Financial Cos. Face CARES Act Litigation, Enforcement Risks

By Marc Gottridge, Allison Schoenthal and Catherine Tremble
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Law360 (May 7, 2020, 6:47 PM EDT) --
Marc Gottridge
Marc Gottridge
Allison Schoenthal
Allison Schoenthal
Catherine Tremble
Catherine Tremble
Through the Coronavirus Aid, Relief and Economic Security, or CARES, Act's Paycheck Protection Program and Main Street New, Priority and Expanded Loan Facilities, Congress, the Small Business Administration, and the Federal Reserve Board have enlisted banks to provide relief to individuals and small and mid-sized businesses harmed by the recession triggered by the COVID-19 lockdown.

But federal funding comes with strings attached. And although regulators — eager to encourage lending — have provided a modicum of reassurance, lenders still risk audits, investigations and lawsuits. Even before the new programs were launched, the U.S. Department of Justice warned that it would "prioritize the detection, investigation, and prosecution of illegal conduct related to the pandemic."[1]

And with the ink barely dry on the CARES Act, civil litigants are already challenging banks' implementation of the PPP and the DOJ is inquiring into loans.

We highlight below the principal sources of regulatory enforcement and litigation risk relating to the CARES Act lending programs.

The New Lending Programs

Under the PPP, financial institutions provide loans to eligible small businesses; the SBA guarantees principal and interest payments and the loans will be forgiven if employees remain on the payroll for eight weeks and the proceeds are used for permitted purposes. After the initial $349 billion in PPP funding was exhausted, Congress approved $322 billion more.[2]

Separately, loans will soon flow to mid-sized businesses through the Main Street Facilities, providing access to $600 billion in loans; businesses eligible for this program may have up to 15,000 employees or $5 billion in revenue.[3]

Lenders are to extend secured and unsecured term loans, and a Federal Reserve Bank-established special purpose vehicle, or SPV, will purchase 80% to 95% of the loan depending on the type.[4] The U.S. Department of the Treasury is investing $75 billion in the SPV.[5]

Potential Liability Concerns

Several aspects of the new programs are likely to engender enforcement actions and/or litigation.

Loan Application Issues, Including False Claims Act Liability

Extending loans under federal programs based on erroneous or materially incomplete applications exposes lenders to enforcement actions and litigation, including under the False Claims Act.

For PPP loans, the SBA's guidance assigns primary responsibility for applications' accuracy to borrowers,[6] but lenders must make certain attestations, including "[c]onfirm[ing] the dollar amount of average monthly payroll costs for the preceding calendar year by reviewing the payroll documentation submitted with the borrower's application."[7]

Although the lender need not replicate the borrower's calculations, it must nevertheless "perform a good faith review, in a reasonable time, of the borrower's calculations and supporting documents concerning average monthly payroll cost."[8]

Moreover, "[i]f the lender identifies errors in the borrower's calculation or material lack of substantiation in the borrower's supporting documents, the lender should work with the borrower to remedy the issue."[9]

Lenders may be second-guessed for failing to spot irregularities, overlooking insufficiently supported material facts, or failing to identify missing documents or material information in loan applications; the SBA intends to review files on all loans exceeding $2 million.[10]

Although the CARES Act prohibits the SBA from initiating enforcement actions or imposing penalties relating to loan forgiveness so long as lenders receive borrower attestations, this provision binds only the SBA, not other enforcement agencies.[11] The DOJ has already begun contacting lenders with preliminary inquiries into potential PPP fraud.[12]

Main Street Facilities lenders are "required to collect the required certifications and covenants from each Eligible Borrower at the time of origination or upsizing."[13] Further, if a lender "becomes aware that an Eligible Borrower made a material misstatement or otherwise breached a covenant during the term of [a Main Street Facility], the Eligible Lender should notify the FRB."[14]

Lenders "must commit that [they] will not cancel or reduce any existing committed lines of credit outstanding to the Eligible Borrower, except in an event of default."[15] FRB guidance also requires lenders to certify that they are eligible to participate in the program, in light of the CARES Act's conflicts of interest prohibition.[16]

Finally, under the Priority Main Street Facility, lenders must "certify that the methodology used for calculating the Eligible Borrower's adjusted 2019 EBITDA for the leverage requirement ... is the methodology it has previously used for adjusting EBITDA when extending credit to the Eligible Borrower or similarly situated borrowers on or before April 24, 2020."[17]

Lenders participating in these new programs may face liability under the FCA. The DOJ or private litigants may bring FCA claims against a party that "knowingly presents or causes to present a false claim for payment or approval" or "knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim."[18]

A claim is broadly defined to include any request for money "presented to an officer, employee, or agent of the United States" or "to be spent or used on the Government's behalf or to advance a Government program or interest" where the government provides any portion of the money or reimburses the recipient.[19]

The FCA's definition of "knowingly" extends beyond actual knowledge; acting with "deliberate ignorance of the truth or falsity of the information" or "in reckless disregard of the truth or falsity of the information" may suffice.[20] FCA violations are punishable by treble damages, monetary penalties, and attorneys' fees.[21]

FCA liability may arise if the lender's certifications are false and the lender knew or had reason to know of the falsity — just as with loans under the 7(a) program, SBA's primary vehicle for providing financial assistance to small businesses.[22] Federal Reserve independence is unlikely to be an impediment to FCA actions involving the Main Street Loan Facilities.

