On July 23, 2020, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) released Frequently Asked Questions (“FAQs”) for its Nonprofit Organization New Loan Facility (the “NONLF”) and Nonprofit Organization Expanded Loan Facility (the “NOELF” and together with the NONLF, the “Nonprofit Facilities”) under the Main Street Lending Program (the “Program”). The FAQs are posted on the Reserve Bank’s website: https://www.bostonfed.org/supervision-and-regulation/supervision/special-facilities/main-street-lending-program.aspx. Additionally, on July 28, 2020, the Federal Reserve announced the extension of the Program, which was originally set to expire on September 30, 2020, to December 31, 2020.
We discuss the Federal Reserve’s previous announcements regarding the Nonprofit Facilities, including its release of updated term sheets, in our previous blogs entitled “Federal Reserve Considers Expanding the Main Street Lending Program to Accommodate Nonprofit Organizations – Comments Welcome” (“MSLP Blog 1”) and “Federal Reserve Approves Nonprofit Organizations for Main Street Lending Program and Released Updated Term Sheets” (“MSLP Blog 2”).
The FAQs clarify and augment certain aspects of the Nonprofit Facilities, including CARES Act requirements, priority and security provisions, eligibility tests for Nonprofit Organizations, and participation by lenders involved in multi-lender facilities. A complete review of the FAQs is beyond the scope of this blog. Rather, we will highlight certain new information and key takeaways from the FAQs that should be considered prior to any borrowing under the Nonprofit Facilities. Readers should review the following FAQ highlights in conjunction with MSLP Blog 1 and MSLP Blog 2. Capitalized terms not otherwise defined in this blog have the meanings set forth in MSLP Blog 1 and MSLP Blog 2.
CARES Act Requirements
The Secretary of the Treasury has committed $75 billion in CARES Act funds in support of the Program. As such, certain CARES Act restrictions apply to the Nonprofit Facilities, including the following:
- No Other CARES Act Support: An otherwise Eligible Borrower will be disqualified from participating in the Nonprofit Facilities if it has received adequate economic relief in the form of loans or loan guarantees under Subtitle A of Title IV of the CARES Act (Payroll Protection Program (PPP) loans are excluded from this prohibition).
- Direct Loans: Eligible Borrowers must comply with the equity repurchase, dividend payment and compensation restrictions applicable to direct loan programs under Section 4003(c)(3)(A)(ii) of the CARES Act (to the extent applicable to Nonprofit Organizations).
- S. Business: Under Section 4003(c)(3)(C) of the Cares Act, the Eligible Borrower must be organized in the United States or under the laws of the United States and have significant operations and a majority of its employees in the United States.
- No Loan Forgiveness – Under Section 4003(d)(3) of the CARES Act, the principal amount of an Eligible Loan or Upsized Tranche may not be reduced through loan forgiveness. For a further discussion of this topic, see “Eligible Loans and Upsized Tranches are Recourse Loans”
- Conflicts of Interest – Under Section 4019 of the CARES Act, Eligible Lenders and Eligible Borrowers must certify that no “Covered Individual” (including the President, Vice President, the head of any Executive Department, any member of Congress and certain immediate family members) owns, controls or holds 20% or more of any class of equity ownership interest in the business.
Inability to Secure Adequate Credit Accommodations from Other Banking Institutions
The Nonprofit Facilities are part of a Federal Reserve lending program. Therefore, as required by of Section 13(3) of the Federal Reserve Act and the Federal Reserve’s Regulation A, Eligible Borrowers must demonstrate that they are unable to secure adequate credit accommodations from other banking institutions. Eligible Borrowers do so by simply certifying that the amounts, prices, or terms of the credit available from other sources are inadequate for the borrower’s needs during the current unusual and exigent circumstances. In making this certification, Eligible Borrowers are not required to: (i) demonstrate that no credit is available from other sources or that applications for credit have been denied by other lenders or (ii) document that the amount, price, or terms of credit available elsewhere are inadequate.
“Pass” Criteria for Eligible Loans and Upsized Tranches
In order to participate in the Nonprofit Facilities, the Eligible Borrower must have been in sound financial condition prior to the COVID-19 pandemic, as further described below:
- NONLF: The Eligible Lender must have assigned an internal risk rating (based on the Eligible Lender’s risk rating system) equivalent to a “pass” in the Federal Financial Institutions Examination Council’s (FFIEC) supervisory rating system to the Eligible Lender’s outstanding loans with the Eligible Borrower as of December 31, 2019.
- NOELF: The Eligible Lender must have assigned an internal risk rating equivalent to a “pass” to the Eligible Borrower’s existing credit facility underlying the Upsized Tranche as of December 31, 2019. If the Eligible Lender originated or purchased the existing credit facility after December 31, 2019, then the Eligible Lender should use the internal risk rating given to the loan as of the origination or purchase date (as applicable).
