What To Know About The First Wave Of CARES Act Litigation

By James Murphy and Daniel Payne
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Law360 (October 15, 2020, 6:03 PM EDT) --
James Murphy
James Murphy
Daniel Payne
Daniel Payne
On March 31, Congress passed the Coronavirus Aid, Relief and Economic Security, or CARES Act, to provide immediate and critically needed financial relief to the economy, which was racing the disastrous consequences of the global COVID-19 pandemic.

The rollout of the CARES Act was a perfect storm for litigation: a $2 trillion law hurriedly written, passed and implemented in a matter of weeks.

The law included direct transfers to states and individuals, along with hundreds of billions of dollars in forgivable loans to small businesses[1] and unrealistic expectations about how quickly and carefully the money could be distributed by the banking industry.[2] Unsurprisingly, demand was high for the so-called free money, and frustrations quickly mounted for borrowers and lenders alike as Small Business Administration guidance shifted on an almost daily basis.[3]

Predictably, what has followed is a wave of litigation, with the first lawsuit, Profiles Inc. v. Bank of America Corp., being filed the same day that the program officially launched.[4] Many more cases were filed in quick succession.

We analyze below what types of cases are being filed, how they are progressing and who is winning in the early going.

The Paycheck Protection Program rollout recalls the 2008 Troubled Asset Relief Program, or TARP, that distributed $700 billion to financial institutions amid economic crisis conditions in which the goal of speed of distributing the funds often outweighed the concern for guarding against errors, fraud and abuse.

The Office of the Special Inspector General for TARP, or SIGTARP, reported recovering $11 billion from its investigations of recipients of TARP funds and referred hundreds of targets for criminal prosecution.[5] Congress modeled the CARES Act watchdog, the Office of the Special Inspector General for Pandemic Recovery, or SIGPR,[6] on SIGTARP: Their statutory responsibilities mirror each other.[7]

Congress doubled down with CARES Act oversight, though, creating the Pandemic Response Accountability Committee[8] and the Congressional Oversight Commission.

In the six months since the CARES Act was signed we have monitored the progress of Cares Act litigation and government investigations. It appears that we are through only the first inning of litigation that might ultimately end up going extra innings.[9] Recently, we have seen signs pointing to a wave of government scrutiny from not only SIGPR and the Pandemic Response Accountability Committee, but a litany of other federal and state regulators.

The First Inning of CARES Act Litigation

To date, over 100 civil actions have been filed arising from the CARES Act, including dozens of cases against the SBA. Although cases have been filed across the country, about one-third have been filed in California. And except for an antitrust case and a securities class action case, every California case includes a claim for unfair business practices pursuant to California Business and Professions Code Section 17200.

And even though Bank of America and Wells Fargo & Co. are facing the most litigation thus far, every SBA lender has effectively been named as a defendant in at least two cases, whether they know it or not. In American Video Duplicating Inc. v. v. Citibank NA[10] and A.D. Sims LLC v. Wintrust Financial Corp.,[11] the plaintiffs named Doe lenders 1 through 4,975, intending to sue every SBA lender.

The early scorecard for these cases looks like this:

PPP Borrower Class Actions

Borrowers have brought class actions against lenders for allegedly prioritizing certain applicants over others. The lender defendants have chalked up some early wins.

A federal court in Maryland quickly denied a temporary restraining order on the grounds that the CARES Act did not provide a private right of action;[12] a federal court in California also denied a TRO, citing the Maryland ruling, for lack of irreparable harm;[13] and a federal court in Texas likewise denied a TRO for lack of irreparable harm.[14]

A number of these lawsuits have been voluntarily dismissed before discovery, suggesting the plaintiffs may have received the PPP loans for which they originally filed suit.[15] But at least 14 more PPP borrower class actions are ongoing according to our database.

PPP Agent Class Actions

Attorneys and certified public accountants have brought class actions against lenders for failing to pay agents fees for helping borrowers submit PPP applications as allegedly required by the CARES Act. The lenders got an early win in Sport & Wheat CPA PA v. ServisFirst Bank Inc., as the U.S. District Court for the Northern District of Florida granted the defendants' motion to dismiss, ruling agent fees are not required to be paid.[16]

The court held that the statutory language did not require lenders to pay the agent's fees, absent an agreement with the lender, noting the permissive language used to permit payments to agents was different than the mandatory language for payments to lenders. The decision is on appeal to the U.S. Court of Appeals for the Eleventh Circuit.

SBA Litigation

Dozens of PPP borrowers sued the SBA directly to prevent the enforcement of various SBA prohibitions on lending to certain types of applicants. Borrowers have been successful in some cases, obtaining court rulings that permit bankruptcy plaintiffs[17] and strip clubs[18] to receive PPP loans.

