisure and hospitality segments have been among the hardest hit. For example, according to the March 2020 jobs report from the U.S. Department of Labor, more than 60 percent of March job losses came from restaurants and bars. In addition to being the hardest hit, these segments are heavily franchised. Accordingly, the Coronavirus Aid, Relief, and Economic Security (CARES) Act has special provisions designed to ensure that those affected will still have access to desperately needed rescue funds.

The Paycheck Protection Program

A key component of the relief offered through the CARES Act is the forgivable federal loans offered by the Paycheck Protection Program (PPP). The PPP, which is administered by the Small Business Administration (SBA), is designed to ensure that businesses with 500 or fewer employees can continue to meet their payroll demands. In determining the number of employees for the purposes of SBA loan eligibility, the SBA has traditionally taken into consideration the employees of all companies with which the applicant business is “affiliated.” Because of franchisor approval rights and transfer controls in franchise agreements, franchisees are often considered to be affiliated with franchisors and are prevented from accessing SBA funds without special modifications to the franchise agreement. Without the relaxation or waiver of the traditional affiliation rules, small businesses that happen to be operating under a franchised brand may be prevented from accessing CARES Act funds.

Waiver of Affiliation Rules and Locations-Specific Loans

To ensure that as many businesses as possible in the restaurant and hospitality sector—including franchised businesses—can still take advantage of CARES Act relief, the act and the interim regulations released thereunder[1] contain three important modifications to traditional SBA lending rules. First, CARES waives the traditional affiliation rules for any business concern with not more than 500 employees that, as of the date on which the loan is disbursed, is assigned a North American Industry Classification System (NAICS) code beginning with 72 (the hotel and food service industry). Second, CARES raises the employee cap for restaurants and hotels by allowing the employee count to be based on the number of employees at each physical location. For example, a restaurant franchisee with 1,000 employees across multiple physical locations could still be eligible for financial assistance under the PPP so long as none of the physical locations has more than 500 employees. Finally, the act waives the traditional affiliation rules for any business concern operating as a franchise that is assigned an NAICS franchise identifier code. Franchisors that have already obtained a franchise identifier code are listed on the SBA’s Franchise Directory. The directory lists all franchises reviewed by the SBA that are eligible for SBA assistance, as well as any further documentation that may be required to resolve eligibility or affiliation issues arising from the franchise relationship.[2]

Essentially, if a franchisee is in a franchised system that has previously obtained a franchise identifier code from the SBA, then the SBA will not apply the affiliation analysis when a franchisee applies for a loan under Section 7(a), as amended by CARES. These franchisees may, therefore, be eligible for SBA assistance under the act without taking the traditional route of having franchisors execute the SBA forms required to resolve any potential affiliation issues.

PPP Logistics

The dollar value of a loan under the PPP is based on 250 percent of the borrower’s average monthly payroll cost for the year preceding the loan disbursement (capped at $10 million) and has an interest rate of 0.5% with a maturity of two years. The first payment under a PPP loan can be deferred for six months. PPP loans can be made by any participating SBA 7(a) lender, bank, or credit union, and the loans will be forgiven as long as at least 75 percent of the funds are used to keep employees on the payroll. The remaining portion of the loan may be used for rent, utilities, or mortgage interest. PPP funding is available on a first-come, first-serve basis, and many businesses have rushed to get in line for these necessary funds.

Unsurprisingly, the first tranche of PPP funding was quickly exhausted. However, Congress infused the PPP with an additional $321 billion on April 24. The SBA began accepting new applications on April 27. As a practical matter, a business will have the best chance of receiving funding if it applies as soon as possible, works with lenders with which the business has a pre-existing relationship, and identifies all possible bases for waiver of the affiliate rules.

The Employee Retention Credit

As an alternative to seeking a loan under the PPP, businesses struggling as a result of COVID-19 should also consider the employee retention credit (ERC). While it does not provide an immediate cash infusion, the ERC is a fully refundable tax credit of up to 50 percent of wages paid to employees after March 12, 2020, and before January 1, 2021. Practically, since the maximum amount of qualified wages for each employee is $10,000, the maximum credit that a business can receive under the ERC is $5,000 per employee.

A business is eligible to claim the ERC if its operations have been fully or partially suspended due to government orders limiting commerce, travel, or group meetings due to COVID-19, or its gross receipts for the calendar quarter for which the credit is claimed are less than 50 percent of the gross receipts for the same calendar quarter in the prior year. The ERC is available to businesses of all sizes, but it offers the most flexibility to businesses with 100 or fewer employees.

The ERC and PPP are mutually exclusive, as the receipt of a PPP loan may render an employer ineligible to claim the ERC. In some instances, however, the ERC may be an easier option for certain businesses. It is easier to qualify for the ERC than for a PPP loan, and the ERC gives businesses more flexibility in deciding when to reopen. Businesses that are concerned about their ability to meet the PPP’s forgiveness criteria should consider the ERC rather than the PPP. The ERC also does not involve a loan application and is not drawn from a limited pool of money, making it a simpler and more realistic option for certain businesses. Businesses should work with experienced counsel to analyze which option may be best.

[2] The SBA Franchise Directory and related forms can be found here.