SBA Survey Signals Enhanced COVID-19 Loan Scrutiny

By Derek Adams and Ellen London
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Law360 (November 6, 2020, 5:39 PM EST) --
Derek Adams
Derek Adams
Ellen London
Ellen London
Paycheck Protection Program borrowers have been on a proverbial rollercoaster since last spring, left woozy by the U.S. Small Business Administration's constantly changing rules and guidance.

Perhaps no issue has garnered more confusion and uneasiness than what it means for a borrower to certify on its loan application that "the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient."[1] This issue recently reared its head again with the SBA's introduction of new loan necessity questionnaires designed to help it evaluate the veracity of a borrower's certification.

This required certification is found in the Coronavirus Aid, Relief and Economic Security, or CARES, Act, at Section 1102(a)(36)(G)(i)(I). Borrowers must make this certification on their loan application, subject to potential criminal and civil penalties.[2] The required certification must be made in good faith by an authorized representative of the borrower on the date of the borrower's loan application.

PPP Early Days

Within a month of the program's passage, news media reported that businesses few would think of as small — e.g., Ruth's Chris Steak House, Shake Shack and the Los Angeles Lakers — were receiving loans. Congress and the public expressed concern, and so did the SBA.

Why did these businesses potentially qualify for loans issued by the SBA? There were a few reasons. First, the program eliminated many of the SBA's typical restrictions in its 7(a) loan program, which is its primary program for providing financial assistance to small businesses. It permitted businesses with fewer than 500 employees to qualify for loans, even if those businesses do not meet the definition of a small business concern.[3]

For example, the Los Angeles Lakers, a sports franchise reportedly worth more than $4 billion with annual revenue last year above $400 million, would not qualify as a small business concern by statute or regulation. The Lakers, however, met the PPP's alternative qualification of a business with fewer than 500 employees, which Congress did not tie to any revenue-based criteria.

Second, while SBA size-based standards typically require a business to include its affiliates, Congress expressly exempted from this requirement PPP borrowers with a North American Industry Classification System, or NAICS, number beginning with 72.[4]

NAICS Sector 72 businesses are in the accommodation and food services industry, which includes restaurants, bars and hotels, among others. This meant that individual locations of national restaurant or hotel chains might still qualify for PPP loans if they had fewer than 500 employees associated with that specific location.

Not only that, but individual locations organized as separate business entities could each obtain a PPP loan. This led to some business groups receiving nearly $100 million in PPP loans, even though the program capped PPP loans at $10 million per borrower.[5]

Following public outcry, on April 23 the SBA put out new guidance regarding its interpretation of the need-based certification, discussed above.

That guidance — issued through question 31 of the SBA's frequently asked questions about PPP loans — stated that borrowers must make this certification "taking 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."[6]

As an example, a "public company with substantial market value and access to capital markets" would not likely be able to make this certification in good faith, according to the SBA.[7] Given that Congress had expressly waived the SBA's ordinary requirement that borrowers must be unable to obtain credit elsewhere,[8] the SBA's interpretation came as a surprise to many.

In addition to the SBA's guidance, U.S. Department of the Treasury Secretary Steven Mnuchin warned that borrowers could face criminal liability for retaining PPP loans that were intended for small businesses, and it was announced that every PPP loan greater than $2 million would be reviewed by the SBA.[9]

Following the SBA's guidance and Mnuchin's comments, many businesses returned their PPP loans, and many more wrestled with the decision of whether to do so. The SBA established an amnesty period, which lasted until May 18, and gave borrowers an opportunity to return their loans without facing penalty.

Prior to the expiration of the amnesty period, the SBA also issued FAQ 46 which appeared to soften the SBA's stance in two important ways. First, it granted a safe harbor for any borrower that, together with its affiliates, had a loan of less than $2 million. For these borrowers, the SBA would deem their need-based certification to be made in good faith.

Second, while it would still review every loan greater than $2 million, if the "SBA determine[d] in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request," the borrower could refund the loan and avoid administrative enforcement or a referral by the SBA to the U.S. Department of Justice.[10]

New Loan Necessity Questionnaires

The SBA had been quiet since May regarding the extent and manner of scrutiny it would apply to the issue of loan forgiveness. That changed on Oct. 26, albeit in a surreptitious manner, when the SBA published a notice in the Federal Register seeking approval from the Office of Management and Budget for information collection using 11 specific forms.[11]

Such permission is required under the Paperwork Reduction Act, as forms for the collection of information from the public developed by federal departments and agencies must be approved in advance by the Office of Information and Regulatory Affairs at the OMB.[12] The public has until Nov. 25 to provide comments on the proposed collection of information.

The eleven forms include many forms previously published by the SBA on its PPP website over the past six months, such as the borrower loan application, lender application and loan forgiveness applications.[13]

Among the listed forms, however, are two new forms titled SBA Form 3509 and SBA Form 3510, referred to as loan necessity questionnaires — one seeking information from for-profit borrowers and the other from nonprofit borrowers.

The SBA has not made these forms publicly available on its PPP site. However, copies of the forms have become public through media reporting.

If approved in their current form, SBA Forms 3509 and 3510 will be provided by lenders to borrowers and will be due back within a short 10 business days of the borrower's receipt.

The forms apply to borrowers that, together with affiliates, received PPP loans of $2 million or more. This aspect of the request is not surprising given the SBA's safe harbor for borrowers with loans less than $2 million, as discussed above.

