By Suzanne M. Scibilia and Brian G. Enright
Funding of the expanded Paycheck Protection Program – another $310 billion – is in full swing. The SBA’s Frequently Asked Questions (“FAQ”) keep changing, adding increasing uncertainty about whether PPP loans will actually be forgiven when the time comes.
The addition of Question #31 to the FAQ on April 23, 2020, the addition of Question #37 on April 28, 2020, and the addition of Question #39 (overnight after this alert was drafted), has employers appropriately worried not only about whether their PPP loans will be forgiven, but about whether they will face substantial federal criminal and civil penalties for having been found to have made false statements on the PPP loan application.
Question #31 was seemingly added in response to the news that many businesses who didn’t need the PPP loans received them anyway. Public companies with access to capital markets, large franchises, and the like have been embarrassed into returning the funding. Secretary Mnuchin said on April 28, 2020 that the SBA will undertake a “full review” of any PPP loan that exceeds $2.0 million. That statement was incorporated last night (April 29, 2020) into a new question, Question #39 of the FAQ.
Question and Answer #31 reads as 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.
Question #37 rephrases Question #31 by replacing “large companies” with “private companies,” making it clear that the standards in Answer #31 apply to all borrowers.
This was not initially contemplated. Unlike the EIDL, the CARES Act specifically waived the SBA requirement that a borrower not be able to obtain credit elsewhere in connection with a PPP loan. Instead the standard was to be that the Applicant determine that “the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the Applicant.”
In advising clients based on that standard, if a client was not experiencing an immediate or substantial loss of business volume (unlike restaurants that are shut down by the State), but was concerned about a future loss of work due to COVID-19 and/or governmental order, the ability of its customers to pay the client for work or services performed during April and May, for example, or the risks to the business related to the shut-down of the economy overall in future periods, it seemed safe to advise that the standard would be met if those concerns were justifiable, whether or not the client had a line of credit with a bank, or a reasonable amount of cash reserves based on historic operations and need.
That has changed. Business owners who have received PPP loans or are about to receive loans, must not only support their determination of need, but also analyze whether the business needs the PPP loan “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.”
What does that mean? “Liquidity” refers to a company’s ability to convert its assets into cash in order to pay its liabilities as they come due; it generally doesn’t refer to incurring debt. “Adequate liquidity” means generally that the liquidity of a company’s assets is adequate, both with respect to amount and quality, to ensure that there is no significant risk that the business cannot meet its liabilities as they fall due.
Adequate liquidity certainly must be evaluated based on current and reasonably anticipated future economic conditions. From a layman’s perspective, it seems a small construction business with active projects that has historically determined that cash reserves of $200,000 were adequate to meet the particular cashflow fluctuations of the business would reasonably (and prudently) revisit the adequacy of those reserves given that new construction projects are being delayed or canceled, and existing jobs are increasingly being suspended due to shortage of materials and equipment, among other reasons. If that business determines in good faith that the existing cash reserves will likely not be sufficient to weather the impact of the pandemic, and applied for a PPP loan to enhance its ability to do so, it’s hard to imagine that the SBA or the lender would be able to successfully challenge that the certification was made in good faith. But, we just don’t have sufficient guidance and definition at this time to come to any firm conclusions.
This language is at the end of Answer #31:
“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 to have made the required certification in good faith.”
This language contemplates that businesses will revisit their determination of “necessity” of the loan under the new standard and not be penalized if they turn it back in if they can’t make the certification “in good faith.” Prior to Question #31, borrowers could rely on the “safe harbor” of Question #17, which provides that Borrowers may rely on the laws, rules, and guidance available at the time of their applications. Based on the interplay between Questions #31, 37, and 39, employers should not rely on Question #17 with respect to the certification that the PPP loan was necessary for their business.
Question #39 asks whether the SBA will review individual PPP loan files. The Answer is “Yes,” and goes on to state, “In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. Additional guidance implementing this procedure will be forthcoming.”
We can’t know what the additional guidance will require, but we are strongly advising Clients both to document their determination of the Company’s need for the PPP loan – cashflow projections, financial statements, work cancellations, supplier shortages, and the like – and to discuss with their accountants what constitutes “sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business ” for their particular businesses so they can support the certification of necessity in good faith.