Locke Lord QuickStudy: SBA Issues New Guidance Reducing Risk of Government Investigations for Paycheck Protection Program Borrowers

Locke Lord LLP
May 19, 2020

Businesses applying for loans under the Paycheck Protection Program (“PPP”) must make certain ‎certifications to the government in their application, including a certification that the loan is ‎‎“necessary” to support the borrower’s ongoing operations. As previously analyzed here, the ‎Small Business Administration (“SBA”) has issued shifting and ambiguous guidance concerning ‎how the “necessity” certification will be interpreted, creating a significant amount of concern and ‎uncertainty among PPP borrowers that they could be exposed to an increased risk of government ‎investigations and enforcement—despite acting entirely in good faith—if the government later ‎took the position that their loans were not “necessary.” Many borrowers decided to repay their ‎PPP loans to eliminate this risk, leaving a significant amount of PPP funds untapped and ‎arguably frustrating the very purpose of the program.‎

On May 13, 2020, the SBA issued new guidance in an effort to clear up this uncertainty ‎and encourage borrowers to retain their PPP funds.  In a dramatic turnaround, this new guidance ‎substantially reduces the risk of government investigations and enforcement related to the ‎‎“necessity” certification.‎

The Previous Guidance Created a Great Deal of Uncertainty

The previous guidance surrounding the “necessity” certification—and more specifically, ‎whether borrowers were required to take into account other sources of capital when determining ‎whether a PPP loan was “necessary”—left PPP borrowers with little clarity.‎

Initially, because the CARES Act expressly exempts PPP loans from the ordinary SBA ‎requirement that the borrower must be unable to obtain “credit elsewhere,” many PPP borrowers ‎reasonably believed they could certify that the loan was “necessary” based solely on the extent of ‎their need, without considering every potential alternative source of capital that might be ‎available.  Exceptions to the ordinary SBA affiliation rules for companies in the hotel and ‎restaurant industries also indicated that such companies would not need to consider the liquidity ‎of their parent companies or affiliates when making the certification.‎

On April 23, 2020, in the wake of public criticism of large companies being approved for ‎PPP loans, the SBA released guidance requiring businesses to consider their “ability to access ‎other sources of liquidity” that would not be “significantly detrimental to the business” before ‎certifying that they needed the PPP loan to support ongoing operations. This left both applicants ‎and approved borrowers confused, as it failed to define precisely what sources must be ‎considered or what terms would qualify as “significantly detrimental to the business.” The April ‎‎23 guidance further stated that any company that repaid its PPP loan by May 7 would be ‎deemed to have made the certification in good faith. (The safe harbor deadline was subsequently ‎extended to May 14, and then again to May 18.)‎

This guidance led many risk-averse PPP borrowers to repay their loans and take ‎advantage of the safe harbor. Given the ambiguous standards and the potential costs of a ‎government investigation—which at best are expensive and time-consuming, and at worst could ‎yield substantial civil and criminal penalties—many borrowers decided that the risks outweighed ‎the benefits of the PPP funds. Thus, although the April 23 guidance was clearly intended to ‎protect against abuses of the program, it created a different problem:  many businesses that were ‎acting in good faith and desperately needed these funds to survive the COVID-19 crisis were ‎now too afraid to apply for PPP loans.‎

The New Guidance Significantly Reduces the Risk of Government Investigations

On May 13, just one day before the previously announced safe harbor deadline for ‎borrowers to repay their loans, the SBA released additional guidance aimed at reassuring ‎borrowers and reducing the risk of government investigations concerning the “necessity” ‎certification.‎1 ‎This new guidance splits borrowers into two categories, depending on the size of ‎their loans.‎

First, any borrower that—together with its “affiliates,” as defined by the PPP’s interim ‎final rule on affiliates2‎—receives a loan with an original principal amount of less than $2 million ‎‎“will be deemed to have made the required certification concerning the necessity of the loan ‎request in good faith.” In other words, with respect to the “necessity” certification, the ‎government will not pursue any fraud investigations for borrowers with loans of less than $2 ‎million. The SBA explained that it chose the $2 million cutoff because “borrowers with loans ‎below this threshold are generally less likely to have had access to adequate sources of liquidity ‎in the current economic environment than borrowers that obtained larger loans.”  It will also ‎‎“promote economic certainty” and “enable SBA to conserve its finite audit resources and focus ‎its reviews on larger loans, where the compliance effort may yield higher returns.”‎

