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The CARES Act, which was enacted on March 27, 2020, implemented the Paycheck Protection Program (“PPP”), which allows small businesses to receive a forgivable loan of up to two and a half times their average monthly payroll costs for the prior year. The CARES Act provided that in order to be eligible for the loan, the business must certify, among other things, that the “uncertainty of the current economic conditions makes necessary the loan request to support the ongoing operations” of the business.
The SBA subsequently issued guidance that required borrowers to take into account current business activities and their ability to access other sources of liquidity in determining whether the loan was necessary, and provided a safe harbor for borrowers to return the loan prior to May 14th. This guidance, and tweets from Senator Marco Rubio that set a very high bar for what “necessary” meant, significantly muddied the waters for many borrowers who were left wondering if the loan was in fact necessary, and if they would face civil and even criminal prosecution for applying for and receiving a PPP loan.
In a dramatic turn of events, the SBA released FAQ #46 on May 13th, which provides immunity from the “necessary” requirement for borrowers with loans under $2,000,000. This FAQ states that if the PPP loan amount is less than $2,000,000, it is deemed to be necessary, and if it is over $2,000,000 and was not necessary, then the result is that it has to be repaid; however, there will apparently be no penalty or criminal exposure. This should put the vast majority of borrowers at ease that if they did not intentionally answer the question of necessity on their PPP loan application inaccurately, then they are likely safe from possible SBA action. This new guidance appears to provide much needed relief to small businesses that were considering whether or not to return their Paycheck Protection Program loan prior to the May 14th deadline.
Additionally, FAQ# 47, which was also issued on May 13th, extends the repayment deadline for amnesty and to not be disqualified from the ability to qualify for the $5,000 per employee payroll credit from May 14th to May 18th to “give borrowers an opportunity to review and consider FAQ #46.”
Borrowers with PPP loans over $2,000,000 that are concerned with the necessity requirement can still return the loan prior to this deadline in order to be eligible for the Employee Retention Payroll Tax Credit. It is not clear whether borrowers with loans over $2,000,000 may return enough to be just under $2,000,000 to qualify for the safe harbor.
The full text of FAQ #46 is as follows:
“Question: How will SBA review borrowers’ required good-faith certification concerning the necessity of their loan request?
Answer: When submitting a PPP application, all borrowers must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA, in consultation with the Department of the Treasury, has determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to this issue: Any borrower that, together with its affiliates, received PPP loans 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.
SBA has determined that this safe harbor is appropriate 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. This safe harbor will also promote economic certainty as PPP borrowers with more limited resources endeavor to retain and rehire employees. In addition, given the large volume of PPP loans, this approach will enable SBA to conserve its finite audit resources and focus its reviews on larger loans, where the compliance effort may yield higher returns.
Importantly, borrowers with loans greater than $2 million that do not satisfy this safe harbor may still have an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance. SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form. If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA 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 after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request. SBA’s determination concerning the certification regarding the necessity of the loan request will not affect SBA’s loan guarantee.”
As indicated in the above safe harbor, the fact that a borrower received a loan of less than $2,000,000 is now seen as self-evident that the necessity certification was made in good faith, according to FAQ #46. The SBA justifies this circular logic by assuming borrowers with loans below this threshold are unlikely to have the same access to adequate sources of liquidity compared to those borrowers with loans over the $2,000,000 threshold. The SBA has made this determination in an effort to conserve finite audit resources. This appears to create little risk for any borrower with a loan of less than $2,000,000, even for those for whom the loan may not be explicitly “necessary”.
The usage of the word “necessary” in FAQ numbers 31 and 46 creates a zone of ambiguity. FAQ #31 asks an applicant to certify in good faith that the “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” FAQ #46 now provides that the SBA automatically assumes that, for any borrower awarded a loan of less than $2,000,000, the certification was made in good faith.
This presumption of good faith, coupled with the SBA’s implied admission that an audit is unlikely for borrowers with loans of less than $2,000,000, would appear to mean that there is little, if any, risk for any borrower of a loan less than $2,000,000. This is not to say that any borrower of a loan less than $2,000,000 is immune from compliance review, however. FAQ #46 still maintains “[a]ll PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements . . . .” Additionally, FAQ #46 establishes that, should it be found that any borrower lacked adequate justification for the necessity certification, then that borrower will be afforded the opportunity to return the loan before administrative enforcement is pursued by the SBA.
