Congress just replenished the funds available for Paycheck Protection Program (PPP) loans, opening the gates to billions in forgivable loans to qualifying small business borrowers via the PPPHCEA (details about the new law and what all those letters mean here). But questions remain about the certification borrowers must provide to obtain a loan.1 Updated FAQs issued April 23 by the Small Business Administration (SBA) on that particular issue now suggest that new borrowers should think carefully about the certification they make. Still, there are steps you can take to protect yourself in order to benefit from a PPP loan.
Amidst the haste with which PPP has been adopted and rules made on the fly, recent comments by Senator Marco Rubio and Treasury Secretary Mnuchin (noted in our April 22 Legal Update) reflected some of the negative press about public companies like Shake Shack, Ruth’s Chris and Potbelly, and some private ones receiving PPP loans.
The SBA’s updated PPP loan FAQs add FAQ 31, which provides guidance that should make borrowers, especially those owned by large companies, think harder about the required certification.
Unfortunately, the guidance also is effectively retroactive by telling existing PPP borrowers that they will not get in trouble if they made the certification without the benefit of the enhanced guidance so long as the certification is correct now or they repay their PPP loans by May 7. This Legal Update endeavors to provide helpful guidance, after a quick review of the background for those coming late to this party.
Overall, we believe that most who already received their PPP loans should be fine, especially borrowers not “owned by large companies,” though all borrowers would do well to document their concerns about the uncertainty of the current economic climate and their need for funds to support their business (presumably at the pre-COVID-19 level).
Certification Required When Applying and Receiving a PPP
The CARES Act requires that a PPP loan applicant certify, in good faith, that “the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.”
The PPP loan application issued by the SBA phrased the certification slightly differently: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
As we noted in our prior article, the focus of both iterations is the same: economic uncertainty from COVID-19.
Meaning of the Certification Language — Until Today
Given the absence of any further guidance from the government, most borrowers (and their legal counsel), assumed that the words meant what they said. In our prior article, we unpacked the certification language in an effort to ascertain what level and type of uncertainty is required to make the certification.
Because just about every business faces uncertainty every day, we advised that it was not reasonable to think that normal “ambient” business risks justified a PPP. We advised that borrowers needed new and additional risks related to COVID-19 and its economic consequences for the business community. Given the stated purposes of PPP loans — to protect payrolls — the easiest case for making the certification was (in our opinion) COVID-19 triggered uncertainty that could reasonably cause employers to reduce their pre-COVID staffing or salaries.
The PPP was designed to incentivize employers — who might otherwise terminate or furlough employees, or need to reduce their salaries, in light of the current economic conditions — not to do so. The government was going to help via forgivable PPP loans — effectively paying eight weeks of salaries and helping with rent, utilities and mortgage interest. Reasonable people might debate the level of worst-case scenario planning a business might need to contemplate to make the certification. However, most of us thought the threshold was pretty low because it is hard to think of a business that does not have a reasonable uncertainty because of COVID-19. Also, the clear purpose of PPP loans was to provide businesses with liquidity for eight weeks to help restart the economy. Indeed, every business we worked with to pursue a PPP loan felt that the potential forgiveness enabled them to forgo (or at least delay) consideration of significant reductions in salaries and staffing, to pay their rent/utilities without interruption, or to accommodate requests by their customers/clients to delay payment of invoices or rent. These PPP loan applicants all made business decisions in reliance on the anticipated forgiveness.
Bad Facts Make Bad Law
Early in law school, every law student learns that bad facts make bad law. PPP loans to some public companies operating restaurants that seemingly complied with the letter of the law, created negative press, even though Congress made the policy decision to exempt hotels and restaurants from the affiliation rules that would otherwise have prevented large companies form obtaining PPP loans. In the face of public outrage, members of the government had to respond. And they did so with seeming surprise that anyone would have interpreted the words of the statute in accordance with the ordinary meaning of such words. (Reminds this author of his favorite scene in Casablanca in which Inspector Renault orders Rick’s establishment closed because he is “shocked-shocked! — to find gambling is going on in here” — whereupon the croupier hands the Inspector his winnings from the roulette table).
