Against the backdrop of a steady flood of negative news articles suggesting that “larger” or venture-backed companies are taking funds meant only for very small businesses, on April 21, 2020, U.S. Treasury Secretary Steven Mnuchin warned of “severe consequences” for large companies that inappropriately accepted PPP loans.1 That warning was followed by the Small Business Administration’s (SBA’s) interpretive guidance in the form of Frequently Asked Questions, which further cautioned large companies and announced “amnesty” for companies that repay their loan in full by May 7, 2020.
Warning to Large Companies with “Adequate Source of Liquidity” and “Amnesty” Program
Of particular significance, FAQ #31 addresses the required certification of business “necessity” for entities applying for loans under the Paycheck Protection Program (PPP):
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. (emphasis added by Fenwick)
The guidance goes on to establish an “amnesty” for entities that previously applied, if they return the funds by May 7, 2020:
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.
Inclusion of the amnesty provision is unusual and can be interpreted as a not-so-subtle signal by Treasury that it believes some appreciable number of companies should not have applied for PPP loans. The complete guidance, issued on April 23 and updated on April 24 and April 26, is available here.
PPP Loan Certification of “Necessity” Remains Unclear
Section 7(a)(2)(G)(i) of the Small Business Act, as amended by the CARES Act, and the SBA’s form of PPP loan application, requires an applicant to certify that a loan is “necessary” to support the borrower’s ongoing operations.2 The necessity standard is vague, but there has been general agreement that current protection of jobs is the bedrock principle and should form a key part of the support for any businesses’ decision to apply for a PPP loan.
FAQ #31 does not change the legal standard for making the necessity certification, but it cautions that publicly traded companies with “substantial market value and access to capital markets” would be unlikely to satisfy the necessity standard. It also introduces the constraint that applicants not have “access” to other sources of liquidity “sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” Unfortunately, what “other sources of liquidity” and “not significantly detrimental to the business” means remains to be seen.
What Will Government Investigations and Enforcement Look Like?
With the ongoing public scrutiny of the PPP program, we expect the SBA to develop a list of recipients who will be asked to demonstrate the basis for their certification that the PPP loan was necessary, as well as the other elements of eligibility. On April 28, Secretary Mnuchin announced that the SBA will conduct a “full review” of all loans over $2 million before there is loan forgiveness. Further, the SBA may use a number of criteria to develop a review list, including financial metrics such as annual revenues, market capitalization (for public companies), and amount of venture capital raised (for private companies). From this initial round of requests, the SBA will be looking to identify entities which may merit further investigation of whether they met the necessity requirement. Another source for identifying companies for further investigation likely will come from audits and oversight of the PPP lenders.
We expect government scrutiny of how lenders prioritized loan applications, with particular attention to potential conflicts of interest or favoritism to certain applicants. Should potential conflicts be identified, we would expect investigators to also look closely at applicants to evaluate their contacts with the lender and the basis for their necessity determination.
We expect a newly created special oversight function to play a leading role in governmental investigation and enforcement related to PPP loans, as well as other governmental aid and spending flowing from the CARES Act. The new law created the Special Inspector General for Pandemic Recovery (SIGPR) to “conduct, supervise, and coordinate audits and investigations of the making, purchase, management, and sale of loans, loan guarantees, and other investments made by the Secretary of the Treasury” through the PPP and other programs. (Pub.L. 116-136 -Coronavirus Aid, Relief, and Economic Recovery Act.) This position appears to be analogous to the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), which was created by Congress in response to the 2008 financial crisis.
SIGTARP has been an aggressive and long-lived enforcement arm of the federal government. It still is functioning nearly a dozen years after its creation and has been credited with criminal and civil actions against over 300 defendants. SIGTARP leveraged its resources by teaming up with the U.S. Department of Justice and other agencies to conduct investigations and bring enforcement actions. We expect SIGPR to function in a similar fashion. Also of note, SIGPR is required to issue quarterly reports to Congress, which will incentivize SIGPR to have a healthy inventory of ongoing investigations.
What Should PPP Applicants Do in Response to FAQ #31?
FAQ #31 and the continuing negative press coverage has increased the risk for many companies that have applied for PPP funds or are considering applying. Companies which previously applied for and have received a PPP loan, or are expecting to receive such a loan, should consider re-evaluating their application decision in light of the new guidance, before the May 7 deadline. These companies should consider a number of factors, including:
- Analysis of whether there is an alternative source of funding that would not be “significantly detrimental” to the business. For example, companies should consider prior and concurrent efforts to obtain financing, sources of available capital (both debt and equity) and the terms of such alternative financing on the business (e.g., does the financing include covenants necessitating a restructuring and significant elimination of jobs?)
- Whether the data and analysis used by the decision-makers would adequately support a necessity determination if examined by the SBA
- How the company could be ranked as against other borrowers in terms of market capitalization, revenue, or other metrics
- Whether the negative public reaction to PPP loan recipients so far creates an outsized publicity risk for the company and its stakeholders, and
- Additional guidance or commentary that may be published over the course of the next week
Having an adequate process for making the necessity determination and certification will be important to defend against any regulatory inquiries, subsequent potential private litigation, or inquiries from the press. The data and analysis used in the decision-making should be collected and readily available should the company need to support its application decision.
Access additional guidance in Fenwick’s COVID-19 Resource Center.
1 Secretary Mnuchin was also reported to have said: "But there are severe consequences for people who don't attest properly to this certification. And again, we want to make sure this money is available to small businesses that need it, people who have invested their entire life savings. We appreciate what's going on, and they're hiring people back." See, e.g., “Treasury Secretary warns there will be 'severe consequences' for large companies,” Business Insider (April 22, 2020).
2 Specifically, the Small Business Act, as amended, requires that a borrower certify in good faith “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.” The SBA PPP loan application uses slightly different wording (“Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”), but is substantively the same standard.