[Editor’s Note: Late in the day on May 5, 2020 the US Treasury issued the following additional guidance “The SBA is extending the repayment date for this safe harbor to May 14, 2020. Borrowers do not need to apply for this extension. This extension will be promptly implemented through a revision to the SBA’s interim final rule providing the safe harbor. SBA intends to provide additional guidance on how it will review the certification prior to May 14, 2020.” This article will be further revised/updated upon the issuance of the additional guidance.]
After hours of assembling documentation, speaking with banks, filling out applications, and trying to interpret ever-changing guidelines, you were finally successful in obtaining a loan through the Paycheck Protection Program (“PPP”) under the CARES Act. But now, rather than feeling relief and having the opportunity to focus on the health and durability of your business, you receive an email notice from your bank warning that you better have made the following certifications in good faith when applying for your PPP loan, because if you didn’t, you may be subject to civil (or criminal) liability for PPP loan fraud1Note: The information in this article is accurate as of the date of publication, but guidance is changing quickly, and this article may not reflect the latest developments.:
“Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
“The funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments, as specified under the Paycheck Protection Program Rule; I understand that if the funds are knowingly used for unauthorized purposes, the federal government may hold me legally liable, such as for charges of fraud.”
So now, at a time when the government is supposed to be helping small businesses stay in business so that businesses can keep workers employed and build internal (and national) morale, the government’s parting shot (via processing lenders) is the threat of potential criminal liability for fraud for false certifications in your loan application. Now, you have to make a decision: keep or return PPP loan funds.
There have been a number of important new developments with the PPP following its early implementation and initial public reaction to the program. You’re likely already familiar with some of the circumstances leading to these developments, but let’s briefly recap: as the initial round of PPP funding ran short, and information surfaced that large companies (including companies like Ruth’s Chris Steakhouse and Potbelly) received maximum PPP loans intended for small businesses, public opinion shifted against the program. In reaction, the Treasury Department and the SBA issued additional guidance for companies who already took advantage of the program or are seeking to. The most important of these include the following:
On April 23, the Treasury Department issued FAQ #31, which states that: “[a]ll borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Specifically, before submitting a PPP application, all borrowers should carefully review the required certification that “current 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.”
FAQ #31 further states, “Any 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.”
On April 28, Treasury Secretary Mnuchin announced that the SBA “will review all loans in excess of $2 million, in addition to other loans as appropriate.” This statement was formalized on April 29 in FAQ #39.
Also on April 28, the Treasury Department issued FAQ #37, which makes it clear that the above-quoted statements in FAQ #31 apply to all businesses, not just those receiving $2 million or more under the PPP.
In response to these developments, banks, at the request of the SBA, started sending notices to borrowers via email blasts like the one referred to above.
First, understand that—as a PPP loan borrower—you were not singled out for a particular reason, and that nearly every PPP loan recipient has received a similar notice. Since PPP loans are intended to keep struggling businesses afloat during the COVID-19 crisis, every loan applicant was required to certify that the “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
The PPP interim rules do not define what is “necessary,” to qualify for a PPP loan, but it does appear that Congress envisioned a broad-based program that would support companies that might not otherwise survive the pandemic, given their limited capital access. In line with this vision, PPP loan applicants were not required to make a demonstration of a likely foreclosure to qualify, and the Treasury expressly waived “the usual SBA requirement that [the applicant] try to obtain some or all of the loan funds from other sources.” Further, PPP loan applicants were not required to demonstrate that they have no other means of obtaining credit.
Just because applicants are not required to seek credit elsewhere or otherwise show likely closure before applying for a PPP loan, the SBA and enforcement agencies will likely be scrutinizing an audited company’s perceived need for the funding. Post-issuance reviews will likely focus on whether the applicant had enough cash reserves, had access to capital from related sources, what projections looked like and the company’s financial position prior to applying for the loan and potentially at the time of the loan disbursement or loan forgiveness.
While the FAQs discussed earlier were initially targeted at public companies based on public outrage, the SBA has set the groundwork to expand its potential scope of review. In the supplemental FAQs issued on April 23 and April 28, the SBA urged borrowers to “review carefully the required certification” regarding the necessity of the loan.
The SBA’s interim final rule provides borrowers a “limited safe harbor” window of opportunity to return funds that, in retrospect, they should not have received. This window is running short though, expiring on May 7, 2020.
The SBA indicated that, if funds are returned by May 7, 2020, it will deem a borrower’s original certification as made in good faith. In other words, if a borrower previously accepted funds without any basis for claiming them, it can avoid civil, or even criminal, enforcement actions by immediately returning the funds.
If you ultimately elect to retain your PPP loan funds, there are several affirmative steps you should take now to document the need for PPP funds and avoid future issues.
Beyond items that will clearly be needed for forgiveness, such as collecting and maintaining records of the company’s employee count and hour requirements, it is also imperative to document the economic state of the company at the time of the application. This should include details regarding pre-COVID-19 operations, relevant financial projections at the time of receiving the loan and any subsequent declines.
In addition, having evidence of the cost of and access to capital, cash on hand, budget forecasts and other metrics of financial performance will help to establish a “need-basis” should you encounter enforcement scrutiny down the road. It may also make sense to prepare an internal memorandum summarizing the nature of the current and foreseeable economic uncertainty that supported the need for a PPP loan request, and how your company will use the funds to support ongoing operations.
Such an analysis might include:
This contemporaneous documentation of the company’s justification for seeking a PPP loan could provide helpful support for the company’s good faith basis for making the “necessity” certification if questioned in the future.
While we believe that this type of evidence should be supportive in the event of a PPP loan audit, there is currently no guidance from regulatory authorities at a sufficient level of detail necessary to address these issues with certainty. In light of the threats of SBA audits, PPP loan fraud charges and bad publicity, one would think that it is not too much to ask for some clear direction.
While there is much uncertainty around how audits will be conducted and how these good faith requirements will be enforced, we at least know that borrowers will need to be able to support their loan application certifications to avoid concerns of PPP loan fraud.
At a minimum, the authorized representative of the borrower should be able to assert, in good faith, that the PPP loan was needed after considering at least these factors:
Again, what is required to satisfy each of these criteria is largely unknown. But if you are clearly unable to justify the need for your business to receive a PPP loan (e.g., a business manufacturing hand sanitizer that has added a third shift and is making record profits), then it may be in your best interest to return any funds you received ASAP, and certainly before the May 7, 2020 safe harbor deadline, if possible.
[Editor’s Note: Get more articles and financial resources in “Coronavirus (COVID-19), Your Business & Your Money: Financial Resources Guide.” To learn more about this and related topics, you may want to attend the following webinars: What Kind of Loan? And Basic Concepts Applicable to All Borrowers & Lenders.]
©All Rights Reserved. May, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Jeremy chairs the Corporate Group at the Sugar Law Firm (Sugar Felsenthal), a national boutique serving the affluent and the companies they own or otherwise control. He advises his clients on significant transactions and operational issues in their businesses. Described by clients as "an essential business advisor" and "a partner in the success of my…
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