The U.S. Court of Appeals for the Second Circuit recently held that the Federal Reserve Banks are agents of the United States within the meaning of the FCA when they extend money to borrowers through emergency lending programs and that the United States provides such funds to the borrowers for purposes of the statute.[23] Moreover, as noted above, the Treasury is investing substantially in the Federal Reserve Bank-established SPV.

The DOJ appears motivated to deploy the FCA in the context of CARES Act lending programs. Even before the statute was enacted, the DOJ announced that it is "committed to pursuing … violations disclosed by whistleblowers under the False Claims Act, especially during this critical time as our nation responds to the outbreak of COVID-19."[24]

SIGPR

The CARES Act establishes the Office of the Special Inspector General for Pandemic Recovery, or SIGPR, with broad audit and investigations authority relating to funds disbursed under the CARES Act, including subpoena-issuing authority.[25]

SIGPR has already been likened to Office of the Special Inspector General for the Troubled Asset Relief Program, or SIGTARP, established under the Emergency Economic Stabilization Act of 2008 to oversee the use of TARP funds.[26] SIGTARP's investigations have led to the convictions or civil penalties against 380 individuals and 24 enforcement actions against financial and other institutions.[27]

Although there are differences between it and SIGTARP, SIGPR is also likely to be an aggressive law enforcement agency.

Preferential Treatment or Disparate Impact Allegations

Several early lawsuits against PPP lenders allege that they failed to treat borrowers fairly. In putative class actions, plaintiffs assert that banks publicly represented they would follow SBA guidance describing the PPP as a ''first-come, first-served program,[28] but prioritized or front-loaded applications for larger loans, ostensibly to generate greater origination fees.[29]

Other plaintiffs allege that banks discriminated by favoring certain customers (e.g., those who were already borrowers, not merely depositors) over others.[30]

Regulators and litigants will likely scrutinize banks' PPP lending for allegedly improper prioritization. Concerns have been raised that underserved groups are less likely to obtain loans from large banks participating in the PPP program.[31]

Class actions may be brought alleging disparate impact under the Equal Credit Opportunity Act, which prohibits lenders from "discriminating against any applicant, with respect to any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex or marital status."[32]

A disparate impact plaintiff need not allege discriminatory intent, but only that "a particular ... practice, although neutral on its face, has produced a significant adverse effect on a protected group to which the plaintiff belongs" and that the practice is not justified by a legitimate rationale.[33]

Consumer Fraud Claims

The CARES Act is silent about consumer fraud claims, but state consumer protection agencies and plaintiffs' lawyers will be alert for opportunities to assert unfair or deceptive acts or practices claims relating to lenders' processing of applications under, and/or public communications concerning, the CARES Act lending programs. Indeed, plaintiffs in some of the early lawsuits assert claims under statutes prohibiting unfair business practices.

Conclusion

Beyond the handful of civil lawsuits already filed, lenders should expect regulatory scrutiny, as well as additional civil litigation, to follow the funds disbursed under the CARES Act programs. Lenders should carefully consider these risks as they review and certify applications, extend funds, and implement the new programs.



Marc Gottridge and Allison Schoenthal are partners, and Catherine Tremble is an associate, at Hogan Lovells.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] DOJ Press Release, Justice Department Files Its First Enforcement Action Against COVID-19 Fraud (Mar. 22, 2020), available at https://www.justice.gov/opa/pr/justice-department-files-its-first-enforcement-action-against-covid-19-fraud.

[2] Andrew Duehren and Siobhan Hughes, House Approves $484 Billion Bill to Aid Small Businesses, Hospital, Wall St. J. (Apr. 23, 2010, 10:53 PM), available at https://www.wsj.com/articles/house-set-to-approve-484-billion-bill-to-aid-small-businesses-hospitals-11587641659.

[3] Federal Reserve Board ("FRB") Press Release, Federal Reserve Board announces it is expanding the scope and eligibility for the Main Street Lending Program (Apr. 30, 2020),available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200430a.htm ("FRB April 30 Press Release"); FRB Press Release, Federal Reserve Takes Additional Actions To Provide Up To $2.3 Trillion In Loans To Support The Economy (Apr. 9, 2020),available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm.

