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Treasury Secretary and SBA Signal Increased Scrutiny of PPP Loan Borrowers

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| Legal Advisory

With the spate of high-profile companies receiving public backlash after obtaining loan proceeds from the Paycheck Protection Program (PPP), on April 23 the SBA added item #31 (followed by item #37 on April 28) to its continually updating Frequently Asked Questions list. In noting that borrowers are required to certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant,” the SBA provided further commentary that borrowers need to 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.” 

The example provided in item #31 referenced that public companies would likely not be able to make this certification in good faith because of their access to capital markets. Without additional explanation or provision of standards, item #37 indicates that a similar analysis applies to businesses owned by private companies with adequate sources of liquidity. It is not clear whether companies that have an existing line of credit or have deep-pocketed venture or private equity investors would be deemed to have sufficient access to liquidity.

Although SBA loans typically require a borrower to demonstrate that it is unable to obtain credit “elsewhere,” the CARES Act explicitly waived the “credit not available elsewhere” requirement for PPP loans. FAQ items #31 and 37, however, indicate that aspects of the “credit not available elsewhere” analysis are being retroactively applied. As such, the profiles and owners of PPP applicants are potentially under greater scrutiny than may have been anticipated when the CARES Act was originally enacted. 

To that end, Treasury Secretary Steven Mnuchin announced on April 28 that borrowers seeking forgiveness on loans in excess of $2 million would be subject to a “full audit” at the time such borrower applied for forgiveness. In such audits, borrowers would need to show how they used the funds and what facts and circumstances they relied upon to back up their good faith certification of eligibility for the program. 

So What Do We Do Now?

A company that has already received PPP loans should do an analysis to determine whether, in retrospect, it can evidence the required good faith certification, particularly if its loan exceeds the $2 million threshold. Based on the language provided in items #31 and 37 of the FAQs and drawing inferences from the SBA’s “credit not available elsewhere” test, a company should consider the liquidity of owners of greater than 20% of its equity and whether a loan would be available from these sources. A company that determines sufficient liquidity would have been available from its owners should consider returning the loan proceeds prior to May 7, as the SBA announced that any borrower that returns its proceeds on or before such date will be deemed to have made the certification truthfully. 

Companies currently considering applying should ensure that they undertake an analysis of their capital needs and potential sources and have a full board discussion to back up the decision to move forward with an application.[i]

As with many other aspects of the PPP, this remains an evolving situation.  We anticipate further guidance, specifically related to the facts a borrower should consider and be ready to demonstrate, in making the good faith certification that the loan is necessary to support its ongoing operations, and whether there are any clear disqualifying factors.

This advisory was prepared by Josh French, Melissa Sampson McMorrow, Steve Patterson, David Rubin, and Shannon Zollo in Nutter’s Corporate and Transactions, Labor, Employment and Benefits, and Tax Departments. For more information, please contact Josh, Melissa, Steve, David, Shannon, or your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

[i] On April 24, 2020, legislation was enacted to provide $310 billion to the Paycheck Protection Program in addition to the original $349 billion provided. Of the $310 billion, $60 billion is reserved for community banks and small lenders.

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