SBA Allows Borrowers to Return PPP Loans if Unable to Show Loan Necessity

Updates as of May 6: the SBA extended the date for borrowers seeking to repay PPP loans from May 7 to May 14. Issuing an updated FAQ (FAQ #43), the date was extended effective immediately. The SBA indicated in its response the following: “SBA is extending the repayment date for this safe harbor to May 14, 2020. Borrowers do not need to apply for this extension. This extension will be promptly implemented through a revision to the SBA’s interim final rule providing the safe harbor. SBA intends to provide additional guidance on how it will review the certification prior to May 14, 2020.”

On March 27, 2020, President Trump signed into law the “Coronavirus Aid, Relief, and Economic Security Act” (“CARES”). The CARES Act was enacted to provide emergency assistance to individuals, families, and businesses affected by the Coronavirus (COVID-19) pandemic. CARES offered funding and authority to the Small Business Administration (SBA) to modify existing loan programs and to establish a new loan option, the “Paycheck Protection Program” (“PPP”), to assist businesses impacted by COVID-19. Therefore, these loans are 100% guaranteed by the SBA, and the CARES Act provisions further state that an organization’s PPP loan could be forgiven if the loan proceeds are used for specified purposes.

The Credit Elsewhere Requirement

Certain requirements normally accompanying SBA-guaranteed loans were waived under the CARES Act, including the SBA’s “credit elsewhere requirement” (defined as follows).

“SBA provides business loan assistance only to applicants for whom the desired credit is not otherwise available on reasonable terms from non-Federal sources. SBA requires the lender or CDC [certified development companies] to certify or otherwise show that the desired credit is unavailable to the applicant on reasonable terms and conditions from non-Federal sources without SBA assistance, taking into consideration the prevailing rates and terms in the community in or near where the applicant conducts business, for similar An Analysis of Lenders’ Compliance with SBA’s Credit Elsewhere Requirement 2 purposes and periods of time. Submission of an application to SBA by a lender or CDC constitutes certification by the lender or CDC that it has examined the availability of credit to the applicant, has based its certification upon that examination, and has substantiation in its file to support certification.”

Reduced SBA Requirements for PPP Loans

Additional documentation that is normally mandated for an SBA-guaranteed loan, such as personal financial statements and business plans, were also waived for PPP loans. The loan application was abbreviated to reduce the time involved to complete it. Additionally, no personal guarantees were expected (which is generally a requirement for SBA loans) to reduce risk placed on borrowers. The loan application process was expedited in general, allowing for lenders to start submitting applications to the SBA portal just one week after the CARES Act became law.

PPP Loan Guidance for Businesses

As you might expect, PPP loans drew much attention and interest from many businesses. The Treasury Department and SBA provided guidance as quickly as possible to assist businesses and lenders in applying for these loans, although not every item was addressed. There were several certifications required by a borrower when he or she applied for a PPP loan. One of the certifications a borrower made in their application was that the “current economic uncertainty makes the loan request necessary.” No specific guidance was provided initially as to how this term would be applied. Thus, the subjective nature of this term and lack of guidance allowed for broad interpretation of this provision.

Generally, eligible borrowers were encouraged to apply as quickly as possible due to the funds being depleted and the opportunity being lost. As we know now, that was a reality as the initial round of funding was fully depleted requiring the President and Congress to pass additional legislation to provide more funding.

Borrowers that applied and received loans also considered the forgiveness provisions of this loan program against obtaining capital by borrowing from a bank or other financing source or obtaining capital from investors. The forgiveness provisions made the PPP loan very attractive but were based on further uncertainty of when federal, state, and local governments would lift restrictions. Unfortunately for many organizations that reduced their workforce temporarily, taking receipt of these funds started the clock on an eight-week “covered” period to calculate the loan forgiveness amount. For many businesses, this timeframe does not match up with when the restrictions are lifted. Thus, they are faced with the difficult decision of bringing workers back earlier than planned to avoid additional indebtedness once the eight-week period expires. These variables created additional uncertainty and were difficult for most borrowers to navigate.

PPP Loan Certification and SBA FAQ 31

This certification has been highlighted in recent days with several high-profile cases, including some well-known publicly traded companies and not-for-profit organizations with access to capital from public financing or large endowments. Several of these organizations applied for and received PPP loans, but since then, have returned the funds or declined to accept the loans. Shortly after reports of these entities receiving PPP loans, public comments followed from Treasury and SBA officials, as well as additional guidance specifically on this certification.

The SBA and Treasury Department have issued various forms of guidance on the PPP loan since its enactment as part of the CARES Act. One such guidance is an FAQ issued by the SBA with updates on a variety of PPP provisions. Question 31 in this FAQ was issued on April 23, 2020 and provided the following:

Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, 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. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.

Lenders may rely on a borrower’s certification regarding the necessity of the loan request. 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.

