Small Business Administration Issues “Fraud Warning” to Paycheck Protection Program Applicants
By: Kyle P. Graham
In response to public backlash surrounding large and profitable companies obtaining loans under the Paycheck Protection Program (PPP), the SBA issued guidance last week clarifying the eligibility of PPP applicants. As part of its Paycheck Protection Program Loans Frequently Asked Questions (FAQs) document, the SBA added FAQ #31, which asks, “[d]o businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?”
The SBA’s response to this question provides that all borrowers must assess their economic need for a PPP loan under the established guidance of 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, borrowers must certify on their application 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 to support ongoing operations in a manner that is not significantly detrimental to the business.
As an example, the SBA explains that it is unlikely that a public company with a substantial market value and access to capital markets is able to make the required certification in good faith. Further, any borrower that applied for a loan and repays the loan by May 7, 2020 will be deemed by the SBA to have made the required certification in good faith.
The PPP loan application indicates that a borrower who knowingly makes a false statement to obtain a loan can face imprisonment up to 30 years and/or a fine up to $1 million. Thus, while FAQ #31 is intended to curb the perceived abuse surrounding the first round of PPP applications, the end result is a subjective standard that raises additional questions for borrowers.
Who does FAQ #31 apply to?
The language of FAQ #31 asks whether businesses “owned by large companies with adequate sources of liquidity” qualify for a PPP loan. However, the answer given by the SBA states that “all borrowers” must assess their economic need for the loan and carefully review the required certification. Thus, the question arises, does FAQ #31 apply only to large companies with adequate sources of liquidity, or to every, single applicant?
The current PPP guidance does not provide an answer to this question. As a result, the conservative approach would be to treat FAQ #31 as if it applies to every, single borrower.
What does the phrase, “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant,” mean?
Similarly, this question is not clarified in the related PPP guidance. It would appear that every company can in good faith say they face “current economic uncertainty” as a result of the coronavirus and no business is totally immune to the pandemic. However, the second part of the phrase – “necessary to support ongoing operations of the Applicant” – is much more subjective.
In determining whether the loan is “necessary,” the following factors should be considered:
- But for the PPP loan, would the applicant have fired or furloughed employees, or reduced compensation levels?
- Would the partners or shareholders of the company need to reach into their personal funds to retain employees?
- When will the business collect its receivables?
- Will the business be able to collect its receivables?
- What is the business’s burn rate?
- How quickly can the business replenish its cash reserves?
- How long can the business stretch its current cash reserves?
Further, when making PPP loan application certifications, applicants should consider the following:
- Impact on the industry. For example, a primarily dine-in restaurant is impacted more by the pandemic than a grocery store.
- Impact on the specific business. Some industries may see an influx of business as a result of the pandemic, whereas others may see business come to a standstill.
- Financial strength of the business. How long would the business be able to keep its head above water without the loan? How much cash is coming in versus going out? Will a business be able to collect its receivables?
- Management team. How adaptable and sophisticated are the business’s decision makers? Is this a large or small group? How flexible and prepared is the business for a catastrophic situation like this?
Reviewing Financial Statements and Projections
Applicants should also be sure to review their financial statements and projections when applying for a PPP loan. Consider whether it is likely that the company will collect its receivables as they are due. Also, consider the length of the pandemic in making projections. However, a financial statement analysis alone should not be the sole consideration. Keep in mind that the goal of the program is to keep people employed and to protect compensation levels.
Comfort letters might be helpful to include with an application, which set forth a good faith statement of necessity in applying for the loan. Borrowers may also want to document the specific reasons why they believe the loan is necessary and what actions they would have taken if they did not receive the loan. Including financial projections showing an expected burn rate can also help support the necessity of the loan. Finally, borrowers that clearly do not meet the eligibility standard set forth above should repay the loans by May 7th as FAQ #31 indicates in order to avoid future problems.
Kyle Graham is an attorney at the Cleveland, OH-based law firm McCarthy, Lebit, Crystal & Liffman.
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