SBA Issues Supplemental Guidance on the Paycheck Protection Program As Congress Replenishes Funding for Small Business Loans

On Friday, April 24, 2020, President Trump signed into law the Paycheck Protection Program and Health Care Enhancement Act, the fourth in a series of coronavirus relief bills. The new law provides supplemental funding for the Paycheck Protection Program and Economic Injury Disaster Loans, originally authorized under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as well as billions in funding for hospitals and coronavirus testing.

Under the CARES Act, Congress initially allocated $349 billion in forgivable loans for small businesses through the Paycheck Protection Program (PPP). Under the PPP, loans of up to $10 million can be used to cover payroll, paid sick leave, insurance premiums, rent, utilities and mortgage payments. The PPP funds were quickly exhausted as countless small businesses raced to apply for loans to sustain their businesses during the pandemic. The new law replenishes the program with an additional $310 billion in funding, with $60 billion of that amount set aside for loans issued by community financial institutions and certain insured depository institutions and credit unions with limited assets. The PPP resumed on April 27, 2020 and will continue until June 30, 2020, or until the funds are exhausted again.

Assessing Economic Necessity of a PPP Loan

In anticipation of the relaunch of the Paycheck Protection Program, the Small Business Administration (SBA) issued additional guidance through a supplemental Interim Final Rule and updated FAQs. Of critical concern to many businesses, especially following the controversy surrounding larger restaurant corporations that obtained PPP loans during the first round of funding, is whether businesses, particularly those publicly held or owned by large public companies or investors with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan. The FAQs clarify that, in addition to considering the applicable affiliation rules, all businesses must assess carefully 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.

During an April 22 press briefing, Treasury Secretary Steve Mnuchin advised of a then-pending FAQ response to question 31 and warned of “severe consequences” for borrowers who obtain a PPP loan based on a misunderstanding of the necessity certification. Subsequent to the issuance of the FAQ responses, on April 28, Secretary Mnuchin stated that every PPP loan of $2 million or more will be audited for program compliance prior to determination of the forgiveness amount of the loan. He indicated that such audits would focus on any other liquidity available to a PPP borrower and warned that borrowers could face “criminal liability” for false certifications.

Although the CARES Act suspends the general Small Business Act requirement that loan recipients must be unable to obtain credit elsewhere, businesses still must certify in good faith that their PPP loan request is necessary. Specifically, the PPP loan application requires businesses to certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The SBA guidance states that businesses must make this certification in good faith and take into account their current business activity as well as “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.” According to the SBA, based on this analysis of economic necessity 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. Critically, businesses should be prepared to demonstrate to SBA, upon request, the basis for their certification of the economic necessity of the loan.

Because lenders may rely on an applicant’s certification, a business that obtains a PPP loan based upon a false certification will likely be the one to suffer the consequences rather than the lender. SBA is providing businesses who already received loans an opportunity to reassess their eligibility for the PPP loan in light of the new guidance. Any business that applied for a PPP loan prior to the issuance of the supplemental SBA guidance, which was published on April 23, 2020, and repays the loan in full by May 7, 2020 will be deemed by the SBA to have made the required certification in good faith. According to the Interim Final Rule, the SBA determined this safe harbor is both necessary and appropriate to ensure that businesses promptly repay PPP loans that were previously obtained based on a misunderstanding or misapplication of the required certification standard.

Arguably, issues of liquidity and resources were inherent in a borrower’s ability to certify in good faith its need for the PPP loan absent which it would be forced to furlough or terminate its employees. Each analysis in this regard is unique to a particular borrower, and each organization moving forward with a PPP loan should contemporaneously document its good faith need for the loan based on its financial status and the relevant impacts of the COVID-19 pandemic.

Additional Guidance on PPP Eligibility and Affiliation Rules

In further response to ongoing requests for supplemental guidance on PPP eligibility, the most recent SBA Interim Final Rule also provides additional clarity on the affiliation rules applicable under the PPP.

The Interim Final Rule expressly states that hedge funds and private equity firms, which are generally ineligible for section 7(a) loans under existing SBA regulations, are ineligible to receive a PPP loan because they are primarily engaged in investment or speculation and are not the type of businesses that Congress intended to receive PPP financing. Although private equity firms are excluded from participation in the program, a portfolio company of a private equity fund may apply for a PPP loan if it determines it is eligible after applying the SBA affiliation rules found in 13 CFR 121.301(f). Faegre Drinker previously issued a client alert outlining how to determine eligibility for PPP loans under the SBA affiliation rules. The affiliation rules apply to private equity-owned businesses in the same manner as other businesses subject to outside ownership or control. The Interim Final Rule also explains that a business’s participation in an employee stock ownership plan (ESOP) does not trigger application of the affiliation rules and thus, does not result in an affiliation between the business and the ESOP.

Finally, as businesses determine how to move forward during this economic uncertainty, many may be considering bankruptcy or have already filed for bankruptcy. The Interim Final Rule confirms that if a loan applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time the business submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the business applicant, or the owner, becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, the applicant has an affirmative obligation to notify the lender and request cancellation of its application. A business in bankruptcy proceedings that accepts PPP funds will have used the funds for an unauthorized purpose.

Faegre Drinker continues to monitor the status of the Paycheck Protection Program and any additional guidance the SBA may issue.

As the number of cases around the world grows, Faegre Drinker’s Coronavirus Resource Center is available to help you understand and assess the legal, regulatory and commercial implications of COVID-19.