Locke Lord QuickStudy: SBA Issues New Guidance Reducing Risk of Government Investigations for Paycheck Protection Program Borrowers

Businesses applying for loans under the Paycheck Protection Program (“PPP”) must make certain ‎certifications to the government in their application, including a certification that the loan is ‎‎“necessary” to support the borrower’s ongoing operations. As previously analyzed here, the ‎Small Business Administration (“SBA”) has issued shifting and ambiguous guidance concerning ‎how the “necessity” certification will be interpreted, creating a significant amount of concern and ‎uncertainty among PPP borrowers that they could be exposed to an increased risk of government ‎investigations and enforcement—despite acting entirely in good faith—if the government later ‎took the position that their loans were not “necessary.” Many borrowers decided to repay their ‎PPP loans to eliminate this risk, leaving a significant amount of PPP funds untapped and ‎arguably frustrating the very purpose of the program.‎

On May 13, 2020, the SBA issued new guidance in an effort to clear up this uncertainty ‎and encourage borrowers to retain their PPP funds.  In a dramatic turnaround, this new guidance ‎substantially reduces the risk of government investigations and enforcement related to the ‎‎“necessity” certification.‎

The Previous Guidance Created a Great Deal of Uncertainty

The previous guidance surrounding the “necessity” certification—and more specifically, ‎whether borrowers were required to take into account other sources of capital when determining ‎whether a PPP loan was “necessary”—left PPP borrowers with little clarity.‎

Initially, because the CARES Act expressly exempts PPP loans from the ordinary SBA ‎requirement that the borrower must be unable to obtain “credit elsewhere,” many PPP borrowers ‎reasonably believed they could certify that the loan was “necessary” based solely on the extent of ‎their need, without considering every potential alternative source of capital that might be ‎available.  Exceptions to the ordinary SBA affiliation rules for companies in the hotel and ‎restaurant industries also indicated that such companies would not need to consider the liquidity ‎of their parent companies or affiliates when making the certification.‎

On April 23, 2020, in the wake of public criticism of large companies being approved for ‎PPP loans, the SBA released guidance requiring businesses to consider their “ability to access ‎other sources of liquidity” that would not be “significantly detrimental to the business” before ‎certifying that they needed the PPP loan to support ongoing operations. This left both applicants ‎and approved borrowers confused, as it failed to define precisely what sources must be ‎considered or what terms would qualify as “significantly detrimental to the business.” The April ‎‎23 guidance further stated that any company that repaid its PPP loan by May 7 would be ‎deemed to have made the certification in good faith. (The safe harbor deadline was subsequently ‎extended to May 14, and then again to May 18.)‎

This guidance led many risk-averse PPP borrowers to repay their loans and take ‎advantage of the safe harbor. Given the ambiguous standards and the potential costs of a ‎government investigation—which at best are expensive and time-consuming, and at worst could ‎yield substantial civil and criminal penalties—many borrowers decided that the risks outweighed ‎the benefits of the PPP funds. Thus, although the April 23 guidance was clearly intended to ‎protect against abuses of the program, it created a different problem:  many businesses that were ‎acting in good faith and desperately needed these funds to survive the COVID-19 crisis were ‎now too afraid to apply for PPP loans.‎

The New Guidance Significantly Reduces the Risk of Government Investigations

On May 13, just one day before the previously announced safe harbor deadline for ‎borrowers to repay their loans, the SBA released additional guidance aimed at reassuring ‎borrowers and reducing the risk of government investigations concerning the “necessity” ‎certification.‎¹ ‎This new guidance splits borrowers into two categories, depending on the size of ‎their loans.‎

First, any borrower that—together with its “affiliates,” as defined by the PPP’s interim ‎final rule on affiliates²‎—receives a loan with an original principal amount of less than $2 million ‎‎“will be deemed to have made the required certification concerning the necessity of the loan ‎request in good faith.” In other words, with respect to the “necessity” certification, the ‎government will not pursue any fraud investigations for borrowers with loans of less than $2 ‎million. The SBA explained that it chose the $2 million cutoff because “borrowers with loans ‎below this threshold are generally less likely to have had access to adequate sources of liquidity ‎in the current economic environment than borrowers that obtained larger loans.”  It will also ‎‎“promote economic certainty” and “enable SBA to conserve its finite audit resources and focus ‎its reviews on larger loans, where the compliance effort may yield higher returns.”‎

