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INSIGHT: New SBA Safe Harbor Leaves ‘Necessity’ Ambiguity in PPP Loans

May 15, 2020, 8:01 AM

Mixed messages about the meaning of “necessity” and saber rattling about enforcement against companies applying for loans under the Paycheck Protection Program (PPP) have led to considerable uncertainty and corporate stress.

On May 1 we wrote about the challenges of navigating the Small Business Administration guidance and the potential hazards associated with PPP loan certifications, including the risk of audits, civil False Claims Act penalties and criminal prosecutions. The lack of clarity and genuine anxiety about whether a company could satisfactorily defend its economic need for PPP loan funds caused many to return the money rather than face uncertain government audits and investigations later.

From the perspective of struggling businesses that we have spoken with during the last two weeks, both the spirit and letter of the CARES Act were being undermined by the changing and uncertain PPP landscape. Companies now have new guidance, a new safe harbor, and a new deadline of May 18 to consider.

A $2 Million ‘Good Faith’ Umbrella

Undoubtedly aware of the government-induced confusion, and perhaps attempting to calm the waters of the PPP loan program, the SBA issued more new guidance on May 13 granting a broad-based “safe harbor” for any borrower (together with its affiliates) that received less than $2 million in PPP loan funds.

Anyone fortunate enough to have the SBA’s loan formula result in a loan that falls under this bright-line cut-off will be “deemed to have made the required certification concerning the necessity of the loan request in good faith.”

It never appeared feasible for the government to realistically audit all PPP loans, and in explaining this new presumed “good faith” threshold, the SBA recognized that it needed to conserve limited audit resources for larger loans.

Fair or not, the $2 million SBA safe harbor appears to create a wide umbrella that substantially reduces (but does not eliminate) the risk that adverse consequences will rain down and soak companies with loans in this category.
This umbrella appears to apply not only for past certifications, but for those made in new PPP loan applications as well.

Necessity Remains Elusive and Risks Linger

Despite the significant import and impact of the new safe harbor, the SBA has still not defined “necessity” or what factors are relevant in making such a business determination in these uncertain times—much less what formula companies should apply in evaluating whether they have access to suitable alternative sources of liquidity.

Similarly, the new SBA FAQ did not explain what it means for a company to “be deemed” to have made the necessity certification in good faith. While such a statement appears to make it much less likely that the SBA will conduct an audit or seek an enforcement action later, it remains an open question whether a certification “deemed” to be in good faith will operate like a legal presumption that can be overcome in the face of contrary evidence.

It must be remembered that the new FAQ is not an agency regulation and does not have the force of law. Moreover, in the absence of further guidance regarding the definition of “necessity” the court of public opinion is free to apply its own definition and make its own judgment about whether any individual company fairly applied the standard of need.

Likewise, other agencies, branches of government and private parties remain free to fill the “necessity” void with their own interpretation or analysis. The SBA’s action does not bar qui tam lawsuits or private litigation.

Some Solace for Larger Loans

The $2 million safe harbor may be cold comfort for borrowers whose past payroll calculations resulted in loan amounts even one dollar over the threshold, but the new FAQ provided some solace for these larger borrowers as well.

Companies (which includes all affiliates) that have loans greater than $2 million will have the opportunity to repay these loans in full if the SBA subsequently determines that they “lacked an adequate basis for the required certification concerning the necessity of the loan request.”

This again seems like welcome news in terms of decreasing the risk of SBA enforcement or future criminal prosecution but stops short of providing any type of immunity from future legal consequences. It also leaves continued uncertainty about how the SBA will determine eligibility for forgiveness of these larger loans.

The SBA promises that it will not pursue administrative enforcement or referrals to other agencies, but this portion of the guidance suffers from the same lack of definition regarding “necessity” that could lead to uncertainly later (and, in any event, public policy debates about the wisdom of offering such de facto protections/reassurances to both the ethical and potentially criminal applicant are, perhaps for good reason, inevitable).

The risk for these larger borrowers goes beyond the possibility that they may not qualify for loan forgiveness and expands into category of False Claims Act litigation and other actions if certifications are viewed as false or fraudulent. Borrowers must therefore exercise their own judgment about how the SBA or others may choose to evaluate its necessity for the loan.

Pro Tip—Due Diligence is Still Warranted

Regardless of your interpretation, and tolerance for risk, the bottom line is that every company will continue to benefit from conducting a PPP necessity analysis using factors that reasonably support its necessity certification.

The PPP compliance steps we previously outlined still apply, with an emphasis on documenting projected and actual Covid-19 impacts on revenues, cash flows, alternative loans and lines of credit, availability and restrictions on other sources of liquidity, and a common sense understanding that the PPP loans are directed at keeping people on the payroll, avoiding layoffs, and helping to keep the rent paid and utilities paid in the face of the most immediate pandemic impacts.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Kevin Feldis is a parter at Perkins Coie with a global practice responding to government enforcement actions, conducting internal investigations, managing crisis response, litigating business disputes and white collar cases, and counseling on a variety of corporate compliance issues. He served as a federal prosecutor for 18 years prior to joining the firm.

T. Markus Funk is a partner at Perkins Coie and the firmwide chair of the White Collar & Investigations Practice and co-chair of the supply Chain Compliance Practice. A former federal prosecutor, he focuses on internal investigations, complex commercial litigation both at the trial and appellate levels, white collar criminal defense, corporate social responsibility and supply chain compliance, and corporate counseling.

David Fletcher is a partner at Perkins Coie with a broad government contracts practice advising clients ranging from startups to established public companies on the contractual and regulatory requirements applicable to government business. He also represents clients in bid protests and contract disputes.

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