The SBA’s answer to question to FAQ 31 has caused concern among many borrowers to revisit their loan application as well as question whether there was a sufficient level of uncertainty to request a PPP loan to support its ongoing operations. It is prudent given this additional guidance that a business or not-for-profit organization receiving a PPP loan should assess and document the specific circumstances that existed to substantiate this economic uncertainty or economic need. The following are some examples of what types of circumstances could have existed as borrowers consider this certification standard further:

• Every business that received a PPP loan should reevaluate their loan application considering this FAQ 31. First, what was the “current economic uncertainty” that directly impacted the business? The company needs to build its case to support what uncertainty existed as a result of the COVID-19 crisis. The management team of the business should document how its revenue changed; how its supply lines were hampered; how much its labor force was impacted; what happened or is expected to happen to its working capital, including the collectability of accounts receivable and marketability of inventory items; and any other applicable facts and circumstances including records that support these circumstances. It is important for management or ownership of the businesses to document how the uncertainty impacted their business, including as much detail as possible.
  • For example, a business owner could cite “incoming orders declined 40% with the onset of COVID-19,” and have the records to support this; or “normal suppliers were unable to deliver raw materials to us and thus finding other supply channels resulted in 30% higher costs and uneven delivery schedules.”
  • Another example could include the borrower having financial projections for the remainder of 2020 that would indicate violation of loan covenants or other contractual or lease agreements that could cause the business to consider bankruptcy or other severe decisions.
• Further, was the PPP loan “necessary to support ongoing operations of the business?” If sales or profitability declined due to additional costs incurred as a result of the pandemic, but the business had more than sufficient working capital or available line of credit to weather the downturn, was it therefore necessary for the business to request the PPP loan? This can also be a factual analysis, and businesses should undertake this exercise to document how necessary the PPP loan was to the ongoing operations of the businesses. Business owners were likely unsure of the long-term impact of this pandemic on their business and their key stakeholders, and it is unclear what timeline applies to the standard of economic need or uncertainty. Best practices dictate that business owners maintain a rolling forecast of business operations for 12 – 24 months by which they monitor their operation and make management decisions. Recent developments still leave a lot of uncertainty as federal and state governments continue to update guidance on when to start to reduce restrictions that impact businesses.
  • Current examples of projected scenarios may include a business’s ability to recruit back their furloughed workforce given the rich unemployment benefits.
  • Additional examples might include the inability to obtain inventories of product to sell, due to the shutdown domestically or internationally or uncertainty around the long-term viability of key customers. Documentation of projected impact and various scenarios should be gathered and summarized now.
• FAQ 31 essentially indicates that any public company deemed to have sufficient resources should not apply for a PPP loan. However, other non-public companies should also go through the exercise of evaluating whether they can support their position that there was economic uncertainty and that it was necessary for the business to request the PPP loan to support its ongoing operations.
• If a business conducts this analysis and believes it was not necessary for it to have applied for and received a PPP loan, the loan proceeds can be repaid to the SBA (through its lending bank) and additional scrutiny by the SBA can be avoided. Repayment of the PPP loan in this case must be done by May 7, 2020. A borrower may also want to consult with his or her legal counsel in this situation, as well as the bank they obtained the PPP loan from.We have prepared a Checklist to assist borrowers in determining their economic uncertainty and documenting the need for a PPP loan to continue their ongoing operations.
• Finally, even if a business determines and documents that it feels justified in its loan application and receipt of its PPP loan, it is possible that the identity of the borrower may be made public at some point. Closely held businesses that often avoid publicity may find themselves cast into the limelight and the subject of questions from the media as a result. Even if the loan is appropriate under the circumstances, the matter can become a significant PR concern for the business.
  • The company should develop a communications plan if required to defend their receipt of the PPP loan; how this messaging will be delivered; and who will deliver it.

Additional Review for PPP Loans

The SBA and Treasury Department have decided to look closer at PPP loans of over $2,000,000. The Treasury Department announced this new procedure the week of April 27, 2020 and issued an updated FAQ on April 29, 2020. Specifically, FAQ 39 provides the following:

Question: Will SBA review individual PPP loan files?

Answer: Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. 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. Additional guidance implementing this procedure will be forthcoming.

Also note, the SBA connected FAQ 31 to FAQ 39 and the importance of the loan certification addressed above. Thus, loans over $2,000,000 in which forgiveness is requested by the borrower will be subject to a further review by the SBA and Treasury Department in part to see if the borrower was “in need.” This $2,000,000+ loan review will be addressed in upcoming guidance from the SBA. Borrowers should be aware of this additional review process.

It is unclear what the review process for PPP loans below $2,000,000 will be. Treasury officials have said that the government will perform a full audit on any company that borrowed more than $2 million, with spot checks for smaller loans.

Takeaways

Congress has poured significant effort, as well as nearly $600 billion, into this PPP loan program, which is designed to help businesses keep their employees. If enough of the PPP loan is used for payroll and other required costs, the PPP loan can be forgiven. Nonetheless, businesses need to monitor the ever-changing landscape for the latest SBA rules. We recommend reviewing and documenting support for the loan certifications that were attested to and seeking the advice of counsel where appropriate. We also recommend preparing messages and a communications strategy in the event reporters ask about the loan.

Please contact your Sikich advisor with any questions you have.