Small Recordkeeping Missteps Risk a Paycheck Protection Probe

The Justice Department is devoting significant resources to recouping Covid-era Paycheck Protection Program payouts that were improperly obtained or forgiven. As a result, borrowers with PPP debts forgiven may end up in the crosshairs of a False Claims Act investigation, facing civil penalties up to three times the entire loan amount plus other penalties, and individuals may face possible criminal charges carrying substantial custodial sentences.

Borrowers may be surprised to learn that actual knowledge isn’t required to have “knowingly” presented false information. Merely signing documents without reading them could be sufficient.

That could put them at risk for the False Claims Act’s draconian civil penalty system that allows the government to seek triple damages equal to the entire loan amount plus other penalties. Individuals also may face criminal felony charges that carry up to five years’ incarceration.

In-house counsel or other legal advisers who are helping perform an internal audit or navigate a formal federal investigation should keep the following issues in mind.

‘No-Show’ Employees

While minimal exposition is needed here, stakeholders should know that the Justice Department is closely scrutinizing PPP borrowers with family members on the payroll—a common practice of small and medium-sized businesses. Where such persons weren’t actually working, False Claims Act liability can attach.

FTE Calculations

To demonstrate threshold amounts were spent on appropriate payroll expenses during a covered period (usually at least 60%), the forgiveness application required proof through an accompanying Schedule A, which contained employee identifiers, compensation, and employees’ average full-time equivalent calculations.

Based on a 40-hour work week, an individual’s FTE total couldn’t exceed 1.0 for a covered period across all borrowers seeking forgiveness. For example, someone working 20 hours a week would have an FTE calculation of 0.5; an individual working 60 hours per week across three borrowers is capped at 1.0 total.

Incorrect FTE calculations can be fertile ground from which an False Claims Act investigation may spring.

Affiliation Rules

Given that entrepreneurs often have multiple ventures, common ownership or decision-making authority presents another issue under the PPP affiliate rules.

The Treasury Department has noted that “the power to control” is what matters most. The Treasury will look at the following variables, which labor and employment practitioners may recognize overlap with the “single entity” test.

• Does any person or entity own or have power to control more than 50% of the company’s voting equity?
• Can a minority shareholder prevent a quorum or otherwise block action by the board of directors or shareholders?
• Who is the ultimate decision-maker? Is it the same party for multiple borrowers?
• Are multiple borrowers controlled by close relatives?
• Was a corporate merger completed or in progress?
• Does the business have non-US affiliates?

Control matters for two reasons. Affiliated borrowers, when aggregated, may find themselves exceeding the PPP program’s threshold eligibility requirements and thus liable for misstating the nature or size of their businesses—all bases for False Claims Act liability.

Second, the False Claims Act doesn’t limit liability to just the entity level, so determining control persons is necessary to determine who may be held individually liable, which the government may seek to impose.

There are limited exemptions to the affiliate rules. The rules are waived for businesses assigned a North American Industry Classification System code beginning with 72—typically restaurant and hospitality businesses, small business investment companies, and franchises assigned a Small Business Association franchise identifier code—and faith-based organizations are exempted.

Savvy practitioners must ascertain the full breadth of a client’s business to analyze whether the affiliate rules have been violated.

Employee Compensation Caps

Issues can arise for borrowers with overlapping employees or with employees who typically receive substantial overtime pay.

An individual’s compensation for payroll cost calculations is capped at $46,154 for a particular covered period, including overtime. The figure represents the prorated gross pay (including wages, tips, bonuses) over a 24-week period at a $100,000 maximum salary for a 52-week period.

For example, if an employee works for multiple related borrowers (such as a business with multiple locations), that employee’s total compensation is capped across all borrowers claiming that employee at $46,154 for a particular covered period.

Borrowers who obtained forgiveness for amounts paid exceeding the caps may face False Claims Act liability.

Employee-Owner Caps

Like the affiliate rules, a non-obvious issue that could trip up participants concerns amounts received by employee-owners owning more than 5% of a borrower.

While an employee’s compensation was capped at $46,154 for any discrete covered period, owner-employees and self-employed individuals’ payroll compensation was capped far lower—either two-and-a-half months’ worth of 2019 compensation, or $20,833, whichever is less, in total across all borrowers.

Since the rules were intended to thwart windfalls for employee-owners, borrowers consisting of family-owned businesses with overlapping ownership may be particularly susceptible. Practitioners should pay special attention to amounts paid to all employee-owners.

Given the False Claims Act’s permissive scienter standard, coupled with the verifications submitted as part of every forgiveness application, even well-meaning borrowers may find themselves in the Justice Department’s sights for seemingly arcane issues defying business realities.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jeffrey Hoffman is counsel at Windels Marx Lane & Mittendorf focused on white collar defense and investigations.

Gabriel Altman is an associate at Windels Marx Lane & Mittendorf focused on white collar defense and investigations, and litigation and dispute resolution.

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