On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act) came into effect as part of an ongoing effort to combat the financial crisis arising from the COVID-19 pandemic. The CARES Act provided $2.2 trillion in much needed assistance to businesses and established loan programs, including the Paycheck Protection Program (PPP). But businesses that have taken advantage of these programs may now find themselves under regulatory or even criminal scrutiny. They may also face significant exposure under the federal False Claims Act (FCA).1
Companies struggling in the midst of the COVID-19 pandemic quickly applied for billions of dollars in assistance, knowing the PPP funds were distributed on a first-come, first-serve basis. Initial PPP funding ran out of money in less than two weeks. On April 23, 2020, Congress passed another bill, which provided an additional $310 billion for the then-depleted PPP.
In the rush to deliver assistance, there was little guidance issued to assist companies navigating the PPP application process. For example, applications for PPP loans require companies to certify that the “current economic uncertainty makes this loan request necessary to support the ongoing operations” of the applicant – but, at the time the PPP was unveiled, there was no definition or guidance on what qualified as “necessary.”
Additional guidance has trickled out in subsequent weeks. On April 23, 2020, the US Treasury Department and the Small Business Administration (SBA) updated an FAQ document on PPP loans, which questioned whether large businesses, such as public companies with substantial market value and access to capital markets, could truly make the certification that the loan was “necessary” to support ongoing operations in good faith. The FAQ document attempted to further define the certification requirement by stating that borrowers making the certification must “tak[e] 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 US Secretary of the Treasury Steven Mnuchin has warned that large companies could face criminal liability for keeping emergency loans intended for small businesses during the COVID-19 crisis. He also cautioned that the SBA would closely scrutinize (through audit) any company receiving a PPP loan exceeding $2 million and would conduct a “full review for forgiveness before they’re repaid.” Secretary Mnuchin specifically warned of the risks associated with falsely certifying that the loan was “necessary” for the company’s continued operations.2 The Treasury Department has announced that companies that repay the loans by May 7, 2020 will be considered to have made the required certification in good faith.
Large companies that do not return PPP funds by May 7 may quickly find themselves the targets of FCA litigation and exposed to other regulatory investigations and enforcement. These evolving announcements also are an indication that other businesses that received millions of dollars in funds may now face legal risks, including FCA prosecution, if the government later determines certain recipients did not meet the ill-defined standard.3
The FCA prohibits, among other conduct, knowingly making a false or fraudulent claim, or making or using a false record or statement material to a false or fraudulent claim, in order to defraud the US government.4 Historically, FCA prosecutions increase following crises. For example, FCA prosecutions rose after the September 11th terrorist attacks, the 2008 financial crisis, and Hurricane Katrina. The CARES Act seems to anticipate fraud in the application for and use of funds, and created a Pandemic Response Accountability Committee to oversee funds distributed under CARES Act programs.
The government is already investigating allegations of fraud. On April 30, 2020, United States Assistant Attorney General Brian Benczkowski announced that a preliminary inquiry had identified possible fraud among businesses seeking relief under the PPP.5 The inquiry found that companies had made misrepresentations related to, among other things, their payroll costs and number of employees.
Given the DOJ’s continued focus on fraud arising from the COVID-19 pandemic, a wave, if not a tsunami, of FCA cases appears inevitable. Attorney General William Barr has directed US Attorneys to prioritize investigations into and prosecutions of fraud related to COVID-19,6 warning the business community that the DOJ “stands ready to make sure that bad actors do not take advantage of emergency response efforts, healthcare providers, or the American people during this crucial time.”7 The US Attorneys have also been instructed to appoint Coronavirus Fraud Coordinators in each US Attorneys’ Office to serve as legal counsel on matters relating to COVID-19, and to direct the prosecution of COVID-19 related crimes.8
The risks to companies applying for funds under a CARES Act program are real and require immediate attention. Fortunately, as described below, companies can take steps that may proactively mitigate the risks of future FCA litigation.
What is the False Claims Act?
The FCA creates civil and criminal penalties for those who submit certain false or fraudulent documents to the federal government. It dates back to the Civil War and was passed to allow the government to prosecute contractors who made false representations when selling critical supplies to the Union Army.
When applying for PPP loans or other funds provided for by the CARES Act, companies that make false representations may violate the FCA. The claims or statements do not have to be made directly to the government – for example, the FCA covers false claims made to a bank in a PPP loan application.
