Client Alert: As the World Turns – PPP Loan Program and the Necessity Certification
On April 24, 2020, President Trump signed the Paycheck Protection Program and Health Care Enhancement Act (H.R. 266
) into law appropriating an additional $310 billion for Paycheck Protection Program (“PPP”) loans to small businesses, which are fully or partially converted into grants under certain conditions. Repayment of the loan to the lending private bank is 100% guaranteed by the U.S. Small Business Administration (“SBA”). This re-appropriation did not make substantive changes to the ‘‘Coronavirus Aid, Relief, and Economic Security Act’’ (the “CARES Act”
) that had created the PPP program, except to set aside $60 billion of the re-appropriated funds to be loaned by smaller community banks and non-bank lenders.
Beginning the day before the bill signing, in response to political pressure due to notable public companies receiving PPP loans, the U.S. Treasury Department (“Treasury”) and SBA began issuing supplemental guidance intending to limit the availability of loans to “large companies” that arguably did not “need” a PPP loan to survive the economic effects of the COVID-19 pandemic and the state of emergency shut-downs (what we will call, broadly, the “Pandemic”). Specifically, Treasury and SBA have issued regulatory guidance, through a series of “Frequently Asked Questions (and Answers)” (each an “FAQ”), on the following certification that each PPP loan applicant had to make, and PPP lenders are entitled to rely upon, that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” We refer to this as the “Necessity” question.
On April 23, 2020, Treasury published FAQ #31, which emphasized that the Necessity certification must be made in good faith, taking into account the applicant’s current business activity and its ability to access other sources of liquidity sufficient to support ongoing operations in a manner not significantly detrimental to the business. Treasury indicated that the SBA can request that a borrower demonstrate its good faith basis for making the necessity certification. By way of example, FAQ #31 stated that it is unlikely that a publicly traded company with substantial market value and access to capital markets would be able to make the necessity certification in good faith. FAQ #31 further provided, “Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.”
On April 28, 2020, Treasury published FAQ #37, which stated the following question: “Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” The answer stated was, “See response to FAQ #31.” Our interpretation of that “Answer” was that the Necessity analysis described in FAQ #31 applies with equal force for privately-held PPP applicants.
On April 29, 2020, Treasury published FAQ #39 stating, “To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans
in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application
Accordingly, if a borrower does not seek forgiveness of the loan amount, the SBA is substantially less likely to scrutinize whether the borrower made the Necessity certification in good faith. In addition, if the borrower’s loan amount was below $2 million, then SBA is less likely to scrutinize whether the borrower made the Necessity certification in good faith. However, the language “in addition to other loans as appropriate” leaves the door open to scrutiny of smaller loans. This is particularly true for affiliated borrowers who, in the aggregate, received loans in excess of $2 million.
The information provided regarding how SBA will analyze the good faith of a borrower’s Necessity certification remains fairly scant. Specifically, all that the SBA and Treasury have revealed is that they will examine, as of the borrower’s date of loan application:
- the applicant’s then-current business activity; and
- its ability to access other sources of liquidity sufficient to support ongoing operations “in a manner not significantly detrimental to the business.”
Presumably, the extent of impairment of the applicant’s business activity, as compared to prior to the Pandemic, will be a factor in determining whether its other sources of liquidity were sufficient to support ongoing operations. For example, a full-service restaurant whose revenues declined dramatically due to the Pandemic would presumably exhaust its capital reserves very rapidly, whereas a quick-service restaurant that primarily sold for take-out and delivery would have had a much less dramatic decline in business and less need for the PPP.
What Should I Do?
We recommend that any borrower that received PPP loans of $2 million or more, either as a single entity or in combination with their affiliates, take the time now
to put together the business case for why the loans were Necessary to support ongoing operations during the Pandemic. This analysis will better position you to decide whether to: (a) return the funds immediately, (b) keep the funds but treat them as a true debt and not apply for forgiveness, or (c) keep the PPP funds and apply for forgiveness. While we cannot predict how the SBA ultimately will analyze the good faith of your Necessity certification, we can review your analysis and provide our perspective on the likelihood of your success in demonstrating good faith should your PPP loan file be examined.
While every business is different, what follows are some questions that you may want to answer in putting together the business case for your PPP loan, with the reference point being the date you applied:
- What uncertainties did your business face from the Pandemic? For example,
- If your business remained open as “essential”, were you aware of problems with obtaining necessary supplies, including increased supply chain costs, or did you have uncertainties about whether customers would be able to afford your product or services?
- If your business was fully and mostly closed as “non-essential,” how had the closure impacted your business?
- Did you have a plan to reduce staff and payroll costs because of the Pandemic, and to what extent did you put such plan on hold because of the expectation of forgiveness?
- If your business was still operational, but primarily operating remotely, what requests had you already received to reduce charges to or work for your customers?
- Had you experienced delayed payments on accounts and increased demands for write-downs of charges? If so, document the decline in your receipts and increase in receivables.
- Were there 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)?
- Did the Pandemic impact your ability 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?
- How did the uncertainty over when and whether the business will recover, after the end of the Pandemic, impact your analysis of whether to use existing working capital or taking on new debt to fund current operations?
- Did any of these risks exist, and how did they impact your decisions:
- 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.
- Were there market trends that suggested disruption in your business was 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).
- As of the date of the analysis (e.g., May 4, 2020), how has your business been impacted as compared to before the Pandemic (e.g., shortfalls in budgeted production or revenue)?
- What other steps have you taken 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.
- What cutbacks and other reductions have been undertaken by other businesses in your industry, and did the PPP loan help prevent you from making similar layoffs and cuts?