Locke Lord QuickStudy: Borrower Beware: Potential Pitfalls and Government Oversight of PPP Loan Certifications

This is a critical week for many borrowers under the Paycheck Protection Program (“PPP”) established by the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), pursuant to which businesses may apply for federally-guaranteed, forgivable loans to support payroll and ongoing operations during the COVID-19 pandemic.

Since the inception of the PPP, the Small Business Administration (“SBA”) and the Treasury Department have issued shifting guidance on a key requirement of the program:  the borrower’s certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” This has forced borrowers to re-assess their certifications in light of the new guidance, and to make a determination by Thursday, May 7 as to whether they should (1) repay their PPP loans to take advantage of a safe harbor that would allow them to evade future regulatory scrutiny or (2) retain their PPP loans and face the risk of a potential government investigation into whether their certifications were accurate and made in good faith. This QuickStudy analyzes the risks of a government investigation and provides guidance to PPP borrowers to assist in making this determination.

Shifting Guidance Concerning the “Necessity” Certification

The CARES Act expressly exempts PPP loans from the general SBA requirement that the borrower must be unable to obtain “credit elsewhere.” Many PPP borrowers therefore believed it was reasonable to certify that the loan was “necessary” based on the extent of their need and financial condition, without considering every potential alternative source of capital that might be available.  The SBA also created express waiver of the affiliation rules (which aggregate the size and revenue of affiliated companies) for companies in the hotel and restaurant industries, franchises registered with the SBA and others with SBIC financing, so long as these applicants have no more than 500 employees.  These exceptions further supported the idea that applicants would not need to consider the liquidity of a parent company or an affiliate before applying for a PPP loan. 

On April 23, however—following public criticism of certain large public companies that applied for PPP loans—the SBA issued updated guidance in its PPP FAQs indicating that the government will adopt a much narrower reading of “necessary.” It stated:

Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere . . . borrowers still must certify in good faith that their PPP loan request is necessary. . . . 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.¹

Despite the CARES Act’s express waiver of the “credit elsewhere” requirement, this new guidance requires borrowers to assess “their ability to access other sources of liquidity” that would be “not significantly detrimental to the business”—without defining what “sources” must be considered or what constitutes terms that would be “significantly detrimental.”

The April 23 guidance also provides a safe harbor for borrowers that made the certification that the loan request was necessary prior to April 23: “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.”

The SBA has since reaffirmed the April 23 guidance. On April 28, it made clear that the guidance applies to “businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations.”² On April 29, it “reminded” borrowers that this is “an important certification” and announced that the SBA “will review all loans in excess of $2 million, in addition to other loans as appropriate,” following the submission of the borrower’s loan forgiveness application.³

The Risk of Government Investigations Concerning the “Necessity” Certification

In the wake of this new guidance, many PPP borrowers are understandably concerned that the government could potentially view their pre-April 23 certifications as inaccurate. Generally, the False Claims Act and other federal anti-fraud statutes require that the defendant made a statement of fact that was knowingly false at the time it was made. Thus, if a borrower believed in good faith that a PPP loan was “necessary” at the time of its certification, it should not be liable for fraud in hindsight merely because the new guidance changed the applicable standards.

There are several reasons, however, why certain borrowers nevertheless may be at risk of a government investigation. First, the government will likely argue that the April 23 guidance did not change the standard, but rather only explained the proper interpretation of “necessary.” As such, the government may investigate borrowers that it believes had access to significant alternative sources of liquidity and then argue that their certifications were made in bad faith. Second, because the safe harbor allows borrowers to escape scrutiny by repaying their loans before May 7, any borrower with other potential sources of liquidity who retains PPP funds after May 7 may be more likely to be asked to provide evidence of their compliance with the new guidance. Third, if a borrower makes or repeats its certification after April 23 (e.g., in a new SBA application, in bank applications/agreements for loans requested before April 23, or in an application for forgiveness of the loan), that borrower would no longer be able to argue that it was unaware of the new guidance at the time of its certification. 

As a result, any borrower with potential alternative sources of liquidity should carefully assess whether a PPP loan is “necessary” to support its ongoing operations in light of the new guidance. Depending on the outcome of this assessment, borrowers should consider whether to take advantage of the safe harbor by repaying the loan by May 7.

