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PPP Loans — Building the Case to Support Your Certification of Economic Need

UPDATE AS OF MAY 5, 2020 – SBA EXTENDS SAFE HARBOR TO MAY 14, 2020 AND PROMISES FURTHER GUIDANCE PRIOR TO THEN

In creating the Paycheck Protection Program (“PPP”), the CARES Act required that “an eligible recipient applying for a covered [i.e., PPP] loan shall make a good faith certification that . . . the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.” To that end, the application for a PPP loan includes the following certification by the applicant:

“[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

Because the PPP loans are a type of SBA “Section 7(a) loan,” but the intent of the Act was to reduce red tape and speed the funds into the economy, the CARES Act also included a provision to remove a standard Section 7(a) loan requirement. The statute specifically stated that “during the covered period, the requirement that a small business concern is unable to obtain credit elsewhere, . . . shall not apply to a covered loan.”

The combination of these two provisions gave most applicants comfort. By the first date applications could be made, April 3, 2020, many businesses had either already suffered or could easily foresee in the near future substantial negative impact to their operations that in most cases had caused and/or would cause job losses and/or compensation reductions. Consistent with the law’s objective, PPP proceeds would enable recipient businesses to retain staff and pay levels, and recipients were incentivized to maximize those benefits for their employees to maximize forgiveness.

In response to several highly publicized examples of public companies with access to capital securing PPP loans, the SBA and Treasury Secretary Mnuchin issued stern warnings that PPP loans were not intended for such companies and reminded applicants of the liability provisions of the CARES Act up to and including liability under the False Claims Act. While some companies returned their loans and others pledged to do so in response to the negative publicity and threats, the SBA took additional action by adding the now (in)famous questions 31 and 37 to the PPP “FAQs”. The responses, particularly to question 31, appeared to walk back from the comfort provided to applicants and recipients under the plain language of the CARES Act, creating uncertainty and a firestorm of criticism.

Specifically, FAQ 31 asks:

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

In response to question 31[1], the SBA takes the position that:

“… 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. . .”

While the CARES Act specifically removed the requirement that an applicant establish it cannot obtain credit elsewhere, the answer to question 31 seems to indicate that the ability to access other sources of liquidity is at least a factor in whether the applicant’s certification may be deemed false. Further, the response introduces the standard that the “need” must be to enable support of ongoing operations “in a manner that is not significantly detrimental to the business.” Read together, these standards imposed by the SBA imply that simply supporting ongoing operations as the certification literally requires is not enough, and the harm avoided by the PPP capital – above other accessible sources of capital – must rise to the level of a significant detriment.

After introducing this uncertainty, the SBA then established a safe harbor of May 7, 2020 by which recipients could return PPP loan proceeds. In that event the recipient would:

” . . . be deemed by SBA to have made the required certification in good faith.”

In other words, returning the money by that date would avoid liability for obtaining the loans using a false certification of economic need. Unfortunately, the SBA did not publish any guidance to interpret the apparent conflict between the implied heightened standard and the CARES Act and application language, leaving recipients in a terrible position to evaluate their exposure.

So, what should a recipient do?

First, on May 5, 2020, the SBA issued a new question 43 as part of the PPP FAQs and provided some relief, even if only incomplete and temporary. The response to question 43 extended the safe harbor date from May 7 to May 14, 2020 and promised additional guidance on this topic before that date.

Second, recipients should build the qualitative and quantitative support for the economic necessity and they should do it now. While every business is unique, following are several suggested areas to evaluate and document:

  1. The uncertainties your business faces from COVID-19, for example:
    a.  uncertainties about your supply chain;
    b.  uncertainties about when the business can reopen to customers;
    c.  uncertainties about whether customers will return when the business opens;
    d.  uncertainties about whether a new wave of the virus will hit; and
    e.  uncertainties about whether customers will be able to afford your product or services, etc. 
  2. Requests you have already received to reduce charges to or work for your customers, or their actions like delayed payments and increased write-downs or charges.
  3. Any limitations on your ability to use working capital (e.g., doing so could take you out of covenant on existing loans or undermine bonding requirements).
  4. Any inability to borrow additional funds, which could be a lender’s denial of a loan request or an assessment of the business’s ability to increase its debt load without substantial detriment to business operations, along with reasons for any unwillingness to use your capital or leverage ability.
  5. Significant business risks to using existing working capital or taking on new debt to fund current operations.
  6. A plan for reducing staff and payroll costs and the extent to which such plan is put on hold because of the expectation of forgiveness.
  7. A current threat assessment to your business in light of the current situation, including risks such as:
    a.  Employees may depart for “greener pastures” if the business were to cut compensation or support staff levels;
    b.  Employees may decide to claim unemployment rather than remain employed given the significantly increased unemployment benefits provided under the CARES Act and the life complications triggered by school and daycare closures/remote learning; and
    c.  Drop-in current or budgeted production levels because employees cannot collaborate as efficiently or because they are less productive when working remotely, or because demand from customers/clients could change if they are adversely affected by COVID-sponsored economic disruptions. 
  8. Market trends that suggest disruption in your business is likely or possible (e.g., evidence that your competitors are facing greater economic challenges that cause you to reasonably suspect that you too should anticipate similar challenges). 
  9. How you are currently impacted (e.g., shortfalls in budgeted production or revenue). 
  10. Other steps you are taking to reduce risk or preserve capital, such as hiring freezes, restricting previously-budgeted expenditures, delaying (or even accelerating) capital expenditures, earnings guidance provided to shareholders/owners, preserving cash, drawing down existing lines of credit, etc. 
  11. Cutbacks and other reductions undertaken by other businesses in your industry.
Once these assumptions have been documented, develop 12-24-month income statement and cash flow projections including “downside” scenarios that capture the quantitative impact of these assumptions. Your cash flow model should include any other capital you can currently access (up to the point of which using that capital would be “significantly detrimental” to your business such as capital necessary for other purposes including maintenance and operational capital expenditures or restricted to stay within loan covenants) and how far that may carry you with and without the PPP proceeds.

Finally, keep in mind that the SBA has announced that all PPP loans in excess of $2,000,000 and a random selection of loans below that amount will be “fully audited” by the SBA at the time when the application for forgiveness is made, and before forgiveness is granted. The SBA has traditionally been rigorous in its audits. The U.S. Department of Justice has also announced they will investigate and prosecute all businesses (no matter the size) that fraudulently applied for or utilized the PPP loans for uses other than intended by the PPP and the CARES Act.


[1] The answer to FAQ 37 made the answer to FAQ 31 applicable to both public and private companies.

Contributing Attorneys:
Tino M. Monaldo
Douglas M. Ventura

Disclaimer: The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls, letters and electronic mail. 

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