Companies may also run afoul of the FCA when using PPP and related funds, responding to audits, or seeking loan forgiveness. If and when the SBA audits how the funds were used (triggered when companies apply for loan forgiveness), companies will be required to provide substantiation supporting the request for forgiveness. In this process, companies must take care not to make or use a false record or statement or knowingly conceal information that could affect their obligation to repay the government.9
Companies face significant penalties for FCA violations. The FCA imposes a civil penalty of $5,000 to $10,000 for each violation, in addition to three times the amount of damages the government sustains because of the fraud.10
The FCA is unique because the DOJ does not have exclusive authority to bring FCA claims – most FCA claims are initiated by private citizens/whistle blowers who bring claims in the name of the government, otherwise known as qui tam actions. Last year, more than 80% of FCA cases were initiated by individuals.11 If an FCA case is brought by a private citizen, the government may intervene and pursue the case itself. If the government declines to pursue the charges, the person who initiated the action usually has the opportunity to continue the litigation.12
The FCA incentivizes individuals to bring these claims. If the government achieves a judgment or settlement with the company, the individual that initiated the case usually receives 15-25% of the settlement or judgement amount. If the person proceeds without government assistance, then the individual generally will receive 25-30% of the settlement or judgment.13
Individuals bringing FCA claims are often (but not exclusively) disgruntled or terminated employees. Even if a company can ultimately prove that the FCA claim is baseless, it will need to defend against these claims and will inevitably incur legal fees and costs.
Given the financial incentives for bringing claims and the costs of defending them, companies should pay close attention to the risks associated with potential whistleblowers. Individuals that are uncomfortable raising concerns internally or feel that the company is not taking the issues seriously also may opt to bring an FCA claim against the company. The FCA expressly prohibits any retaliation against a whistleblower, and any retaliation could result in additional legal exposure.14
How does the CARES Act open the door for FCA litigation?
Companies face potential FCA risks at several stages of the PPP/ CARES Act funding process.15
The PPP – among the most well-known CARES Act program – provides two-year loans of up to $10 million at 1% interest to businesses with less than 500 employees. The loans are intended to cover payroll costs, health care benefits, and mortgage, lease, and utility payments.
In addition to the PPP, the CARES Act provides other forms of financial assistance. For example, businesses with 500-10,000 employees may obtain direct loans from banks and other financial institutions subject to requirements different than those attached to PPP loans. The CARES Act also separately provides funding for distressed sectors, such as aviation, that is subject to limitations on reductions in employment levels, stock buybacks, dividends, and executive compensation.
Companies applying for assistance are required to make certain representations, and any false statements made while seeking these funds may constitute an FCA violation. The SBA explicitly allows lenders to rely on certifications and documents provided by the applicant to determine its eligibility for the program, the qualifying loan amount, and the recipient’s eligibility for loan forgiveness. Applicants that make a misrepresentation to the bank evaluating the application and distributing funds may violate the FCA.16
Some of the required representations are more straightforward than others. For example, a company usually knows if it is a debtor in a bankruptcy proceeding, and can easily answer that question. But other representations contain amorphous and ambiguous terms, and, given the lack of guidance, companies risk making inadvertent inappropriate or inaccurate representations.
The example that has drawn the most attention is the “necessary” certification. Applicants for PPP and mid-size loans must certify in good faith that the uncertainty of economic conditions makes the loan request “necessary” to support its ongoing business operations. The CARES Act does not define “necessary,” and the US Department of Treasury and SBA initially did not provide any guidance defining that term. Only weeks after the program was unveiled and billions of dollars in loans had been issued, and in response to public outcry that large businesses unfairly took advantage of the PPP program at the expense of small businesses, did the federal government publish additional guidance on the certification requirement. Curiously, though, it has still not defined the term “necessary.”
Companies applying for other types of loans, such as loans intended for distressed sectors, also must make several certifications in applying for these funds, including that credit is not reasonably available to the company at the time of the transaction, and that the company believes it will be able to repay the loan. There is a similar lack of concrete guidance for companies seeking to determine whether they can make these representations in good faith.
Eventually, distressed companies are hoping that their loans will be forgiven. To obtain partial or full forgiveness, loan recipients will need to provide documentation to the bank, including information related to payroll costs, the number of employees, salaries, and mortgage, lease, and utility payments. Recipients of mid-sized loans and loans to distressed sectors (but not recipients of PPP loans) will have to prove that they met additional requirements, including that they retained at least 90% of their workforce at full compensation and benefits until September 30, 2020.
At the loan forgiveness stage, businesses will again need to ensure that they do not provide information or make representations that could violate the FCA. First, businesses without adequate compliance programs, or businesses whose compliance programs have suffered resource reductions due to the COVID-19 crisis, may not have been tracking the required information on an ongoing basis. Companies attempting to re-create events months later risk making material errors. Second, businesses are likely to still be under extraordinary financial pressure. While businesses naturally will want to maximize loan forgiveness, they must carefully review the information submitted for accuracy.
What companies are at risk?
Any and all applicants for, or recipients of, funds provided under CARES Act programs face FCA risk. Small businesses may face increased risk, in that they may be more likely than large businesses to lack the procedures necessary to properly manage the influx of cash or document the use of funds. However, large companies who receive PPP funds and other industry-specific grants are more likely to be the subject of FCA and other fraud scrutiny and enforcement. Following the 2008 economic crisis, the public has little appetite for corporate bailouts. Members of the US Senate already have asked the SBA Inspector General to investigate PPP lenders to determine whether larger companies received preferential treatment at the expense of smaller companies during the initial PPP period.17
Under this pressure, some companies have returned funds prior to the May 7, 2020, safe harbor deadline. For example, Shake Shack and the Los Angeles Lakers returned $10 million and $4.6 million PPP loans, respectively, after facing intense criticism that they took money intended to assist small businesses.