What is surprising, however, is the depth of information requested by the SBA. The forms ask for, among other things, the borrower's:

  • Second quarter 2020 gross revenue;

  • Q2 2019 gross revenue;

  • Information on partial or full shutdown orders or restrictions;

  • Voluntary partial or full shutdowns or restrictions;

  • Expenses associated with business alterations due to COVID-19;

  • Information on any new capital improvement projects since March, including cash outlays for such projects;

  • Cash or cash equivalents at the end of the quarter proceeding the loan;

  • Dividends or capital distributions made to owners;

  • Prepayment of debts;

  • Annualized compensation amounts to any employee above $250,000;

  • Whether the entity is publicly listed and, if so, its market capitalization;

  • Whether any publicly traded company holds a greater than 20% ownership interest in the borrower and, if so, that company's market capitalization;

  • The shareholders' equity value at the end of the quarter proceeding the loan, if a private business;

  • Parent company ownership information;

  • Whether any private equity firm, venture capital firm or hedge fund holds a greater than 20% ownership interest in the borrower; and

  • Whether the borrower received funds from other CARES Act programs, including the funding amount;

The information requested from nonprofit borrowers is very similar, with minor differences and additions such as:

  • Q2 2019 and Q2 2020 gross receipts instead of revenue;

  • Q2 2019 and Q2 2020 gross receipts from gifts, grants, contributions and similar amounts;

  • Q2 2019 and Q2 2020 expenses;

  • Any restrictions on the borrower's use of net income or cash, savings, and temporary cash investments for payroll and other costs such as mortgage interest, rent, and utilities payments;

  • Assets held in any endowment funds;

  • Value of non-cash investments at quarter end proceeding the loan;

  • Whether the borrower is a school, college or university and, if so, the median tuition paid per student for the 2019-2020 academic year, whether it offered any additional financial assistance to students, and whether revenues decreased from any tuition decrease; and

  • Whether the borrower provides health care services and if so, the revenue from patient care in Q2 2020 as compared to Q2 2019, and any discounts offered on patient care services.

In sum, the questions seek to assess the borrower's financial standing prior to its loan request, its availability of alternative sources of capital — including through partial ownership by other companies, how its business has fared during part of the pandemic and its use of non-PPP funds since March, all presumably for the SBA to now make its own assessment of how badly the borrower needed the loan.     

Borrowers are likely to be unpleasantly surprised at both the level of detailed information that will be required, as well as the level of potential scrutiny by the SBA that this questionnaire signals.

And notably, the borrower must certify, subject to civil and criminal penalties, that the information it provides on the form, and in supporting documentation requested by the form, is "true and correct in all material respects ... after reasonable inquiry of people, systems, and other information available to the [b]orrower."

Thus, borrowers must carefully compile this information and ensure that their statements and supporting documentation are supported and appropriately vetted.

Takeaways

The extent of information sought by the SBA should raise alarm bells for borrowers. Requiring such a large amount of information suggests that the SBA intends to closely scrutinize borrowers' original certifications and that the agency will likely seek to claw back a significant amount of funds.

The information sought further suggests particular SBA scrutiny is forthcoming for public company borrowers, borrowers with public company investors, and borrowers with investments from private equity, venture capital, and hedge funds. This may, in turn, lead to referrals by the SBA to the DOJ for False Claims Act lawsuits —consistent with the DOJ's signals this summer that its CARES Act enforcement efforts may include a focus on private equity investors.[14]

The SBA's forms also signal that it may be crafting its own standards for evaluating loan necessity, which will lead to significant pushback from borrowers, who will argue, among other things, that the statute did not limit their ability to pay executives above $250,000 per year, did not specify that partial ownership by other companies would be relevant and did not indicate that the use of non-PPP funds would be up for review.

Borrowers will assert, in a nutshell, that all that was required was a good faith certification of need at the time of their loan request, based on the uncertainty arising from the global pandemic. The regulators will likely defend the necessity of having some standards in order to separate those who acted in good faith and those who took advantage of the situation. While there is still a great deal of uncertainty surrounding this, it looks like the PPP rollercoaster ride will continue for some time.



Derek Adams is a partner at Potomac Law Group PLLC and former trial attorney with the DOJ's Civil Fraud Section.  
Ellen London is a partner at Alto Litigation PC and formerly served as an assistant U.S. attorney for the Southern District of New York and the Northern District of California.

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, Section 1102(a)(36)(G)(i)(I).

[2] These include. among others, Title 18 of the U.S. Code, Section 01 — false statements to the government; 15 U.S.C. § 645 — false statements to the SBA; and 31 U.S.C. § 3729 et seq. — False Claims Act.

[3] Small Business Act of 1958, 15 U.S.C. § 632(a).

[4] https://www.naics.com/search-naics-codes-by-industry/. Congress also exempted franchises and borrowers with investments from licensed small business investment companies from the SBA's affiliation rules.

[5] The SBA later imposed a group cap of $20 million.

[6] https://www.sba.gov/sites/default/files/2020-10/Final%20PPP%20FAQs%20%28October%207%2C%202020%29-508.pdf

[7] Id. at FAQ 31.

[8] See CARES Act, Section 1102(a)(36)(I).

[9] https://www.sba.gov/article/2020/apr/28/joint-statement-secretary-steven-t-mnuchin-administrator-jovita-carranza-review-procedure-paycheck

[10] https://www.sba.gov/sites/default/files/2020-10/Final%20PPP%20FAQs%20%28October%207%2C%202020%29-508.pdf

[11] https://www.federalregister.gov/documents/2020/10/26/2020-23594/reporting-and-recordkeeping-requirements-under-omb-review

[12] 44 U.S.C. § 3501 et seq.

[13] https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program

[14] Principal Deputy Assistant Attorney General Ethan P. Davis delivers remarks on the False Claims Act at the U.S. Chamber of Commerce's Institute for Legal Reform, June 26, 2020, https://www.justice.gov/civil/speech/principal-deputy-assistant-attorney-general-ethan-p-davis-delivers-remarks-false-claims.

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