Businesses with connections to China should proceed with caution when deciding whether to apply for funds from round two of the federal Paycheck Protection Program. New restrictions limit the eligibility of companies with “significant” ties to Asia’s largest economy, and may expose such applicants to increased government scrutiny.
The Small Business Administration (SBA) began accepting applications for Second Draw Paycheck Protection Program (PPP2) loans on January 13, 2021. Stricter eligibility requirements, added by Congressional lawmakers in response to scathing criticism of the initial program’s lack of controls, are a hallmark of PPP2. Congress also reduced the maximum loan amount in the second round of the program.
Generally, a borrower is eligible for a PPP2 loan if it previously received a First Draw PPP (PPP1) loan, will or has used the full amount of the loan only for authorized uses, has no more than 300 employees and can demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020. However, there are some additional disqualifiers in PPP2 that were not contained in PPP1, including one that forces an examination of the borrower’s relationship with China. Because Congress has specifically targeted China in PPP2, businesses with any ties to the country should proceed with extreme caution when deciding if a PPP2 loan is the right choice, and should certainly expect heightened governmental scrutiny if the loan is taken.
The Relevant Statutory Language
The relevant statute states:
The term “eligible entity … does not include any business concern or entity for which an entity created in or organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong, or that has significant operations in the People’s Republic of China or the Special Administrative Region of Hong Kong, owns or holds, directly or indirectly, not less than 20 percent of the economic interest of the business concern or entity, including as equity shares or a capital or profit interest in a limited liability company or partnership, or that retains, as a member of the board of directors of the business concern, a person who is a resident of the People’s Republic of China;
15 U.S.C.A. § 636(a)(37)(A)(III)(AA) and (BB). Similarly, the Paycheck Protection Program Second Draw Borrower Application Form states, in relevant part:
“The authorized representative of the Applicant must certify in good faith to all of the below by initialing next to each one: ___The Applicant is not a business concern or entity (a) for which an entity created in or organized under the laws of the People’s Republic of China or the Special Administrative Region of Hong Kong, or that has significant operations in the People’s Republic of China or the Special Administrative Region of Hong Kong, owns or holds, directly or indirectly, not less than 20 percent of the economic interest of the business concern or entity, including as equity shares or a capital or profit interest in a limited liability company or partnership; or (b) that retains, as a member of the board of directors of the business concern, a person who is a resident of the People’s Republic of China.”
The statutory language is unclear to say the least, and invites questions about its Congressional drafters’ aptitude for comma and conjunction use. Nonetheless, one thing is plain when these provisions are read in conjunction with their surrounding legislative history – Congress has made a policy decision that it does not want PPP2 funds entering the Chinese economy.
PPP1 vs. PPP2
PPP2 has enhanced eligibility requirements that were not present in PPP1. Ownership by a foreign company, such as China, was not listed as a disqualifier in PPP1. The PPP1 loan application form instead only asked applicants to verify that the individuals on their payroll are U.S. citizens or permanent U.S. residents. While PPP1 also asked for the identities of significant shareholders of the borrower entity, this request appears largely aimed at ensuring that borrowers were eligible to participate in SBA-administered programs. With its new China restrictions, the rules of the road are decidedly different in PPP2.
Congressional Intent
PPP2 disqualifies companies:
- That are created in or organized under the laws of China
- That have significant operations in China
- Of which a Chinese Company owns or holds, directly or indirectly, 20% or more of the economic interest of the business
- That retain as a member of the board of directors of the business a person who is a resident of China.
Congress made clear that its members believe China is to blame for the devastation caused by the pandemic. Legislators emphasized their intent was to provide PPP loans to small businesses and nonprofits, while preventing a single penny from flowing to China. Speakers on the floor of the House of Representatives stated, among other strongly worded criticism, that if China had been honest about the virus, 95% of the crisis would have been contained. Further, members of Congress blamed China for stockpiling PPE when the United States desperately needed it and wanted to hold China accountable. That the statute singled out China, and not Russia or North Korea, further demonstrates that Congress clearly did not want China to benefit from funds distributed through the PPP.
Practical Application
While Congress is clearly discouraging businesses with ties to China from applying for and receiving PPP2 loans, it is unclear exactly what will constitute “significant operations” in China. Significant operations could certainly include having a warehouse or factory in China, as well as if a substantial part of the business is dependent on operations in China.
Furthermore, it is unknown if a business can simply buy back shares owned by Chinese companies to qualify, and if so, how the details of that transaction should occur in order to ensure the SBA would conclude that the deal was made in good faith. It is likely inconsistent with the intent of Congress for a company to buy back shares from Chinese investors for the sole purpose of applying for a PPP2 loan immediately before filing an application. If a business wants to complete a buy-back transaction in order to qualify for a PPP2 loan, it is imperative to ensure that the shares are repurchased using appropriate consideration and that the structure of the deal is reasonable. All of these considerations would need to be evaluated on a case-by-case basis, and the likely outcome would be that Chinese companies with significant Chinese relationships are debarred from participation in PPP2.
The expansive language of the Chinese disqualification provisions in PPP2 means companies with ties to China that decide to apply for funds through PPP2 should expect a greater degree of governmental scrutiny. Any business owner who is considering applying for PPP2 loans should consult with counsel. The owner of any business that has already applied for a PPP2 loan and has concerns about compliance should also immediately consult with counsel who can assess the full potential for civil and criminal exposure.
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