What can companies do to mitigate FCA risk?
While companies struggle to maintain their businesses and take care of their employees during these unprecedented times, it is easy to overlook the importance of maintaining basic procedures. It is important that companies consider how best to mitigate future risks related to FCA litigation – not to mention how best to position themselves for maximum loan forgiveness. There are several steps companies should consider taking:
Document, document, document! The most important step companies can take is to maintain accurate and comprehensive documentation. Companies often assume that they will be able to recall details, such as when the company used the funds and why the funds were used. Reconstructing that information later – even if possible – substantially increases the chance that the company may unintentionally provide inaccurate information. When applying for funds, document the rationale justifying the certifications (e.g., necessity of funds). Once the company has the funds, document how and when the funds were used.
Segregate the funds. Companies should open a separate account to segregate PPP or other CARES Act funds from the rest of the business’s finances. Doing so will streamline accounting and assist the company if it needs to substantiate when and how the funds were used to obtain loan forgiveness or defend FCA claims.
Implement internal and accounting controls. Companies should ensure that they have sufficient internal and accounting controls in place to monitor how the funds are being used. To obtain loan forgiveness, companies may only use CARES Act funds for specified purposes, including employee retention, maintaining payroll, or making mortgage, lease, or utility payments. Creating a document trail will help later substantiate that the funds were used properly.
Establish a comprehensive compliance program. Companies that lack a robust compliance program could land in hot water. As a general matter, an effective compliance program must be tailored to each company’s profile to account for its industry, geographic location, and size. Even if your company has a compliance program in place, this is the time to revisit and enhance the program as necessary.
Establish procedures. Consider establishing procedures to ensure that the company does not violate any of the other representation and certification requirements in the applications. For example, companies in the distressed sectors receiving funds should implement procedures to monitor employment levels and executive compensation.
Fine-tune the whistleblower program. Finally, make sure that your company has in place an effective whistleblower program. Employees should be able to raise concerns internally without fear of retaliation. Remember – private citizens can bring FCA claims, and the individuals who bring FCA claims are often disgruntled and terminated employees. These claims automatically bring any potential misconduct to the government’s attention, so it is in the company’s interest to encourage employees to raise issues internally first. Furthermore, the FCA explicitly prohibits any retaliation against whistleblowers who file such claims, and any sort of retaliation will only exacerbate the company’s legal issues. Companies should be particularly mindful of whistleblower programs and protections during the COVID-19 crisis, which has led to increased layoffs and employment uncertainty, and is expected to lead to an increase in whistleblower claims.
Companies, in sum, should take the risks of FCA litigation seriously, and should consider taking steps to protect themselves by implementing the preventative measures described above. During this crisis, many businesses are understandably focused on maintaining their day to day operations. But taking preventative actions now may avoid costly FCA litigation in the future.
3 For example, on May 1, Treasury Secretary Mnuchin advised in a Twitter post that private schools with “large endowments” should return PPP funds.
4 31 U.S.C. §3729(a)(1).
5 “Justice Department Sees Early Fraud Signs in SBA Loan Flurry,” Bloomberg (Apr. 30, 2020)
available at https://www.bloomberg.com/news/articles/2020-04-30/justice-department-sees-early-fraud-signs-in-sba-loan-flurry?srnd=premium.
6 “Attorney General William P. Barr Urges American Public to Report COVID-19 Fraud,” Department of Justice, Office of Public Affairs (Mar. 20, 2020)
https://www.justice.gov/opa/pr/attorney-general-william-p-barr-urges-american-public-report-covid-19-fraud.
7 For additional information, see
The DOJ’s response to COVID-19 (Mar. 17, 2020).
8 “Attorney General William P. Barr Urges American Public to Report COVID-19 Fraud,” Department of Justice, Office of Public Affairs (Mar. 20, 2020)
https://www.justice.gov/opa/pr/attorney-general-william-p-barr-urges-american-public-report-covid-19-fraud.
17 Letter from U.S. Senators Charles E. Schumer, Sherrod Brown, and Benjamin L. Cardin to the Honorable Hannibal “Mike” Ware, Inspector General, U.S. Small Business Administration (Apr. 23, 2020)
available at https://www.sbc.senate.gov/public/_cache/files/3/5/35ed6b8a-98b6-48bb-b981-bec36093d414/032BC243A62968CAB16F7E1EDE36900D.200424cardinschumerbrownlettertosbaigware.pdf; Letter from U.S. Senators Elizabeth Warren and Nydia M. Velázquez to Hannibal “Mike” Ware, Inspector General, Office of the Inspector General, U.S. Small Business Administration, and Richard K. Delmar, Acting Inspector General, Office of the Inspector General, U.S. Department of the Treasury (Apr. 23, 2020)
available at https://www.warren.senate.gov/imo/media/doc/2020.04.23%20Letter%20to%20SBA%20and%20Treasury%20IG.pdf.
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