In response to the economic crisis caused by the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), was signed into law and dedicated $349 billion to the Paycheck Protection Program (“PPP”). After the entirety of the funds were exhausted in less than two weeks and Congress worked on passing an additional stimulus package to add an additional $310 billion to the PPP, public displeasure and dissatisfaction grew. While many struggling small businesses were unable to obtain loans in the first round of the PPP, some high profile public companies and large hotel and restaurant franchises received large PPP loans.
In light of many of the concerns raised regarding “Round 1” of the PPP, in updates to certain Frequently Asked Questions on April 23, 2020, April 28, 2020 and April 29, 2020, the Small Business Administration (SBA) provided additional guidance regarding a borrower’s demonstration of financial “necessity” when applying for PPP loans. The additional guidance is found at FAQ #31, #37 and #39. The stated purpose of these FAQs are to clarify the existing obligations under the program. The SBA also issued an Interim Final Rule on Requirements for Promissory Notes, Authorizations, Affiliation, and Eligibility on April 24, 2020 that reiterated the guidance provided in the FAQs. Importantly, no changes were made to the application, borrower certifications, or eligibility requirements for PPP loans.
The PPP suspended a required certification for other SBA loans that a business is “unable to obtain credit elsewhere.” However, the SBA instructed that PPP “borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that "current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The SBA went on to clarify that 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.” The SBA has created a safe-harbor for businesses that applied for a PPP loan prior to the issuance of the new guidance and now feel that they cannot make this certification. If you believe that your business cannot make the required certification, the new guidelines state that any borrower who applied for a PPP loan prior to the issuance of the new guidance who returns funds by May 7, 2020, will be deemed by the SBA to have made their certification in good faith and avoid any future scrutiny or penalties. (FAQ #31). While the new FAQs offer some additional information regarding the “necessity” requirement, there is, unfortunately, still no bright-line, objective test or metrics to determine “necessity.”
In light of these clarifications and comments by Treasury Secretary Mnuchin to the Wall Street Journal regarding Treasury’s intent to audit PPP borrowers, it is advisable to keep clear, detailed records of: (i) the financial condition of your business at the time you applied for the loan, (ii) liquidity or cash flow at the time of application, (iii) any other attempts to obtain financing or liquidity from other sources, (iv) any denials of applications for other sources of financing, (iv) any insolvency events or inability to pay other debts, and (v) (most importantly) all disbursements and use of the PPP loan proceeds. FAQ #39 provides that the SBA will review all PPP loans in excess of $2 million, in addition to other loans if appropriate, after the lender’s submission of the borrower’s loan forgiveness application. This, along with the PPP certifications and guidance make clear that a borrower may be called upon to provide evidence to support the use of PPP loan proceeds. These could include IRS payroll tax filings, state income, payroll, and unemployment insurance filings, and payment records (such as receipts, card records, or payment receipts). If offers of reemployment were made to employees, but were not accepted, you should document these communications, as well, should the need arise to show good-faith efforts to reemploy your workforce.
A number of borrowers have asked about the use of PPP funds once the eight-week loan forgiveness calculation period ends. The eight-week period starts the day of the first loan disbursement. (FAQ #20). Even if the full amount of the PPP loan is not used during the eight-week forgiveness calculation period, the funding must still be limited to only permitted purposes (payroll and benefits costs, interest on preexisting (as of February 15, 2020) mortgages, payments on preexisting (as of February 15, 2020) lease agreements, and payments on preexisting (as of February 15, 2020) utilities services). Many borrowers are establishing separate accounts for the receipt of PPP funds so that this money is segregated from other sources of revenue and it will be easier to demonstrate that the funds were only used for payroll and other permitted uses (note that at least 75% of the proceeds must be used for payroll costs).
Borrower caution is warranted in light of the affirmation on the PPP application that states: “knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law, including under 18 USC 1001 and 3571 by imprisonment of not more than five years and/or a fine of up to $250,000; under 15 USC 645 by imprisonment of not more than two years and/or a fine of not more than $5,000; and, if submitted to a federally insured institution, under 18 USC 1014 by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.” Additional information regarding the risks related to the application and the use of the proceeds is available in our previous client alert on this topic: False Claims Act and Other Potential Liability for Misuse of Paycheck Protection Program Loans.
