As we previously wrote, the Paycheck Protection Program (“PPP”) is intended to be a lifeline for small businesses suffering during the coronavirus crisis. The focus of that article was to highlight the need for proper underwriting to address possible fraud. This entry builds upon the prior writing and addresses the Treasury Department’s latest effort to curb fraud and abuse of the PPP system. The Treasury Department intends to audit all PPP loans exceeding $2 million to ensure the applicant is appropriate for a PPP loan. The prospect of mass borrower audits merits attention from all lenders participating in the PPP loan program.
As previously noted, the PPP initiative was rolled out so rapidly that lenders were left with substantial questions as to proper underwriting and avoiding liability for failure to do so. [Click Here for Related Article]. Since that time, it came to light that many large companies with questionable need took out massive PPP loans. Examples abound. Ruth’s Chris Hospitality group, which owns Ruth’s Chris Steak House took out a $20 million PPP loan. Shake Shack received a $10 million PPP Loan. AutoNation, Inc. a network of car dealership received $77 million in PPP funds. Even the Los Angeles Lakers entered the fray by taking a PPP loan of $4.6 million. Facing mounting scrutiny and a public outcry, many of these organizations are now rushing to return PPP funds.
In a move to curb what appears to be rampant abuse, on April 28, 2020, the Treasury Department announced a stringent new control mechanism: an audit of all PPP loans over $2 million. Speaking to the media, Treasury Secretary Steven Mnuchin stated “this was a program designed for small businesses” rather than companies with liquidity. With respect to lenders, some banks have faced criticism that their administration of the PPP has favored large existing bank clients to the exclusion of smaller businesses. At the center of the issue is the requirement that applicants certify that the PPP loan necessary to support ongoing operations.
Following Secretary Mnuchin’s statement, the Treasury Department announced that “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,” and explained “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.”
In accordance with statements from the Treasury Department, the SBA updated its PPP FAQ’s on April 28, 2020 to make it clear that its recent guidance concerning borrower eligibility and the required good faith certification by a borrower in the PPP application concerning the need for the loan. Further, alternative sources of liquidity such as credit lines or cash reserves should be considered when certifications are made.
Based on the foregoing, recipients of PPP loans exceeding $2 million should expect an audit by the SBA to confirm, among other things, the veracity of their certification that the PPP loan is necessary to continue operations. At best, businesses that fail the audit will not receive PPP loan forgiveness. At worst, such businesses may face criminal liability for false certifications. Furthermore, the false certification an create recourse liability on the loan from key participants. Regarding this, the SBA has stated that it is giving “Safe Harbor for applicants that may no longer think they qualify, stating that “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.”
Fortunately, lenders may still rely upon applicant’s certifications regarding the necessity of a PPP loan and supporting documentation. Lenders, however, should recognize that a SBA audit of an applicant’s eligibility will necessarily brush up against information provided to the lender and the lender processing the loan. For this reason, it is vital that lenders adhere to the guidance from the SBA regarding documentation and certifications for determining eligibility. During processing, lenders should receive payroll processor records, payroll tax filings, Form 1099-MISC for independent contractor applicants, or records of income and expenses from a sole proprietorship applicant. In the absence of such documentation, lenders may rely on other supporting documentation, such as bank records, that are sufficient to demonstrate the qualifying payroll amount.
Crucially, even though lenders are only required to perform minimal review, a lender should not blindly rely upon an applicant’s information because there is an obligation perform the review in good faith. All certifications should be in order, documentation should be received, calculations should be reviewed, and any errors or inconsistencies should be addressed with the applicant. If the lender has an eligibility concern, it should be examined.
We advise all of our lending clients to remain abreast of current guidance and adhere to prudence with the expectation that PPP Loans over $2 million will be examined by the SBA. Further, as the situation is fluid, lenders should consider that Treasury may further increase audit triggers in the future.