May 6, 2020 - Coronavirus, Small Business

Is My Company’s PPP Loan “Necessary to Support Ongoing Operations?” What If I’m Wrong?

FCA

This post has been updated on May 6, 2020 with new safe harbor deadline for repayment of PPP loans.

Given the proliferation of adverse news articles and TV pundit segments about well-funded companies that have received federal, Small Business Administration (SBA) loans under the Paycheck Protection Program (PPP), it is important to separate what guidance has now been issued and what appears to be more political rhetoric than law.  As discussed below, companies should take agency guidance seriously and consider (and document) the issues raised, but legitimate small business PPP recipients can to a large extent take with a grain of salt what amounts to political sabre rattling in a time where specific large companies are being pilloried in the press.

The PPP, which we have written about previously, is part of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).  The program initially had $349 billion in appropriations, but when that was quickly exhausted, Congress injected another $310 billion into the program.  The program provides aid to qualifying small businesses in the form of loans with terms favorable to borrowers, including, in particular, provisions that allow potentially the entire loan amount to be forgiven if the proceeds are spent on payroll and other qualifying expenses.

Shortly after the second round of funding, and in the face of new negative publicity surrounding the program, the SBA and the Treasury Department came out with additional FAQs[1] specifically focused on one element of the application process, the fact that the borrower must certify that“[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  In addressing a question (#31) as to whether companies with adequate sources of liquidity might qualify for PPP loans, the agencies provided the following clarification:

Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary.  Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.  For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.

The FAQ went on to clarify that if a company that previously applied for a loan now believes, based on this additional guidance, that it should return a loan, “[a]ny borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020, will be deemed by SBA to have made the required certification in good faith.”  In addition, the FAQ emphasized that lenders need not perform additional research in order to rely on the borrower’s certification that the loan was necessary.

On April 29, SBA and Treasury issued yet another clarification, addressing the “necessary” language in the context of private equity-backed companies:

37. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: See response to FAQ #31.

Finally, in response to a question (#39) about whether or not the SBA will review PPP loan files, the agency responded as follows:

Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan.  To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.  Additional guidance implementing this procedure will be forthcoming.

In light of these FAQs we have received a number of questions from companies trying to determine whether they should return PPP funds already received or retract applications that are in process.  The following key considerations should guide companies’ assessments of these questions:

1. The “necessary to support . . . ongoing operations” standard is subjective.

Because the standard was developed specifically for the PPP program and is not further defined in any FAQ, the “necessary” standard has no objective measure.  SBA’s 7(a) loan regulations do not address this language, because they do not follow this standard.  Indeed, for other SBA loan programs, potential borrowers must demonstrate an affirmative lack of access to capital, known as the “Credit Elsewhere” policy.  SBA has made clear that no such standard applies here (FAQ # 31:  “Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary.”)  As result, one thing we do know is that “necessary” does not include a proven inability to obtain credit elsewhere—at least as that concept is implemented in the 7(a) program.

The best standard the agencies have articulated to date may be this one:  “Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.”  As a result, in place of the clear “Credit Elsewhere” policy, the agencies appear to have created a subjective factor test where harm to “current business activity” (e.g., loss of sales and uncertainty) is balanced against “liquidity” that can be tapped without significant detriment to the business (e.g., lines of credit and cash on hand).  It is difficult not to see this as a lower and easier to meet standard than that which applies for 7(a) loans.  A lesser standard would comport with apparent Congressional intent to distribute the PPP funds quickly with a minimum of hassle.

Given that this is a factor-based test relying on the borrower’s good faith, absent a showing of absolute bad faith, or indicia of profligate spending on the part of a loan recipient, it is difficult to imagine how SBA will be able to demonstrate with legal certainty that a company did not have a good‑faith belief that the PPP loan proceeds were “necessary.”  Companies can protect themselves in this regard by documenting adverse impacts that the current environment has had on its business, and by showing that but for the loan proceeds, the company might not be able to maintain its workforce or ongoing business operations into the foreseeable future.  The fact that a company has access to a line of credit or other capital does not in and of itself bar a company from seeking a PPP loan.  However, especially where a company has a comfortable cash cushion or wealthy investors, the basis for the PPP loan request should be carefully documented to show, for example, that funds are insufficient to maintain the business without PPP or that they are otherwise required for significant expenditures necessary for the business.

2. It is almost certain that public companies or those receiving more the $2 million in loan proceeds will be audited or otherwise scrutinized in some manner.

Even before FAQ #39 was issued, the Treasury Secretary stated in television appearances that companies receiving PPP loans in excess of $2 million would be audited, and that criminal prosecutions would be initiated if wrongdoing is discovered.  It remains to be seen whether such large‑scale audits can be performed as a practical matter or what level of depth of analysis would be performed.  But it is undeniable that the PPP program itself will be scrutinized for many years—by Congress, by agency officials and Inspector Generals, and most certainly in the press and the court of public opinion.  For these reasons, companies decided whether to return or reject PPP funding should document their good‑faith belief now and consider whether the hassle factor, potential legal fees, and adverse publicity outweigh any loan benefits.

3. Criminal and civil prosecution, while unlikely in the absence of actual fraud, are risks to be considered.

Criminal False Claims Act and False Statements Act cases are somewhat rare.  However, in theory, if SBA determines that a company did not certify eligibility in good faith, the company could be charged criminally under the federal False Claims Act[2] or False Statements Act[3].  The civil False Claims Act, which is far more commonly used, allows for treble damages, which in the context of the PPP could be three times the value of the loan.  As noted above, we think it is unlikely such prosecutions ultimate would be successful where the issue will turn on a subjective determination of good faith as to whether the loans were necessary and the balancing of multiple subjective factors.  Prosecution is further unlikely if a company’s submissions were accurate and complete in all material ways.  However, companies that did not disclose or consider affiliates, or that otherwise had incorrect or misleading information on their applications, could be prosecuted.  Any litigation could also name the certifying individual as part of the charging documents.  One aspect of the False Claims Act to further consider is the qui tam provisions of the Act that permit a whistleblower or other person with non-public information to come forward with a complaint and share a portion of the proceeds of any settlement or verdict.  This provision incentivizes individuals within a company that might be uncomfortable with the loan certification to come forward.  The plaintiffs’ bar has already taken note of this possibility and issued public statements indicated they expect many qui tam matter emanating out of the CARES Act relief programs generally, and PPP in particular.

In sum, companies for which PPP loan funding is an available and appropriate avenue for relief should feel confident in taking and retaining loan monies to which they are entitled.  They should document their analysis and be prepared to provide it when appropriate.  However, those companies with significant doubts as to whether the funds are needed (e.g., with significant cash reserves), or whether in fact they qualify for the loans in light of affiliation and other considerations, might reconsider their initial inclination to apply under the PPP.  The costs of defending a suit or being audited or just dealing with adverse publicity need to be considered by companies in balancing whether it makes the most sense to return or refuse loan proceeds.  Any company that decides to take this route should do so by May 7.[4]

[1] All prior FAQs were consolidated into a single document on the Treasury CARES Act website on April 29, 2020.  Importantly, the FAQs do not carry the force and effect of law independent of the statute and regulations on which they are based.

[2] Per 18 U.S.C. § 1031, fraud against the U.S., including obtaining money from the government under false or fraudulent circumstances, is punishable by fine, imprisonment of up to ten years, or both.

[3] Per 18 U.S.C. § 1001, false statements may be punished by fines, imprisonment for no more than five years, or both.

[4] On May 5, 2020, SBA and Treasury issued additional FAQ guidance extending the safe harbor to May 14, 2020. Companies need not apply for this extension.