One of the most appealing features of the PPP loan program was the ability to potentially obtain repayment forgiveness of the amounts used by recipients for qualifying expenses, including payroll costs to retain or rehire employees. In the weeks since the PPP program was first rolled out by the SBA, some businesses have been publicly scrutinized for applying for, and accepting, PPP funds despite the receipt of them not being truly “necessary.”
The SBA has also taken notice, and has issued guidance making clear that PPP loans are going to be audited and wrongful borrowers may face adverse criminal and civil proceedings for, inter alia, violations of the False Claims Act, which carries the potential for a reverse payment of the funds to which the holder is not entitled, treble damages, and per-claim penalties.
In preparation for this ramp-up in scrutiny, the SBA has issued two additional interim final rules – on April 23, 2020 and April 28, 2020 – regarding unqualified PPP borrowers. The April 23 supplemental FAQS urge businesses to “review carefully the required certification” regarding necessity of the requested loan. Together, these rules create a temporary “safe harbor” window for unqualified borrowers to return the PPP funds they received by May 7, 2020 without penalty.
This guidance is aimed at PPP loan recipients making a good faith assessment of the necessity and appropriateness of the loan application and received funds. Aside from obvious cases of inappropriate loan applications and receipt of PPP funds (e.g., those who provided false or misleading information in the application), the main risks areas for companies that applied for a PPP loan include, but are not limited to: (1) employee/size eligibility, (2) amount of the loan requested, (3) “necessity” of the PPP loan, and (4) use of the loan funds. Companies who have viable alternative access to capital similar to the funds received under the PPP program will need to justify their calculus that the PPP loan they received was truly “necessary.” Each of these risks are addressed in turn.
Is the business properly classified as a small business under the PPP?
Prior and potential new PPP borrowers need to carefully assess whether they qualify as small under the PPP size standards. The PPP defines eligible businesses as those with their primary place of business within the U.S., and which:
The PPP’s and SBA’s size standards require the business in question to account for employees of any “affiliates” when determining headcount. What constitutes an “affiliate” and whether a business has the power to control another involves an assessment of the business’s ownership and management structures. Importantly, the PPP exempted SBA-recognized franchises and businesses in the hospitality and food services industry from these affiliation regulations.
The SBA issued guidance regarding the more common bases for “affiliation” under the PPP on April 3, 2020. For a more complete discussion of the affiliation rules, companies must look to the SBA rules found at 13 C.F.R. § 121.301.
What size loan does the business need?
Businesses must also analyze whether the size of their requested loan was/is appropriate. The PPP loan amount granted is based on the business’s average monthly payroll costs for the prior 12 months multiplied by 2.5 (with a loan cap of $10 million). Only salary, wages, and tips up to $100,000 per employee are covered. In most cases, accurate information can be gathered through the payroll records maintained by the employer or third-party vendors. Companies who do not have a full year of payroll costs on which to base their calculation are allowed to utilize a modified formula.
Providing misleading information about historical payroll costs, number of employees, and/or total salary for employees creates significant risk for businesses borrowing under the PPP program. Amendments to, or deviations from, any contemporaneous or independently prepared documents are likely to be viewed with suspicion.
Does the business need the PPP loan?
Because PPP loans are meant to keep struggling businesses above water during the COVID-19 pandemic, the loan application requires a certification that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
While necessity has not been defined, Congress’s intent of supporting companies that may not survive due to limited access to capital is clear. While PPP applicants were not required to show a likelihood of closure or seek our capital elsewhere before applying, the SBA and related enforcement agencies will surely be scrutinizing the perceived need for PPP funding.
Reviews of PPP loan funding are likely to focus on whether the business applicant issued projections evidencing a minimal impact to business operations during the COVID019 pandemic, had access to alternative source of capital, and/or was otherwise in a strong financial position prior to applying for the PPP loan and/or loan forgiveness.
How did the company use the loan proceeds?
Possibly the most significant risk for businesses that secured PPP funding is how they used the proceeds. The federal CARES Act allows loan proceeds to be used for any allowable use identified in the SBA 7(a) loan program. However, businesses who want to obtain loan forgiveness under the PPP must use the loan proceeds for the following specified costs:
Loan forgiveness is available under the PPP program if the proceeds are: (1) used primarily (greater than 75%) to cover payroll costs over the 8-week period following when the PPP loan funds are disbursed, with any remaining amounts used for other qualifying costs above; and (2) employee count and compensation levels are maintained for the 8-week period after funds are disbursed.
The SBA will issue additional guidance regarding the loan forgiveness requirements and process. This aspect of the PPP will receive particularly close scrutiny and enforcement attention. For example, U.S. Treasury guidance notes with emphasis that “if the proceeds are used for fraudulent purposes, the U.S. government will pursue criminal charges …” Liability may extend beyond just the initial business recipient of the funds, including to shareholders, members, or partners of the business. This is supported by the SBA’s final rule, which notes: “If one of [the borrower’s] shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA will have recourse against the shareholder, member, or partner for the unauthorized use.”
Important Next Steps for Businesses Who Applied for and/or Received PPP Loan Funds
Besides the cases of true criminal intent, it is likely that the majority of scrutiny related to the PPP loan program will be focused on claims under the False Claims Act. If after a hard-look analysis borrower decide to retain PPP loan funds, they should be proactive in creating a detailed account of how and why the loan proceeds were spent to obtain loan forgiveness. This includes, but is not limited to, collecting and maintaining records of the business’s pre, during, and post-COVID-19 employee count and hour requirements; operations; cost of, and access to, capital; cash on hand; budget forecasts; and other metrics of financial performance. It also would be prudent for borrowers to create an internal memorandum summarizing the current (and foreseeable) economic uncertainty and market conditions created by the COVID-19 pandemic that make the PPP funds necessary to support the business’s ongoing operations.
We are working hard to keep our clients apprised of developments in the SBA’s rapidly changing handling of the PPP loan program. If you would like additional guidance on the PPP for compliance or are the subject of an audit or inquiry from any investigator, our team is here to assist you in responding and addressing any concerns.
Keith Galbut can be reached at firstname.lastname@example.org.
DISCLAIMER: This article is designed for general information only. The information presented herein does not constitute legal advice or the formation of a lawyer/client relationship.