SBA Loans: Economic Injury Disaster Loans (EIDL)
As a response to anticipated financial hardship during the Coronavirus (COVID-19) outbreak, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (also known as the CARES Act) into law. This act provides for hundreds of billions of dollars worth of relief for the United States, which, namely, includes the American working public and small businesses. In regard to small business owners specifically, there are two derivatives of the CARES act that come to ears: the Economic Injury Disaster Loan (EIDL) and the Paycheck Protection Program (PPP).
Entities are eligible for an Economic Injury Disaster Loan (EIDL) during the coronavirus pandemic by virtue of 7(b)(2) of the Small Business Act. After months of waiting for the SBA to approve applicants for the EIDL, business owners are currently receiving their loan offers. Naturally, questions arise when loan proceeds are offered, so it is important to know the dos and don’ts from a legal point of view.
The most asked question regarding the EIDL is: what can the loan proceeds be used for? In short, these loans are provided “in order to meet [small businesses’] ordinary and necessary financial obligations that cannot be met as a direct result of the disaster.” Under the current circumstances, the EIDL may only be applied towards fixed debts, payroll, accounts payable, and some bills that could not have been paid had the COVID-19 pandemic not occurred. More specifically, the loan proceeds may be used for:
(1) Providing paid sick leave to employees unable to work due to the direct effect of COVID-19;
(2) Maintaining payroll to retain employees during business disruptions or substantial slowdowns;
(3) Meeting increased costs to obtain materials unavailable from the applicant’s original source due to interrupted supply chains;
(4) Making rent or commercial mortgage payments;
(5) Repaying obligations that cannot be met due to revenue loss; and
(6) Paying accounts payable and other normal business operating expenses.
As can be concluded from the above list, the EIDL is meant to prevent a business from utterly failing; the EIDL proceeds are not to be used as an opportunity for investment, renovation, expansion, or addition income that goes beyond what would have been realized under normal circumstances.
More specifically, a small business owner is NOT permitted to use the loan proceeds for any of the following reasons:
(1) Payment of any dividends or bonuses;
(2) Disbursements to owners, partners, officers, directors, or stockholders, except when directly related to performance of services for the benefit of the small business or in the normal course of business;
(3) Repayment of any principal or stockholder loans;
(4) Expansion of facilities or acquisition of fixed assets;
(5) Repair or replacement of physical damages;
(6) Refinancing long term debt;
(7) Paying down or off loans provided by another Federal agency or any other entity licensed under the Small Business Investment Act;
(8) Payment of any part of a direct Federal obligations, except IRS debt;
(9) Payment of any penalty resulting from noncompliance with the law, regulation or order of a federal, state, regional, or local agency;
(10) Contractor malfeasance; and
For purposes of clarification, we would like to expand on items (2), (3), (4), (10), and (11).
Disbursements to owners, partners, officers, directors, or stockholders
EIDL proceeds may only be distributed to owners, partners, officers, directors, or stockholders if it is in the ordinary course of business or if the individual is providing direct services for the benefit of the company.
If an owner of a restaurant, for instance, has been receiving a monthly salary of $10,000 for the past year, then the EIDL proceeds may be used to continue paying the owner that same amount per month. However, owners cannot spontaneously change their salaries after receiving the loan to obtain larger funds from the EIDL proceeds.
The owner of small business may also be entitled to EIDL disbursements if the owner is providing direct services for the benefit of the company. For instance, let’s consider a clothing store where a manager is usually paid a monthly salary to negotiate with online vendors and manage the e-commerce sector of the business, but, due to COVID-19, the manager is unavailable to do so. If the owner finds himself completing the work of the manager by negotiating with vendors and managing the e-commerce sector of the business (thereby providing direct services for the benefit of the company), then the EIDL proceeds may be used to pay him for the services rendered.
Repayment of any principal or stockholder loans
An EIDL recipient may not use the loan proceeds to pay off any outstanding loans to a principal or stockholder of a business. Hence, if any individual having ownership in the company provided the company with a loan in the past, that loan CANNOT be paid off with EIDL proceeds. Again, the EIDL is meant to provide stability to the company, not provide funds to pay off preexisting debts to shareholders at the expense of the company’s debt to total assets ratio.
However, there is one exception. If (1) money was injected into a company on an interim basis as a result of the COVID-19 pandemic and (2) non-repayment would cause undue hardship to the owner or stockholder, then the EIDL proceeds are allowed to be used towards payment of such debt. For instance, let’s consider the situation of a tanning salon that was forced to temporarily close due to the COVID-19 pandemic. In spite of the closure, the tanning salon still had an obligation to pay for the leasing of costly machines, and as such, the owner injected money into the company on a temporary basis to avoid non-payment. In such a case, the owner may recover his or her money by using the EIDL proceeds to pay off the debt, but only if non-repayment would cause undue hardship to the owner. The EIDL essentially rewards those owners who invested their own money for the protection and well-being of the company during the pandemic.
Expansion of facilities or acquisition of fixed assets
A common question we receive from our clients is whether they may use the EIDL proceeds to expand the business or acquire new assets. The bold and clear answer is: no. The EIDL proceeds cannot be used to purchase any new fixed assets or expand a facility, and they may not be used for renovation or relocation. If you are a restaurant owner, for instance, looking to expand or move, you may do that on your own accord, but not using the funds of the EIDL.
In conclusion, during this time of change, the EIDL loan can provide support to small businesses all throughout the country. Nobody knows how long the consequences of the pandemic will last, nor how finances will be affected in the long term. Regardless, however, it is important to follow the guidelines enumerated above to make sure that the EIDL proceeds are used correctly. If you have any questions or concerns, we suggest reaching out to an attorney, who may advise you further.