[4] FRB April 30 Press Release, supra note 3. 

[5] Id.

[6] For example, lenders are not "required to make an independent determination regarding applicability of affiliation rules under 13 C.F.R. 121.301(f) to borrowers," and may rely on borrower representations that they are authorized to sign the loan documents. Paycheck Protection Program Loans: Frequently Asked Questions (FAQs), SBA (Apr. 29, 2020), available at https://home.treasury.gov/system/files/136/Paycheck-Protection-Program-Frequently-Asked-Questions.pdf ("PPP FAQs").

[7] Business Loan Program Temporary Changes; Paycheck Protection Program, 85 Fed. Reg. 20,811, at 20,815 (Apr. 15, 2020) (to be codified at 13 C.F.R. pt.120) ("PPP Interim Rule").

[8] PPP FAQs, supra note 6.     

[9] Id.

[10] Id.   

[11] The Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), Pub. L. No. 116-136, § 1106(h)(1), (2).

[12] Tom Schoenberg & Christian Berthelsen, Justice Department Sees Early Fraud Signs in SBA Loan Flurry, Bloomberg Politics (Apr. 30, 2020, 5:42pm), available at https://www.bloomberg.com/news/articles/2020-04-30/justice-department-sees-early-fraud-signs-in-sba-loan-flurry.

[13] FRB, Main Street Lending Program: Frequently Asked Questions (Apr. 30, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200430a2.pdf.

[14] Id. at 17.

[15] Id.

[16] FRB Press Release, Main Street Priority Loan Facility (Apr. 30, 2020),available at https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200430a2.pdf.

[17] Id.

[18] 31 U.S.C. § 3729(a)(1)-(2).

[19] 31 U.S.C. § 3729(b)(2)(A).

[20] Id. § 3729(b).

[21] Id. § 3729(a).

[22] See, e.g., U.S. ex rel. Brickman v. Bus. Loan Express, LLC , No. CIV.A. 1:05-CV-3147J, 2007 WL 4553474, at *1 (N.D. Ga. Dec. 18, 2007), aff'd, 310 F. App'x 322 (11th Cir. 2009).

[23] United States v. Wells Fargo & Co. , 943 F.3d 588, 595 (2d Cir. 2019). 

[24] Lydia Wheeler, Coronavirus False Claims Task Force Urged at Justice Department, Bloomberg News (Mar. 17, 2020), https://news.bloomberglaw.com/health-law-and-business/coronavirus-false-claims-task-force-urged-at-justice-department.

[25] CARES Act, § 4018(c)-(d).

[26] Economic Emergency Stabilization Act, Pub. L. No. 82 110-343, §§ 104, 121, 125 (2008).

[27] Office of the Special Inspector General for the Troubled Asset Relief Program (last visited Apr. 21, 2020), https://www.sigtarp.gov/Pages/Home.aspx.

[28] PPP Interim Rule at 20,813. SBA does not appear to have intended that each bank be required to deal with applications on this basis. That has not deterred plaintiffs' lawyers from predicating lawsuits on that aggressive interpretation.

[29] See, e.g., Complaint, Law Office of Irina Sarkisyan v. U.S. Bancorp, No. 20-cv-03589 (C.D. Cal. filed Apr. 19, 2020); Complaint, Ryan M. Kull Licensed Clinical Social Work LLC v. JPMorgan Chase & Co., No. 20-cv-3138 (NRB) (S.D.N.Y. filed Apr. 20, 2020).

[30] See, e.g., Complaint, Profiles Inc. v. Bank of America, No. 20-cv-894 (D. Md. Apr. 3, 2020). The District Court denied plaintiff's motion for injunctive relief, and plaintiff has appealed. See also Complaint, Scherer v. Frost Bank, No. 20-cv-1297 (S.D. Tex. Apr. 12, 2020) (challenging bank's alleged requirement that applicant had a business checking account as of April 1, 2020).

[31] See, e.g., Ruth Simon & Peter Rudegeair, Big Banks Favor Certain Customers in $350 Billion Small-Business Loan Program; Some Small-Business Owners Worry That The Pot Of Money Will Run Out Before They Are Able To Dip Into It, Wall St. J. (Apr. 6, 2020) ("Firms owned by African-Americans were 20% less likely to obtain financing at large banks than white-owned businesses with similar profitability, credit risk and other factors . . .").

[32] 15 U.S.C. § 1691(a).

[33] Trites v. 21st Mortg. Corp. , No. CV 19-11387, 2020 WL 1531773, at *5 (E.D. Mich. Mar. 31, 2020) (quoting Kovacevich v. Kent State Univ. , 224 F.3d 806, 830 (6th Cir. 2000).

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