The fact that Congress essentially told these companies to apply for a PPP loan by turning off the affiliation rules for them, or that these companies likely would also have laid off employees without the prospect of PPP forgiveness, became irrelevant when the first $349 billion of PPP ran dry and those that did not get PPP loans felt that they were crowded out by public companies that could have just leveraged up. Nobody seemed to care that PPP loans were capped at $10 million and open to any employer with 500 or fewer employees, certainly suggesting that the program was intended for businesses with up to $4 million per month of average payroll costs — not exactly the corner restaurant. Indeed, the Treasury Department seems to have forgotten their administrative contortions (described here) — just two short weeks ago — to materially relax the existing affiliation standards that otherwise would have governed the PPP program. The bad press became too much for the administration to resist.
To paraphrase my college physics professor (and with apologies to Werner Heisenberg and the observer effect): The mere act of observing a phenomena causes a change in the underlying system.
April 23 Reinterpretation of the Certification Required of PPP Applicants
The SBA, in consultation with the Treasury Department, has now updated the PPP loan FAQs to add FAQ 31, which provides:
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 carefully review 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 will be deemed by SBA to have made the required certification in good faith.
This FAQ effectively amends the certification (without changing the words) to add additional factors to consider when making the certification — at least for businesses owned by large companies. Notwithstanding the reference in the question itself to “businesses owned by large companies,” the answer tells us that “all borrowers must assess their economic need under the standard established by the CARES Act and the PPP regulations at the time of the loan application.”
Thus, intentional or not, it seems that all borrowers must take 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. Obviously, no one reading the original statute could have intuited such additional requirements when they made their certifications weeks before this new guidance.
These new considerations add risk. After all, there is no way to know whether, in a future time after the crisis passes, the national mood will incentive punishing some subset of PPP borrowers. On the other hand, the only example the SBA gave for a business not able to make the certification is a public company with substantial market value and access to capital markets. And, even for this example, the SBA described such a company as “unlikely” to be able to provide the certification. Further, the SBA included a “not significantly detrimental to the business” limitation for assessing use of other liquidity sources. Taken together, we believe that the references to the lack of a detrimental impact, substantial market value and access to capital markets indicate that a closely-held business having a pre-existing line of credit or access to a few wealthy owners does not prevent a business from making the certification. On the other hand, all borrowers should address this consideration, especially borrowers owned by large companies.
How the FAQ Changes the Certification Analysis
Let’s dissect the verbiage of this new “guidance” to determine how it might be applied. First of all, it seems clear that the Treasury was focused on borrowers owned by “large” companies, as evidenced by the underscored language of the question itself. So on the one hand, most borrowers are probably safer today in their certifications than they were yesterday when Secretary Mnuchin and Senator Rubio were making threats to alter the certification without suggesting how they would do so. Nevertheless, the choice of language is concerning as there is no explanation of what is “large” for these purposes. Are all public companies considered large? Are all PE and VC firms considered large? Does the cost of the capital to the borrower impact the analysis?
FAQ 31 seems directed at “borrowers owned by large companies,” suggesting that the financial wherewithal of the borrower itself is not at issue, only that of its large borrower parent company that has access to capital. Startups owned by PE firms should take note.
But then the FAQ answer begins (after the first clause) by telling us 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.” Given the reference to “all borrowers,” it is easy to imagine that the rule intended for borrowers owned by large companies may provide a playbook for any government official trying to second guess the propriety of certifications by all borrowers.
Accordingly, even borrowers not owned by large companies should probably consider whether their access to capital should cause them to (i) forgo the favorable terms of a PPP and instead expend its own funds to maintain its workforce intact or (ii) furlough/terminate their employees. Borrowers, especially those owned by large companies, should balance their access to funds with the extent to which they believe they are currently harmed by COVID-related economic challenges. How much of their own (or borrowed) capital they use before adjusting their employment levels, and how much COVID trauma they need to be currently experiencing, is a complicated calculus for which there is no precedent and no rule book. Given that nobody knows how long the COVID-sponsored recession will last, or how deep it will be, many businesses will now be less willing to use up their own savings or leverage their business to retain payroll.
Until yesterday, we could advise clients that retaining their employees for at least the eight weeks after they received their PPP basically cost them little or nothing, so they should delay any reductions in FTEs or salary that the current environment might otherwise cause them to consider. Now, giving that advice should at least address the ability of the business to continue paying their employees with their own funds and what level of working capital depletion or borrowing would be significantly detrimental to their business. All but the largest eligible businesses will make the same decisions, but the math just got a lot harder, and some will no doubt decide that it is easier or less risky to simply send out pink slips.
