The Paycheck Protection Program (“PPP”) began with rushed legislation and a race for financial support in the middle of a pandemic. This race was hardly a straight line as the Small Business Administration (“SBA”) and the U.S. Department of the Treasury scrambled to build the program in flight, issuing a series of evolving FAQs and guidance. Banks then tried to internalize that guidance and build systems that could withstand the onslaught of applications. After many months and multiple waves of funding, businesses completed their initial applications, banks completed their eligibility determinations, and thousands of loans were successfully issued. With the initial scramble behind us, SBA and Treasury guidance became more concrete just in time for thousands of forgiveness applications.
Although the seeming chaos of the initial application process is over and PPP funding has been fully expended, the true test for the applications submitted since April 2020 is yet to come. Borrowers are now entering into a new phase consisting of forgiveness appeals, audits, fraud reviews, and enforcement. Given the distinct possibility for calm 20/20 hindsight and the shaky ground of guidance developed by agencies under extreme pressure, this phase may be the most difficult yet.
In short, not every conclusion made in the rush for PPP funds was correct, and not every borrower truly understood the nuances of the small business rules as they raced against the clock for funding. The confluence of speed, dynamic guidance, and challenging rules will lead to forgiveness denials and hard conversations with banks and regulators.
Anticipating a rush of forgiveness denials, the SBA recently unveiled its new procedures for appeals of unfavorable forgiveness decisions. The SBA has also been auditing larger and/or suspicious loans, making clear that this review can proceed even after a forgiveness determination has been made. This means that even firms that received forgiveness are not necessarily in the clear. Simultaneously, the U.S. Department of Justice (“DOJ”) has been busy prosecuting PPP loan fraud.
Companies that are disappointed by the SBA’s forgiveness determinations, that have received pointed questions during an audit, or that find themselves embroiled in an enforcement action should review our prior advice with respect to the details of the PPP Loan Program. Below, we’ve included the highlights:
· Affiliation. This is easily the trickiest part of PPP analysis and the one most likely to be unfamiliar to commercial borrowers. The affiliation rules that apply to PPP borrowers are those in 13 C.F.R. 121.301. In general, if a company, together with its affiliates, has fewer than 500 employees, it has met one of the basic criteria for PPP eligibility. However, some clients benefit from application of the alternative size rule, which is based on annual revenues and net worth of the borrower and its affiliates. Others, such as restaurants and hotels, are subject to industry-specific affiliation rules. The key to all of this, however, is whether or not borrowers considered other entities owned and controlled by their affiliates when assessing eligibility. We described the size and affiliation rules here.
· Forgiveness process. Forgiveness calculations are not necessarily straightforward. We’ve previously provided a handy checklist and have noted the interplay between forgiveness and recovery under federal contracts.
· Effect on M&A Transactions. In October 2020, the SBA issued specific guidance concerning how merger and acquisition activity, and other activity resulting in a change of control, could proceed when one of the parties involved was the recipient of a PPP loan. We explored these requirements here and further elaborated on other M&A considerations here. These requirements remain an ongoing concern, as many borrowers entering into transactions do not yet have full forgiveness of their prior PPP loans.
· Economic Aid Act and Second Draw Loans. In late December 2020, the Economic Aid Act further extended the PPP program and allowed certain borrowers to take out a second PPP loan. The Act, and ensuing SBA implementing regulations, also implemented key changes to the PPP program, retroactive to the initial loans. Most significantly, this included new permitted uses of proceeds, including coverage of certain operations expenses, property damages, and supplier disruptions; the cost of personal protective equipment for employees; and employee benefits costs. The Act also modified the procedures for forgiveness and introduced a simplified application for borrowers of $150,000 or less.
· PPP Flexibility Act. In June 2020, Congress enacted changes to the PPP program in the form of the PPP Flexibility Act. This Act, among other things, extended the time period for loan expenditures from eight weeks to 24, changed the percentage of forgivable costs attributable to payroll from 75% to 60%, and implemented additional forgiveness reduction safe harbors.
· Necessity. Beginning in January 2021, borrowers of $2 million or more began receiving Form 3509, a “necessity questionnaire” from the SBA. This form is designed to probe whether the loan was “necessary to support ongoing operations,” one of the criteria for loan eligibility. In July 2021, use of the form was discontinued, but necessity remains an issue ripe for audit.
In short, we are not yet at the halfway point of the PPP story. Now is the time that regulators and enforcement agencies can, in the calm after the PPP storm, second guess, quibble, and challenge PPP borrowers. Given the nuances in this area and the many ways to get forgiveness right (or wrong), companies of all sizes would be wise to seek counsel when the questions start and not delay until they are the subject of an enforcement action.