Eligible Loans and Upsized Tranches are Recourse Loans
Eligible Loans and Upsized Tranches are full recourse loans, meaning that the principal amount cannot be reduced through loan forgiveness. However, the SPV may agree, together with Eligible Lenders and Eligible Borrowers, to reductions in interest, extensions of amortization schedules and maturity dates, or the incurrence of higher priority priming loans as part of a restructuring or workout of an Eligible Loan or Upsized Tranche.
Amendments to Existing Credit Agreements to Accommodate Upsized Tranche
For purposes of the NOELF, Eligible Borrowers and Eligible Lenders may amend existing credit agreements to accommodate the term sheet requirements for the NOELF.
Payment Priority under NONLF – No Contractual Subordination
Under the NONLF, an Eligible Loan may not be contractually subordinated in terms of priority to any of the Eligible Borrower’s other loans or debt instruments. To illustrate this point, the FAQs provide that an Eligible Loan may not be junior in priority in a bankruptcy proceeding to the Eligible Borrower’s other unsecured indebtedness. What is the practical application of this requirement to the NONLF?
In contractual subordination, a provision is added to a loan document expressly subordinating the lender’s right to repayment of the new indebtedness to the borrower’s other indebtedness (the latter being the “senior indebtedness”). Thus, in the event of a bankruptcy or similar restructuring, the senior indebtedness would be paid in full before the subordinated new indebtedness. In the loan documentation for the NONLF, an Eligible Lender would be prohibited from taking such a subordinate position.
To contrast this point, The FAQs provide examples of transactions that would not violate this prohibition:
- Obtaining a secured Eligible Loan (including a second or other lien position behind existing first lien indebtedness) notwithstanding that the Eligible Borrower has an outstanding secured loan of any lien position or maturity;
- Obtaining an unsecured Eligible Loan notwithstanding the term or security status of the Eligible Borrower’s outstanding loans; or
- Obtaining additional secured or unsecured indebtedness after the incurrence of an Eligible Loan, provided that the additional indebtedness would not have a higher contractual priority than the Eligible Loan in bankruptcy.
Based on these examples, the Federal Reserve appears to be distinguishing between payment priority and collateral security. Stated differently, the restriction on contractual subordination under the NONLF should be limited to the order in which the Eligible Borrower’s outstanding indebtedness (including the Eligible Loan) is repaid, rather than lien subordination in respect of any collateral. In any event, prior to applying for an Eligible Loan, Eligible Borrowers should review the requirements for additional indebtedness included in the loan agreements governing any outstanding indebtedness, to determine whether they include any similar (and therefore potentially problematic) subordination requirements.
Payment Priority and Collateral Security under NOELF
In contrast to the NONLF, in terms of priority and security, Upsized Tranches of existing credit facilities under the NOELF must be senior to or pari passu with the Eligible Borrower’s Loans or Debt Instruments, other than Mortgage Debt. What is the practical application of this requirement to the NOELF?
In contrast to the NONLF, the NOELF imposes the following collateral security requirements for Upsized Tranches:
- The Upsized Tranche must be secured if, at the time of origination, the Eligible Borrower has any other outstanding secured Loans or Debt Instruments (other than Mortgage Debt that does not also secure any other tranche of the underlying credit facility).
- The Upsized Tranche must be secured by the collateral securing any other tranche of the underlying credit facility on a pari passu basis (even if, as noted above, such collateral also secures Mortgage Debt).
- If the existing credit facility underlying the Upsized Tranche includes both term loan tranches and revolving credit tranches, the Upsized Tranche must share collateral on a pari passu basis only with the term loan tranches.
- The Upsized Tranche may be unsecured if, at the time of origination, the Eligible Borrower does not have any outstanding secured Loans or Debt Instruments (other than Mortgage Debt that does not also secure any other tranche of the underlying credit facility).
Similar to the NONLF, (i) secured Upsized Tranches must not be contractually subordinated in terms of priority to any of the Eligible Borrower’s other secured or unsecured Loans or Debt Instruments and (ii) unsecured Upsized Tranches must not be contractually subordinated in terms of priority to any of the other unsecured Loans or Debt Instruments
Loan Documentation for Upsized Tranches
To effectuate the above-referenced requirements and maintain such status over the life of the Upsized Tranche, the documentation governing the Upsized Tranche must include:
- A covenant that the Upsized Tranche will not become contractually subordinated in terms of priority to any other Loans or Debt Instruments;
- A covenant that the Upsized Tranche will remain secured on a pari passu basis by the collateral securing the underlying credit facility; and
- A permitted lien or negative pledge covenant consistent with the Eligible Lender’s ordinary course of lending to similarly-situated borrowers.
Multi-Lender Facilities under NOELF
Under the NOELF, an Eligible Lender may sell a participation in an Upsized Tranche to the SPV even if the existing credit facility was originated as a multi-lender facility. To do so, the Eligible Lender must retain an interest in the existing credit facility as of the date of the Upsized Tranche. The other lenders in the multi-lender facility are not required to be Eligible Lenders for this purpose.