Although FAQ numbers 31 and 46 appear to contradict each other, perhaps a distinction can be drawn. FAQ #31 specifically references “businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations”. The answer goes on to state that, although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere, borrowers still must certify that their PPP loan is considered to be necessary. More specifically, FAQ #31 provides that borrowers should take into account their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner not significantly detrimental to the business when certifying that their loan request is necessary. In doing so, one could conclude that FAQ #31 stops short of explicitly preventing borrowers with access to liquidity from certifying that the loan is necessary. Rather, FAQ #31 provides that access to liquidity is an important factor to be weighed heavily when considering whether the loan is “necessary.” In an effort to provide further clarification, FAQ #46 further elaborates on the “necessary” certification by drawing a distinction between loans above and below the $2,000,000 threshold respectively. FAQ #46 maintains that all borrowers must still certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
However, FAQ #46 goes on to provide that any borrower with loans totaling less than 2,000,000 will be deemed to have made the required certification concerning the necessity of the loan request in good faith.
FAQ numbers 31 and 46 may be viewed together as a sort of continuum. Both of them maintain that all applicants must make good faith certifications that the loan request is necessary to support the ongoing operations of the applicant. FAQ# 31 provides that applicants should consider whether or not their access to liquidity would truly allow them to make a good faith certification that the PPP loan would be “necessary” to support the ongoing operations of the applicant. FAQ #46 picks up where #31 left off by drawing a distinction between loans above and below the $2,000,000 threshold. Borrowers with loans totaling less than $2,000,000 are presumed to have made their certification in good faith, due to the SBA’s assumption that borrowers with loans below this threshold are generally less likely to have access to adequate sources of liquidity in the current economic environment. Of course, the inverse of this assumption is that borrowers with loans totaling more than $2,000,000 will have adequate access to liquidity, therefore, their good faith certifications will be subject to a higher level of scrutiny.
It is noteworthy that the SBA did not explicitly annul or withdraw FAQ numbers 31 and 37, which are now inconsistent with FAQ# 46 and will cause continued confusion. In addition, would-be borrowers who would have qualified, but for doubt as to whether they had the economic need for PPP loans, will now consider whether they should apply when they have no necessity at all. Those businesses may want to apply now and decide whether to accept the loan if it is approved and funded, after we have more guidance, or do they risk perjury exposure for signing an application that requires necessity when there is no necessity, although this new pronouncement seems to throw necessity out the window? Perhaps the applicant can insulate themselves by providing an addendum to the application to the effect that they are relying upon FAQ #46 in concluding that there is necessity given the economic uncertainty now faced by every business. This, of course, assumes that the SBA has the power to issue all of these pronouncements.
While Sec.1114 of the CARES Act states that the SBA “shall issue regulations to carry out [Title 1]” of the Act, numerous lawsuits have already been filed challenging the SBA’s authority to issue regulations which “change the rules,” and guidance that establishes borrower eligibility requirements. The plaintiff’s claim that the regulations and FAQ’s are contrary to Congressional intent, and the plain language of the CARES Act. However, it seems likely that borrowers can rely on SBA pronouncements, even if they are wrong. But please remember that taxpayers cannot rely upon erroneous IRS instructions, so we need to be careful and advisors need to encourage clients not to be “hogs that get slaughtered.”
Further, while FAQ #46 states that the safe harbor will apply to SBA’s review of PPP loans with an original principal amount of less than $2,000,000, it does not explicitly state that all civil and criminal liability exposure eliminated. Although fraud may not be asserted by the SBA in an audit, this does not prevent it from being asserted in other forums. The expression “loose lips sink ships” can easily apply to businesses and these loans. For instance, a disgruntled employee or other individual that learns of a loan taken without necessity may be happy to make their discovery known to the right authorities. With taxpayers footing the bill for these loans and businesses sinking every day due to their inability to secure them, it isn’t a far-fetched assumption that many will want to see legal ramifications when the local mom & pop shop had to close because it was deprived of funds that another business received when it truly didn’t need them.
Although many may interpret the language of FAQ #46 as giving a free pass to take out a loan of less than $2,000,000 that is now automatically deemed as “necessary,” businesses that aren’t in jeopardy, are making more money than they were before the pandemic, or that have secure government contracts and no obstructions to meeting their obligations to fulfill the contracts, need to keep in mind that the loan application still requires the certification that the loan is necessary, regardless of the amount being borrowed. With the amount of uncertainty there still is, in addition to changing guidance, erring on the side of caution is never a bad idea.
The new FAQ provides a change in the rules and also in the tone of the SBA, after issuing guidance that seemed to greatly exceed what was intended by Congress, and what we believe it was authorized to do. We can only hope the trend continues and that the promised and much needed guidance on the details of loan forgiveness is forthcoming soon. It would also be helpful if future acts of Congress either authorize the SBA to make rules, or better define what those rules are, upon issuance, or by technical correction.
We will be discussing PPP Loans in a free webinar tomorrow at 12:00 noon (ET.) You can sign up by CLICKING HERE.