Guidance for Borrowers Who Opt
Not to Return Their PPP Loans by the
May 14 Safe Harbor Deadline

Under the Small Business Administration’s (SBA) recently implemented safe harbor, borrowers who applied for their Paycheck Protection Program (PPP) loans before April 24 must now decide by May 14, 2020, whether to keep or return the funds. In our prior alerts issued in connection with the financial assistance programs available under the CARES Act (COVID-19 Legal Resource Guide), we have discussed PPP loan eligibility criteria in general, including the revised guidance — summarized again here — on what “necessity” means for purposes of the PPP. The primary purpose of this alert is to provide particular guidance to pre-April 24 borrowers who choose not to seek safe harbor protection and elect to retain their loans.

Background: The Good Faith Certification of "Necessity"

The SBA’s first interim final rule issued on April 2, 2020 — restating language from the CARES Act — required loan applicants to certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant.” Neither the Act nor the interim final rule defined “necessary.” Over the next few weeks, PPP loan applications flooded in and the initial round of PPP funding was quickly exhausted. The spotlight focused on large high-profile companies — such as Shake Shack Inc., Potbelly Corporation and Ruth’s Chris Hospitality Group — that sought and obtained loans but seemingly did not need them to be able to continue operating. On April 22, 2020, Treasury Secretary Steven Mnuchin threatened “severe consequences” for borrowers who obtain PPP loans based on a misunderstanding of the necessity certification.

On April 23, 2020, to address this issue, the SBA issued FAQ 31. The question was: “Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” The answer, in relevant part, states:

[B]efore submitting a PPP application, all borrowers should review carefully the required certification that ‘[c]urrent 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.

FAQ 31 also provided that “[a]ny 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.” This safe harbor was implemented through a new interim final rule issued on April 24, 2020.

In public remarks on April 28, 2020, Secretary Mnuchin offered additional guidance on what “necessity” means. He explained, among other things: “This was a program designed for small businesses, it was not a program that was designed for public companies that had liquidity,” and “the certification was very clear in saying that if people had other sources of liquidity, they could not take this loan.” He said that borrowers “have criminal liability if they made this certification and it’s not true.” He also announced that “we’re going to do a full audit of every loan over $2 million.” That announcement was implemented through FAQ 39, issued the next day, which indicates that smaller loans may also be subject to audits. FAQ 39 states, in relevant part, that the SBA “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.”

On May 5, 2020, the SBA extended the safe harbor deadline from May 7, 2020, to May 14, 2020. Against this backdrop, all companies that received PPP loans before April 24 must now decide whether to keep the money or return it. Determining whether any given borrower meets the “necessity” requirement — and predicting the public relations fallout that may ensue even if the loan was technically “necessary” — are highly fact-specific questions, not amenable to one-size-fits-all guidance. But for those pre-April 24 borrowers who do determine that they need and will retain their loans, we offer the following advice, which is equally applicable to all.

Guidance for Pre-April 24 Borrowers Who Choose to Retain Their Loans

First, it is critical to memorialize in writing — now, not down the road — why your company meets the “necessity” requirement, as it was clarified in FAQ 31 and Secretary Mnuchin’s April 28 public remarks. Borrowers who submit false certifications may be subject to criminal prosecution and/or civil enforcement under the False Claims Act. To avoid or defend against such claims, a borrower would have to demonstrate (among other things) that its certification of necessity was made in “good faith,” based on circumstances existing at the time it applied for the loan. The government is likely to be skeptical about written backup that companies create after the fact, when forced to justify earlier decisions. Contemporaneous documentation of need will be far more persuasive evidence that a borrower acted in good faith. Moreover, because borrowers will be exposed to potential civil and criminal claims for up to a decade, not only might it look suspicious to create written backup years down the road; with the passage of time, it may become difficult if not impossible to reconstruct an accurate historical account at all.

In documenting good faith need, a PPP borrower should address, at minimum, the following categories:

• The borrower’s current financial condition
• Current forecasts and projections, both with and without the loan
• Why the funds are needed to support the borrower’s ongoing operations, and what specifically the funds would be used for
• How much cash and liquidity the borrower currently has on hand
• Whether the borrower has access to other sources of capital
• Whether and why it would be “significantly detrimental” to the borrower’s business to access other sources of capital

It would also be advisable to convene a board meeting to discuss, with members of senior management, whether to keep or return the loan, and to memorialize that discussion and decision in writing.

For all borrowers, including pre-April 24 applicants who intend to keep their loans and companies that applied for PPP loans after the guidance changed, it is critical to document why they meet the modified eligibility criteria. Those who applied prior to April 24 may be doing this for the first time. But even those borrowers who applied after April 24 and may already have gone through this exercise would be well advised to revisit their written backup and expand and update it as appropriate, to demonstrate that the company still has a good faith need for the funds as of the extended safe harbor date.

Taking the time to carefully document “necessity” will serve one of two equally important ends. For companies that choose to retain their loans, it will help them establish a good faith defense to any future civil or criminal claims. Alternatively, engaging in this exercise may lead to the conclusion that a company cannot in good faith demonstrate necessity, and should therefore return its loan.

Second, going forward, borrowers who choose not to return their loans should segregate the loan funds and retain meticulous records of how those funds are used. If a company cannot readily demonstrate that the loan was used for permissible purposes, it may have difficulty obtaining loan forgiveness — and may face criminal and/or civil liability for failing to comply with the statute. On the back end of the immediate crisis, borrowers who thrive may face the most scrutiny. Those companies may be put to the test of proving that the PPP loan is what enabled them to succeed and prosper. For all borrowers, but those in particular, accurate record-keeping of how the loan funds were used may prove critical.

Third, borrowers who choose not to return their loans should take into account the possibility that they may face a criminal or civil government investigation, or at minimum, an audit. Under any of these scenarios, the company will become an open book. Emails and documents from this time period, even if created for other purposes, may become discoverable. Accordingly, when deciding whether to keep or return the loan, all borrowers would be well advised to consider whether they have emails or other documents that could be construed, by a prosecutor or auditor, as inconsistent with their good faith certification of necessity.