Second, any borrower that receives a loan with an original principal amount greater than ‎‎$2 million “may still have an adequate basis for making the required good-faith certification, ‎based on their individual circumstances.” As previously announced, the SBA reaffirmed that it ‎plans to review all PPP loans in excess of $2 million for compliance with program requirements. ‎The SBA also provided new information on the potential consequences of those audits. If the ‎SBA determines that a borrower “lacked an adequate basis” for the required certification, it “will ‎seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower ‎is not eligible for loan forgiveness.” If the borrower repays the loan, however, “SBA will not ‎pursue administrative enforcement or referrals to other agencies” for further investigations into ‎the false certification.‎

What This Means for PPP Borrowers

The new guidance is incredibly helpful for PPP borrowers, as it greatly limits the risk of ‎government investigations related to the “necessity” certification. For loans under $2 million, ‎each borrower is now automatically deemed to have acted in good faith. For loans over $2 ‎million, borrowers do not have the same automatic protection, but even if they are deemed ‎ineligible by the SBA’s review, they can escape further government enforcement simply by ‎repaying the loan.‎

It is important to note that the May 13 guidance only applies to the “necessity” ‎certification. Borrowers should therefore continue to ensure that all of their other certifications ‎are accurate, and that they comply with all other PPP requirements. By choosing to limit ‎enforcement risk for the “necessity” certification, the SBA is strongly suggesting that the ‎government will focus its enforcement efforts on other areas of potential fraud—for instance, a ‎borrower overstating its payroll costs to obtain a fraudulently excessive loan amount, ‎misrepresenting its number of employees or its compliance with SBA affiliation rules, or falsely ‎certifying that it would only use PPP funds for the purposes permitted by the CARES Act. ‎

In addition, because the SBA characterizes its new guidance as a “safe harbor,” it is ‎possible that it might not apply in extreme cases where there is clear evidence of fraud or bad ‎faith. Indeed, the PPP-related enforcement actions to date indicate that the government intends ‎to be unforgiving in cases involving brazen fraud or plain violations of PPP requirements. For ‎instance:‎

  • The first criminal prosecution arising out of the PPP was filed in Rhode Island on May 5 ‎against two borrowers who allegedly sought to obtain over $500,000 in loans by falsely ‎representing that they operated four different business entities and employed dozens of ‎individuals when, in reality, there were no employees working for any of the businesses.‎3 ‎The government charged the two defendants, David Staveley and David Butziger, with ‎bank fraud, conspiracy to commit bank fraud, conspiracy to make false statements, and ‎aggravated identity theft.‎
  • Federal prosecutors in Texas charged Shashank Rai, an engineer, with wire fraud, bank ‎fraud, false statements to a financial institution, and false statements to the SBA for ‎allegedly fabricating having a business and hundreds of employees to obtain ‎approximately over $10 million in PPP loan funds.4‎ 
  • Maurice Fayne, aka “Arkansas Mo,” a TV personality from “Love & Hip Hop: Atlanta,” ‎was charged with bank fraud on May 13 for allegedly spending more than $1.5 million of ‎a $2 million PPP business loan on personal items, including a Rolls-Royce, a Rolex watch, ‎a diamond bracelet, and a 5.73 carat diamond ring.5‎ ‎ ‎

Overall, the SBA’s new guidance provides the certainty and clarity that was sorely ‎lacking in the April 23 guidance, and likely will encourage more borrowers to apply for and retain ‎their PPP loans. It also recognizes the reality of the current environment:  in the midst of a global ‎pandemic and economic crisis, a company’s good faith determination that it needs stimulus ‎funds—a complex and difficult judgment call, which may be critical to the company’s survival—‎should not be unduly influenced by the threat of a fraud investigation. That being said, recent ‎enforcement actions indicate that the government’s intent to prosecute fraud related to CARES ‎Act relief programs remains unchanged. Therefore, prudent PPP borrowers are advised to ‎continue to abide by the requirements of the loan program and to carefully monitor compliance ‎with those requirements throughout the life of the loan.  ‎

Please visit our COVID-19 Resource Center often for up-to-date information to help stay informed of the legal issues related to COVID-19.


1 FAQ #46 available here.
2 85 FR 20817 (Apr. 15, 2020).‎
3 Department of Justice Press Release, May 5, 2020, available here.
4 Department of Justice Press Release, May 13, 2020, available here.
5 Department of Justice Press Release, May 13, 2020, available here.