Public Outcry Leads to New SBA Guidance on PPP Eligibility, the “Necessary to Support the Ongoing Operations” Certification, and a “Safe Harbor”

Following criticism that large restaurant chains were able to obtain funds before the loan program had been depleted - seemingly shutting out much smaller restaurants - Shake Shack has publicly announced that it is returning its $10 million Paycheck Protection Program (“PPP”) loan. Other large restaurant chains such as Ruth’s Chris Steakhouse, Potbelly and J. Alexander’s have also been in the news for receiving large PPP loans. Calling the program “confusing” and without a “user manual,” Shake Shack noted that while it met the CARES Act criteria for a loan, it now understands that the program was underfunded and that the corporation had the alternative ability to “access the additional capital we needed through an equity transaction in the public markets.”

Restaurants received a special waiver of the affiliation rules in the CARES Act, which enhanced the eligibility of these large corporations with multiple locations and many employees for significant loan amounts. But the current outcry isn’t limited to restaurants. Forbes is reporting that 71 publicly traded companies received PPP funding before the money ran out last week, including 20 publicly traded companies with current market capitalizations greater than $100 million.

These developments beget the question many applicants confronted at the time of their program application: What establishes a sufficient basis for the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” to determine program eligibility? Without guidance from the SBA, there was only the CARES Act directive that the certification had to be made in “good faith.” Now, under headline and political pressures, the SBA has issued new guidance.

Unfortunately, the guidance doesn’t provide any clear resolution or measurable metric: “[B]orrowers still must certify in good faith that their PPP loan request is necessary.” The SBA utilizes a “credit elsewhere” test for some loans, and under typical circumstances the SBA would not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the requested financing. But these tests were waived by the CARES Act for determining PPP eligibility. Now, renewed assessment of alternative liquidity appears in the SBA’s latest guidance. The guidance now establishes that before certifying to the necessity for the PPP loan, applicants should take “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 new guidance also suggests that the SBA may be auditing these certifications, at least for larger businesses: “[I]t 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.”

The timing of this new guidance might suggest that it is intended for future applicants if loan funds are replenished and the processing of additional applications resumes. However, it appears to be extended even to current loan recipients. Despite the SBA’s continuing assertion that, “Borrowers and lenders may rely on the [SBA’s] guidance” and it’s assurance that, “The U.S. government will not challenge lender PPP actions that conform to this guidance, and to the PPP Interim Final Rule and any subsequent rulemaking in effect at the time,” the guidance newly provides a “safe harbor” for borrowers concerned about the scope of their earlier certification in the new public glare: “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.”

Prompted by the weight of enhanced public glare, this “safe harbor” suggests that the SBA may be recasting the rules of eligibility by assessing liquidity and newly weighting the allocation of the PPP funds away from public conglomerates while leaving the “good faith” standard for eligibility certification unchanged. Perhaps with any additional program funding we may receive further guidance.

The full text of the SBA guidance newly issued on April 23, 2020 follows:

31. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), 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 “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” 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. Lenders may rely on a borrower’s certification regarding the necessity of the loan request. 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.