UPDATE: The updated forgiveness application for first draw and second draw PPP loans indicates that the SBA separately applies the $2 million uncertainty certification safe harbor to first draw PPP loans and second draw PPP loans, rather than to combine first draw PPP loans and second draw PPP loans. The application provides: “If Borrower (Together with Affiliates, if Applicable) Received First Draw PPP Loans of $2 Million or More or Second Draw PPP Loans of $2 Million or More, check here: ☐ ”
Borrowers applying for a second draw Paycheck Protection Program (PPP) loan must make the same uncertainty certification (sometimes referred to as the “necessity certification”) that they made in connection with their first draw PPP loan: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Although the Small Business Administration (SBA) has not made any changes to the borrowers’ uncertainty certification from the first draw PPP loan, we now have the benefit of both precedent and the impact of COVID-19 on a borrower’s business to better assess a borrower’s comfort level with this certification.
Last April and May, the SBA provided evolving (and often conflicting) guidance concerning the uncertainty certification, which we discussed here, here, here and here. As the SBA’s position became known, the SBA allowed borrowers to return PPP funds, no questions asked, if the borrower felt that they could no longer make the uncertainty certification in light of the SBA’s updated guidance. The SBA’s multiple explanations of when borrowers could make the uncertainty certification itself created significant uncertainty.
FAQ 46 of the SBA’s PPP loan FAQs ultimately drew a line in the sand by deeming borrowers to have made the uncertainty certification in good faith if the total amount of their PPP loan together with PPP loans of its affiliates, was less than $2 million. Leaving aside the question of whether the $2 million threshold could be considered arbitrary and capricious, it became clear that borrowers not eligible for this safe harbor faced potential SBA scrutiny regarding the uncertainty certification. Confusion only increased when the SBA released its uncertainty certification questionnaires — SBA Form 3509 (for-profit borrower) or SBA Form 3510 (non-profit borrowers).
This safe harbor eliminated most, but not all uncertainty about the uncertainty certification for borrowers with PPP loans under $2 million. Although the SBA will not challenge whether a borrower under the $2 million threshold made the uncertainty certification in good faith, FAQ 46 does not prevent the U.S. Department of Justice from bringing initiating charges (e.g., violation of the federal False Claims Act).
For many PPP borrowers with loans of $2 million or more, the uncertainty certification remains an ongoing concern. However, our position on the SBA approach to the uncertainty certification has consistently been that borrowers should undertake the due diligence normally associated with a loan or transaction for the amount and memorialize the factual basis for making all representations, including especially the uncertainty certification.
As we discussed in this article and this article, the uncertainty certification questionnaires suggest that the SBA may use a borrower’s performance after receiving the PPP loan to judge the uncertainty the borrower had before receiving the PPP loan. The SBA’s position prompted the Associated General Contractors of America (AGC) to sue the SBA to enjoin the SBA from using the questionnaires. It remains to be seen whether the SBA will be allowed to use hindsight to punish borrowers.1
In the meantime, this background provides guidance for the impact of the uncertainty certification on second draw PPP loans:
$2 Million Safe Harbor
The deemed good faith certification for PPP loans under $2 million generally should continue to apply. However, we suspect that the SBA will take the position that the total amount of PPP loans of all affiliates, first draw and second draw, should be combined to determine whether the safe harbor applies to a second draw PPP loan. For example, if the borrower received a first draw PPP loan of $1.5 million and a second draw PPP loan of $1.5 million, we believe the safe harbor should apply to the first draw PPP loan, but not the second draw PPP loan.
It is possible that the SBA would take the position that a second draw PPP loan causing all PPP loans to exceed $2 million eliminates the safe harbor for first draw PPP loans under $2 million. As a practical matter, we think it would be difficult to enforce such a policy change, especially because many borrowers already have filed forgiveness application for first draw PPP loans under $2 million. Unfortunately, however, the SBA has not released any guidance about this.
Memorializing Basis for Uncertainty
As with first draw PPP loans, borrowers should memorialize the basis for the uncertainty certification. For this, the potential factors we previously identified continue to apply:
- Uncertainties from COVID-19.
- Financial impacts from, or made alterations because of, COVID-19 and anticipates continued downward pressure from economic fallout.
- Requests for discounts and indications of decreases in project budgets.
- Limitations on ability to use working capital.
- Ability to borrow additional amounts.
- Risks from using existing working capital or taking on new debt to fund current operations.
- Potential reductions in staff.
- Different threats in light of the current situation.
- Industry surveys about disruption in the borrower’s business.
- Steps to reduce risk or preserve capital.
- Cutbacks and reductions undertaken by other businesses in the Company’s industry.
The analysis above (second factor) should include a summary of the impact of the COVID-19 pandemic from March 2020, including an assessment of the borrower’s financial condition. That is, when applying for the first draw PPP loan, borrowers had no idea of what would happen with the pandemic. We all now have a better understanding of how the pandemic could impair both revenue and earnings. Even if the borrower experienced a 25 percent decline in quarterly revenue (a prerequisite for a second draw PPP), the borrower should be able to explain how and why COVID-19 still creates the uncertainty to necessitate the loan to support its ongoing business operations. That could be hard for some borrowers to certify given how they have pivoted their business model.
In addition, borrowers should review the applicable uncertainty certification questionnaire and anticipate how the borrower would complete the questionnaire after the eight to 24 week covered period for PPP loan forgiveness.
1 We analogize the SBA’s position on the usefulness of post -PPP quarter financial information as follows:
My neighbors were getting sick from COVID-19 and I am scared that I too could succumb — and it was hard to predict (especially back in April) what would happen to those who became infected. A vaccine becomes available and I firmly and reasonably believe that I need it because I am uncertain about how COVID could affect me — even though I recognize that only a small percentage of those afflicted actually have serious symptoms and an even smaller percentage of those afflicted actually die. Still, getting infected could be bad for my health so I reduce my uncertainty by getting vaccinated — and thankfully I don’t get sick. Subsequently, the government comes to me and says that because I stayed healthy throughout the pandemic, I clearly never needed the vaccine and my uncertainty/fear was not justified.