The next hurdle is figuring out the benchmark against which a borrower’s need is supposed to be tested. The FAQ tells us that all borrowers must test 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. But there is absolutely no standard of financial need in the CARES Act or the PPP regulations. And no regulations have even been issued yet! Indeed, the CARES Act and existing PPP guidance speak only of the 500 or fewer employee test. Financial need is addressed elsewhere in the CARES Act but has no relevance to the PPP — precisely because the PPP was not supposed to be about need; it was an inducement for employers to maintain their staffing levels and salaries when they might otherwise consider layoffs and furloughs. Indeed, as the Answer to FAQ 31 itself reminds us, the CARES Act suspended the normal SBA 7(a) loan program requirement that borrowers establish they do not have an alternative access to credit.
Further, the first part of the answer clearly prescribes that liquidity and need must be addressed at the time of loan application. But, even if this new and improved certification standard makes sense for new PPP loans, imposing it retroactively on existing borrowers who made their certifications weeks ago seems to undermine the very social contract created by the CARES Act. Businesses made decisions based on the rules in effect when they made their PPP certifications; paying the funds back by May 7 will not un-ring the bell on those expenses. It is hard to imagine that borrowers not owned by large companies could get in too much trouble for reasonably making the certification based on its meaning before the addition of FAQ 31 so long as they made that certification in accordance with the guidelines we outlined in yesterday’s Legal Update.
What PPP Borrowers Should Do in Light of the New Certification Guidance
The negative stories about a few PPP loan borrowers and the comments made by certain politicians could cause some borrowers — certainly those owned by “large” companies — to reconsider whether the PPP is worth the heightened risk created by the modified certification. Some will do so by expending their working capital or leveraging their businesses to support their existing staffing levels. Others, including those who have not yet received their PPP loans and thus not yet made their certifications, will start laying people off or reducing salaries because they would rather forego a PPP (or repay a PPP loan already borrowed) than impair their business operations.
We believe, however, that for most PPP borrowers, there is a more practical solution than turning their back on this much-needed relief: consider the new guidance as a roadmap for assessing (or reassessing) your need for the PPP loan. We suspect that most borrowers will discover that they can make the updated certification in good faith. Because 25 percent of PPP forgiveness can be attributable to non-payroll expenses, this approach has the added benefit of helping to cover some non-payroll costs in addition to helping maintain staffing and salary levels.
Documenting or memorializing the analysis to support the certification should not only minimize exposure under the False Claims Act (discussed in yesterday’s Legal Update), but should also lead to better-informed decision making. Such documentation should include all of the usual information you would assemble and debate in making a business decision for a business of your size, governance structure and stability, including:
- The uncertainties your business faces from COVID-19 — for example, uncertainties about your supply chain, uncertainties about when the business can reopen to customers, uncertainties about whether customers will return when the business opens, uncertainties about whether a new wave of the virus will hit, uncertainties about whether customers will be able to afford your product or services, etc.
- Requests you have already received to reduce charges to or work for your customers, or their actions like delayed payments, increased write-downs of charges.
- 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).
- 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.
- Significant business risks to using existing working capital or taking on new debt to fund current operations.
- 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.
- A current threat assessment to your business in light of the current situation, including risks such as:
- Employees may depart for “greener pastures” if the business were to cut compensation or support staff levels.
- 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.
- 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.
- 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).
- How you are currently impacted (e.g., shortfalls in budgeted production or revenue).
- 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.
- Cutbacks and other reductions undertaken by other businesses in your industry.
Remember, as we described in our prior Legal Update, the PPP loan was designed to help borrowers survive the COVID-19 changes to the economy. Borrowers need not prove that they could not get funding elsewhere or that they probably would have survived without a PPP loan. Any challenge to your PPP loan certification will need to be reviewed in that light. Further, predictions about the likely impact of your decisions, and how your business is currently or could be affected, need not be perfect and need not come to pass. They simply need to be reasonable. If you are not comfortable with your certification, then you should not proceed without first securing input and guidance from others working in this area.
1 As noted in our prior Legal Updates available here, in addition to more money, we hoped that Congress would clarify some of the confusion created by the language in the CARES Act and SBA guidance. Of course, this likely would have delayed the increased allocation of money. The new law passed by Congress and headed for White House approval does not provide any clarifying guidance. We anticipate that the SBA and Treasury Department will continue to bring clarity out of the chaos.