More than one lender in a multi-lender facility may choose to upsize an existing credit facility by means of an Upsized Tranche and sell a participation to the SPV; provided, that: (i) each lender qualifies as an Eligible Lender; (ii) the upsizing is accomplished through separate transactions involving each Eligible Lender; and (iii) the aggregate amount of each Eligible Lender’s Upsized Tranche does not exceed the Eligible Borrower’s borrowing capacity under the NOELF.
Qualifying as an Eligible Borrower under the Nonprofit Facilities
In order for interested borrowers to participate in the Nonprofit Facilities, they must first identify themselves as Nonprofit Organizations and then meet the conditions established for Eligible Borrowers. The FAQs provide the following additional information to facilitate these determinations.
Public Hospitals and Public Colleges and Universities
Among other conditions, an Eligible Borrower must be a Nonprofit Organization, which includes a tax-exempt nonprofit organization described under Section 501(c)(3) of the Internal Revenue Code (“Section 501(c)(3)”). Although otherwise fitting the description of a nonprofit organization described under Section 501(c)(3), a public hospital or public college or university may qualify as tax-exempt under a different section of the Internal Revenue Code. Under such circumstances, the entity may still be eligible to participate in the Nonprofit Facilities as a Nonprofit Organization. To establish such eligibility, the entity must reasonably determine, through a written record maintained by the entity, that it is an organization of the type described in Section 501(c)(3).
Hospitals owned by Government-Owned Entities
If an Eligible Borrower is also an Ineligible Business, then it may not participate in the Nonprofit Facilities. Government-owned entities are generally considered Ineligible Businesses. Nevertheless, a hospital that is owned by a state or local government may participate in the Nonprofit Facilities if the hospital receives less than 50% of its funding from state or local government sources, including Medicaid, and otherwise qualifies as an Eligible Borrower.
Employee Headcount and 2019 Annual Revenues
In order to qualify as an Eligible Borrower, a Nonprofit Organization must meet several conditions including: (1) having either: (i) 15,000 employees or fewer or (ii) 2019 annual revenues of $5 billion or less and (2) having at least ten employees. To make this determination, the Nonprofit Organization must aggregate its employees and revenues with the employees and revenues of its affiliated entities. The FAQs direct Nonprofit Organizations to particular SBA regulations for purposes of determining their 2019 revenues and identifying their employees and affiliated entities.
Term Sheets as Floors
The FAQs clarify that the term sheets for the Nonprofit Facilities are a floor, above which Eligible Lenders may set additional requirements for Eligible Loans and Upsized Tranches. In that respect, Eligible Lenders are expected to conduct their own evaluation of an Eligible Borrower’s financial condition and creditworthiness, and may require additional information and documentation, as part of the application process. Ultimately, the Eligible Lender will determine whether or not an Eligible Borrower is approved for an Eligible Loan or Upsized Tranche.
No LIBOR Floors
As set forth in the term sheets, the interest rate for an Eligible Loan or Upsized Tranche is 1-month or 3-month LIBOR plus 300 basis points (3.00%). LIBOR floor provisions, where the interest rate on the Eligible Loan or Upsized Tranche would not go below a baseline rate even if the formula used to calculate the interest rate would make it so, are not permitted for the Nonprofit Facilities.
As a condition to receiving an Eligible Loan or Upsized Tranche, Eligible Borrowers must agree to certain restrictions on their ability to repay, cancel or reduce their indebtedness, until the Eligible Loan or Upsized Tranche is repaid in full. Notwithstanding these restrictions, Eligible Borrowers are permitted to undertake any of the following actions during the term of an Eligible Loan or Upsized Tranche:
- Repaying a line of credit (including a credit card balance) in the normal course of business;
- Obtaining and repaying additional debt obligations in the normal course of business, including inventory and equipment financings, so long as the indebtedness is secured solely by the newly-acquired property and, with the exception of such security, is of equal or lower priority than the Eligible Loan or Upsized Tranche; or
- Refinancing debt maturing no later than 90 days from the date of such refinancing transaction; provided, that the Eligible Loan or Upsized Tranche may not be used to refinance such debt at the time of origination.
In considering an Eligible Loan or Upsized Tranche, potential borrowers should consult with their legal counsel and financial advisor not only to review the requirements of the term sheets and FAQs, but also to analyze any additional debt restrictions or lead-time requirements under the documentation governing their existing indebtedness. We will continue to monitor developments with respect to the Nonprofit Facilities and provide further updates as warranted. Readers are invited to contact either Neal Pandozzi at email@example.com or Jonathan Cabot at firstname.lastname@example.org with any questions.
 This prohibition would not prevent an Eligible Borrower from incurring obligations with a mandatory priority under the U.S. Bankruptcy Code or other insolvency laws.
 “Loans or Debt Instruments” is defined as “debt for borrowed money and all obligations evidenced by bonds, debentures, notes, loan agreement, or other similar instruments, and all guarantees of the foregoing” (emphasis added). “Mortgage Debt” is defined as “(i) debt secured only by real property at the time of the NOELF Upsized Tranche’s origination; and (ii) limited recourse equipment financings (including equipment capital or finance leasing and purchase money equipment loans) secured only by the acquired equipment.”