And in response to a lawsuit filed by a company concerned that its PPP loan may not be forgiven under the SBA's "credit elsewhere" guidance,[19] the SBA subsequently issued additional guidance that any PPP borrower that received less than $2 million would be deemed to have made the required certification concerning the necessity of the loan request in good faith.[20] Because that guidance is not definitive and can change at any time, the case is proceeding.

Fewer Economic Injury Disaster Loan program, or EIDL, lawsuits have been filed. In Celebration Law PA v. Carranza in the U.S. District Court for the Middle District of Florida, the small business plaintiffs argue that loan advances were not made timely and the loan amounts were inappropriately reduced.[21] The court denied two separate requests for preliminary injunctions before the plaintiffs voluntarily dismissed the case.

Other PPP Cases

There are a variety of other cases involving different legal theories. A TRO was denied in a case alleging that the administration of the PPP program discriminates against minorities.[22] Another court denied a TRO sought in a case alleging antitrust violations because the plaintiff failed to allege irreparable harm.[23] Both of these cases are ongoing.

Meanwhile, a securities class action against Wells Fargo alleging shareholders were hurt due to its poor PPP rollout is proceeding, as the court recently named the lead plaintiff and lead counsel in the case.[24]

There are dozens of active cases in discovery that could shift the playing field in the months ahead and no appellate court has been heard from as of this writing.

Next Innings

Even as active cases progress through discovery, summary judgment, trial and appeals, new cases and investigations will arise in the next innings.

Denial of Loan Forgiveness Litigation

Applications for PPP loan forgiveness are beginning in earnest.[25] We believe another wave of litigation will likely come from borrowers if their applications are denied. Many borrowers believe they are not borrowers at all, but rather recipients of a government grant.

And many small businesses do not have the cash available to pay back an unforgiven loan. Indeed, the borrowers are likely to argue that the loan proceeds were spent on payroll, and, to a lesser extent, rent, exactly as Congress intended. These lawsuits may allege statutory claims, breach of contract, or even fraud, with potential allegations that the borrowers were told their loans would be forgiven if they spent the money on payroll.

Government Scrutiny

Government authorities are beginning to focus substantial resources on CARES Act fraud and abuse. Wells Fargo disclosed in its first quarter U.S. Securities and Exchange Commission filing that it "received formal and informal inquiries from federal and state governmental agencies regarding its offering of PPP loans."[26]

Although the U.S. Department of Justice began indicting borrowers in connection with PPP fraud in May,[27] the scale has increased: On Sept. 10, federal authorities charged 57 people in jurisdictions across the U.S. with stealing $175 million from the PPP.[28]

After JPMorgan Chase & Co. made news for firing employees that improperly obtained EIDL funds in early September,[29] Sen. Marco Rubio, R-Fla. — who is chairman of the U.S. Senate Committee on Small Business and Entrepreneurship — sent a letter to JPMorgan requesting "information regarding JPMorgan Chase's investigation into potential misuse of PPP and/or EIDL funds."[30]

Additionally, the SBA issued guidance for lenders regarding their obligation to investigate fraud in CARES Act loans.[31]

A government report issued in September found "tens of thousands of loans could be subject to fraud, waste, or abuse."[32] That was followed by a U.S. Government Accountability Office report to the U.S. House of Representatives that noted the SBA's fraud hotline had received more than 42,000 reports of alleged fraud.[33]

We expect momentum to pick up as more investigations and lawsuits are announced. Lenders should consider immediate steps they can take to manage their risk, including:

  • Ensure your process and decisions around CARES Act programs are well documented, including discussions with the SBA and the U.S. Department of the Treasury.

  • Develop comprehensive compliance processes and procedures for CARES Act programs, including the loan forgiveness decisioning process.

  • Investigate potential borrower fraud in these programs and the possibility that employees may have aided such fraud.

  • Investigate whether employees may have improperly obtained EIDL funds for themselves.

  • Review the legal risks associated with holding or selling CARES Act loans.

Conclusion

With the first inning completed, many borrowers and lenders are only beginning to recognize the substantial litigation and regulatory risks they are facing. Should the CARES Act become TARP 2.0, expect it to fare far worse. The stakes are higher and the oversight is greater.



James Murphy is chairman and co-founder of Murphy & McGonigle PC.

Daniel Payne is a shareholder at the firm.

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] CARES ACT, Public Law 116-136 (2020).

[2] https://home.treasury.gov/news/press-releases/sm961.

[3] Cowley, Stacy "Banks Warn of 'Overwhelming Demand and Messy Start for Small Business Loans," New York Times (Apr. 2, 2020) available at https://www.nytimes.com/2020/04/02/business/small-business-coronavirus-stimulus.html.

[4] The program launched on April 3, 2020, which is the date that Profiles v. Bank of America, 20-cv-894 (D. Md.) was filed.

[5] https://www.sigtarp.gov/Pages/Home.aspx.