Given the devastating economic fallout from the crisis, the ambiguous standards, and shifting guidance, these determinations may be difficult. For many borrowers, they may be tough judgment calls over which reasonable minds may disagree. It is therefore possible that the government’s enforcement efforts may focus initially on cases where there are clear red flags indicating bad faith. After all, making an honest but incorrect judgment call is not fraud.

But the SBA and Treasury Department have already come under fire for approving loans to large companies that were perceived to be beyond the intended “small business” scope of the PPP. This likely contributed to the narrow interpretation of “necessary” in the new guidance, and could lead to more aggressive enforcement. Public and political pressure on the government may lead it to investigate and pursue any companies that are viewed (rightly or wrongly) as abusing the program.⁴

There are numerous federal fraud statutes, both civil and criminal, that the DOJ could invoke in these investigations. One likely enforcement mechanism is the False Claims Act (31 U.S.C. § 3729, 18 U.S.C. § 287), which prohibits the submission of a knowingly false or fraudulent claim for payment to the federal government (as well as the making or use of any false statement or record in connection with such a claim). In such an investigation, the DOJ would look to see whether a borrower in fact had another source of liquidity, whether the borrower knew that, and whether with that knowledge the borrower falsely certified that the loan was necessary in applying for or retaining PPP funds. Because of its broad scope and strict penalties—including treble damages and civil penalties—the False Claims Act is a powerful tool for prosecutors, which yielded recoveries exceeding $3 billion in 2019 alone.⁵  Under the criminal anti-fraud statutes, penalties may include imprisonment or fines.

At best, government investigations are expensive and time-consuming, and can cause great reputational harm even if the borrower is cleared of any wrongdoing. At worst, they can result in harsh civil or criminal penalties for fraud. Thus, borrowers should proceed with caution, and carefully weigh the benefits of a PPP loan—funds that may be critical to a company’s survival during the pandemic—against the risk that the government may evaluate their potential alternative sources of liquidity and call their good faith into question. 

Steps to Take Now to Avoid Protracted Inquiry and Investigation Later

An analysis of whether a PPP loan was “necessary” to a borrower is a highly fact-specific inquiry.  Borrowers should analyze in detail (i) the impact of the COVID-19 crisis on their workforce, finances, and operations; (ii) the benefit and expected use of the PPP funds (e.g., retaining or rehiring employees, ending furloughs, keeping the business open); and (iii) other possible sources of liquidity that may be available, the terms of any such liquidity sources, and whether utilizing those sources would impose significant burdens or constraints on the business going forward.  

Borrowers that decide to proceed with applying for or keeping federal funds should document clearly the reasoning for their decision, so that they can demonstrate a good faith basis for their certifications, if challenged. To the extent that alternative sources of liquidity are determined to be unavailable or “significantly detrimental to the business,” borrowers should document as fully as possible the reasons why those sources would be unavailable or unduly burdensome. This is especially true for borrowers with well-capitalized owners or investors.  It will be important to note through board resolutions, meeting minutes or other means the reasons why the well-capitalized owner or investor was unable to provide liquidity to replace the PPP loan.  When and if government scrutiny comes, contemporaneous evidence of the decision-making may convince an investigator that a borrower acted in good faith.  Even with these challenges, the PPP can be a lifeline for distressed companies, especially those that can meet the eligibility standards set forth by the SBA and the Treasury.

*UPDATE: In new guidance, released late on May 5, 2020, the Small Business ‎Administration (SBA) announced that it is automatically extending its May 7, 2020 safe harbor ‎deadline to May 14, 2020. Any borrower who repays their loan in full by May 14, 2020 will be ‎deemed to have made their required loan certification in good faith. The ‎agency also promised to provide, prior ‎to May 14, 2020, additional information on how it will review certifications, which may further influence borrowers' assessments of whether to repay their loans. Locke Lord will continue to monitor new developments and post an ‎analysis of the new guidance regarding certifications once it is made available. 

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.

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_{1 Paycheck Protection Program FAQ #31 (emphasis added). ‎
2 FAQ #37.‎
3 FAQ #39‎.
4 The Federal Reserve Board has announced that it will publicly disclose “substantial amounts of information” ‎regarding the PPP on a monthly basis, including the names of borrowers and the amounts of their loans. This ‎transparency could further increase media scrutiny of borrowers, which could lead to more attention from ‎regulators.‎ ‎
5 Whistleblowers may also bring qui tam actions under the False Claims Act asserting claims on behalf of the ‎government, which could be another significant source of fraud litigation related to the PPP.‎}