Second, any borrower that receives a loan with an original principal amount greater than ‎‎$2 million “may still have an adequate basis for making the required good-faith certification, ‎based on their individual circumstances.” As previously announced, the SBA reaffirmed that it ‎plans to review all PPP loans in excess of $2 million for compliance with program requirements. ‎The SBA also provided new information on the potential consequences of those audits. If the ‎SBA determines that a borrower “lacked an adequate basis” for the required certification, it “will ‎seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower ‎is not eligible for loan forgiveness.” If the borrower repays the loan, however, “SBA will not ‎pursue administrative enforcement or referrals to other agencies” for further investigations into ‎the false certification.‎

What This Means for PPP Borrowers

The new guidance is incredibly helpful for PPP borrowers, as it greatly limits the risk of ‎government investigations related to the “necessity” certification. For loans under $2 million, ‎each borrower is now automatically deemed to have acted in good faith. For loans over $2 ‎million, borrowers do not have the same automatic protection, but even if they are deemed ‎ineligible by the SBA’s review, they can escape further government enforcement simply by ‎repaying the loan.‎

It is important to note that the May 13 guidance only applies to the “necessity” ‎certification. Borrowers should therefore continue to ensure that all of their other certifications ‎are accurate, and that they comply with all other PPP requirements. By choosing to limit ‎enforcement risk for the “necessity” certification, the SBA is strongly suggesting that the ‎government will focus its enforcement efforts on other areas of potential fraud—for instance, a ‎borrower overstating its payroll costs to obtain a fraudulently excessive loan amount, ‎misrepresenting its number of employees or its compliance with SBA affiliation rules, or falsely ‎certifying that it would only use PPP funds for the purposes permitted by the CARES Act. ‎

In addition, because the SBA characterizes its new guidance as a “safe harbor,” it is ‎possible that it might not apply in extreme cases where there is clear evidence of fraud or bad ‎faith. Indeed, the PPP-related enforcement actions to date indicate that the government intends ‎to be unforgiving in cases involving brazen fraud or plain violations of PPP requirements. For ‎instance:‎

• The first criminal prosecution arising out of the PPP was filed in Rhode Island on May 5 ‎against two borrowers who allegedly sought to obtain over $500,000 in loans by falsely ‎representing that they operated four different business entities and employed dozens of ‎individuals when, in reality, there were no employees working for any of the businesses.‎³ ‎The government charged the two defendants, David Staveley and David Butziger, with ‎bank fraud, conspiracy to commit bank fraud, conspiracy to make false statements, and ‎aggravated identity theft.‎
• Federal prosecutors in Texas charged Shashank Rai, an engineer, with wire fraud, bank ‎fraud, false statements to a financial institution, and false statements to the SBA for ‎allegedly fabricating having a business and hundreds of employees to obtain ‎approximately over $10 million in PPP loan funds.^4‎ 
• Maurice Fayne, aka “Arkansas Mo,” a TV personality from “Love & Hip Hop: Atlanta,” ‎was charged with bank fraud on May 13 for allegedly spending more than $1.5 million of ‎a $2 million PPP business loan on personal items, including a Rolls-Royce, a Rolex watch, ‎a diamond bracelet, and a 5.73 carat diamond ring.⁵‎ ‎ ‎

Overall, the SBA’s new guidance provides the certainty and clarity that was sorely ‎lacking in the April 23 guidance, and likely will encourage more borrowers to apply for and retain ‎their PPP loans. It also recognizes the reality of the current environment:  in the midst of a global ‎pandemic and economic crisis, a company’s good faith determination that it needs stimulus ‎funds—a complex and difficult judgment call, which may be critical to the company’s survival—‎should not be unduly influenced by the threat of a fraud investigation. That being said, recent ‎enforcement actions indicate that the government’s intent to prosecute fraud related to CARES ‎Act relief programs remains unchanged. Therefore, prudent PPP borrowers are advised to ‎continue to abide by the requirements of the loan program and to carefully monitor compliance ‎with those requirements throughout the life of the loan.  ‎

Please visit our COVID-19 Resource Center often for up-to-date information to help stay informed of the legal issues related to COVID-19.

---
_{1 FAQ #46 available here.
2 85 FR 20817 (Apr. 15, 2020).‎
3 Department of Justice Press Release, May 5, 2020, available here.
4 Department of Justice Press Release, May 13, 2020, available here.
5 Department of Justice Press Release, May 13, 2020, available here.}