[6] SIGPR's initial report can be found here: https://www.oversight.gov/sites/default/files/oig-reports/SIGPR-Initial-Report-to-Congress-August-3-2020.pdf.

[7] See https://www.jdsupra.com/legalnews/the-special-inspector-general-for-22243/.

[8] https://www.pandemicoversight.gov/.

[9] This article focuses on CARES Act litigation impacting lenders: primarily the PPP and EIDL programs. There are several other areas of CARES Act litigation that we do not address here, including litigation related to mortgage forbearance, public school funding, and stimulus funds.

[10] Dkt. No. 20-cv-3815 (C.D. Cal. Apr. 27, 2020).

[11] Dkt. No. 20-cv-2644 (N.D. Ill. Apr. 30, 2020).

[12] Profiles, 20-cv-0894, Dkt. No. 17 (D. Md. Apr. 13, 2020).

[13] Outlet Tile Center et al. v. JP Morgan Chase & Co. et al., Case No. 20-cv-3603, Dkt. No. 12 (C.D. Cal. Apr. 23, 2020). This case was voluntarily dismissed by the plaintiffs after the TRO was denied.

[14] Scherer et al. v. Wells Fargo Bank, N.A., Case No. 20-cv-1295, Dkt. No. 20 (S.D. Tex. Apr. 29, 2020). The plaintiffs later voluntarily dismissed their case.

[15] See, e.g., BSJA v. Wells Fargo Bank & Co., Case No. 20-cv-3588 (C.D. Cal.).

[16] 3:20-cv-05425, Dkt. No. 87 (N.D. Fla. Aug. 17, 2020).

[17] Roman Catholic Dio. Of Santa Fe v. SBA, 20-ap-1026, Dkt. No. 15 (Bankr. N.M. May 1, 2020).

[18] DV Diamond Club of Flint, LLC et al. v. SBA, 20-cv-10899, Dkt. No. 42 (E.D. Mich. May 11, 2020); Camelot Banquet Rooms, Inc. et al. v. SBA, 20-cv-601, Dkt. No. 28 (E.D. Wis. May 1, 2020).

[19] Zumasys, Inc. et al. v. SBA, 20-cv-851 (C.D. Cal.). The "credit elsewhere" guidance suggested borrowers with ready access to alternative sources of capital (.e.g public markets; lines of credit; etc.) should not apply.

[20] Paycheck Protection Program Loans Frequently Asked Questions, available at https://www.sba.gov/sites/default/files/2020-08/Final%20PPP%20FAQs%20%28August%2011%2C%202020%29-508.pdf (FAQ 46).

[21] See, e.g., Glenn, Caroline, "Florida businesses sue Small Business Administration over delayed loans," Orlando Sentinel (Apr. 28, 2020), available at https://www.orlandosentinel.com/coronavirus/jobs-economy/os-bz-coronavirus-sba-lawsuit-20200428-s6d56ax575gfbav7b4bmi4imri-story.html.

[22] Infinity Consulting Group, Inc. v. SBA et al., Case No. 20-cv-981, Dkt No. 24 (D. Md. April 26, 2020).

[23] Legendary Transport, LLC v. JP Morgan Chase & Co. et al., Case No. 20-cv-3636, Dkt. No. 31 (C.D. Cal. April 24, 2020).

[24] Ma v. Wells Fargo & Company, et al., Case No. 20-cv-3697 (N.D. Cal.); Ruscoe, Emilie, "Rosen Law Firm to Lead Wells Fargo Investors' PPP Suit." Law360.com available at https://www.law360.com/articles/1308288 (subscription required).

[25] Hayashi, Yuka "U.S. to Start Forgiving PPP Loans After Borrowers Complained," Wall Street Journal (Sept. 29, 2020) available at https://www.wsj.com/articles/u-s-to-start-forgiving-ppp-loans-after-borrowers-complained-11601414687.

[26] https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/sec-filings/2020/first-quarter-10q.pdf.

[27] https://www.justice.gov/opa/pr/two-charged-rhode-island-stimulus-fraud.

[28] https://www.washingtonpost.com/business/2020/09/10/ppp-fraud-charges/.

[29] https://www.bloomberg.com/news/articles/2020-09-09/jpmorgan-finds-some-workers-improperly-pocketed-relief-funds.

[30] https://www.rubio.senate.gov/public/index.cfm/2020/9/chairman-rubio-sends-letter-to-jpmorgan-chase-requesting-information-on-alleged-ppp-and-eidl-fraud.

[31] https://www.sba.gov/document/information-notice-5000-20037-guidance-regarding-identification-reporting-suspicious-activity-covid-19-eidl-loan-program.

[32] Majority Staff of the Select Subcommittee on the Coronavirus, Preliminary Analysis, available at https://coronavirus.house.gov/sites/democrats.coronavirus.house.gov/files/2020-09-01.PPP%20Interim%20Report.pdf.

[33] https://www.gao.gov/products/GAO-21-117T.

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