Late on Tuesday, May 5, 2020, the US Treasury Department extended the deadline for a safe harbor repayment of PPP loan funding from May 7 to May 14 and promised additional guidance on how the Small Business Administration will review the good-faith “necessity” certification prior to that time.
We will summarize here the current guidance (or lack thereof) on the CARES Act’s certification requirement that PPP funds are necessary and what businesses should consider in deciding whether or not to return funds. Unfortunately, recent comments from political leaders, government officials, and media personalities have left recipients of PPP loan funds confused and concerned about eligibility requirements and the appropriateness of their receipt of funds.
The CARES Act specifically states that an eligible recipient shall make a good-faith certification “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.” Businesses make this certification in their application for the loan. The CARES Act also specifically waives the traditional requirement for SBA 7(a) loans that a borrower be unable to obtain credit elsewhere, which should inform what “necessary” means in this context. In contrast to the Economic Injury Disaster Loan program, the CARES Act does not require borrowers to demonstrate a direct financial impact from COVID-19, focusing instead on economic uncertainty.
Based upon the above text, as well as initial comments from Congressional leaders, many businesses rightly assumed that if the business was otherwise eligible, and if the business could demonstrate significant economic uncertainty that could impact its ability to support operations, then based on the plain text of the CARES Act, the business could make this certification.
However, when the program quickly exhausted allocated funding and many small businesses were left out, a public outcry began. Companies such as Shake Shack found themselves in the crosshairs of the traditional media and a social media smear campaign. Criticism regarding entities that were not the “intended” beneficiaries of the CARES Act is difficult to reconcile with the clear language of the legislation.
The PPP is a SBA 7(a) lending program, which has been traditionally limited to “small business concerns,” defined by SBA regulations that establish size standards based on revenues (confusingly for this purpose, revenues include gross revenue plus costs of good sold) or headcount for each industry using NAICS codes. In the CARES Act, presumably to broaden the scope of relief for American workers, Congress deliberately expanded the scope of eligible borrowers beyond the traditional “small business concerns” by extending eligibility to any business, nonprofit organization, or certain tribal or veterans’ organizations with 500 or less employees. Taking a large step even beyond that initial expansion of eligibility, Congress created very specific eligibility rules for franchises and for businesses classified under NAICS Code 72, including hard-hit restaurants and hotels. The sole purpose of those specific eligibility rules was to allow certain businesses with more than 500 employees to qualify by measuring employees on a location-by-location basis. Thus, the suggestion that large restaurant chains were not intended to benefit from the program is quite difficult to reconcile with the law itself.
The criticism was further difficult to reconcile with the clear aim of the program to protect workers. The CARES Act and subsequent administrative guidance ensure that the use of PPP loan proceeds and forgiveness are tied overwhelmingly to payroll costs, and no payroll in excess of $100,000 per year for any individual employee is included. Despite those built-in restrictions, critics seemed to prefer aiding employees who work for small employers rather than larger employers. Particularly for low-income employees of larger companies, whom the CARES Act very specifically targeted for relief, it must be difficult to make sense of the outcry.
Treasury Secretary Mnuchin has stated publicly that the program was not intended to benefit companies with access to public markets, an ability to access other credit, and adequate reserves of cash on hand. Businesses were warned of audits and potential criminal liability, and initially given until May 7 (extended to May 14) to return PPP funds without penalty. In addition, all businesses receiving over $2 million in PPP loan funding have been advised that their loans will be reviewed.
After Secretary Mnuchin’s statements, the Treasury Department updated its FAQs to include the following:
A business’s liquidity is a particular concern as many companies have cash reserves. While we do not necessarily agree with the Treasury Department’s approach, Treasury’s comments suggest that they would be more likely to challenge the necessity certification for companies with ready access to cash, whether cash on hand or through the ability to raise funds in the capital market. On the other hand, even under Treasury’s approach, if the use of cash or other sources of capital would have a significantly detrimental effect on the business, then the good-faith certification is still appropriate.
The CARES Act certainly could have been clearer in defining “necessary.” The lack of clarity on that term in the CARES Act is the key source of the considerable uncertainty that has led many struggling businesses to consider repaying PPP funds and reducing their headcount and/or wages in order to avoid government scrutiny, which most observers would identify as counter to the underlying purpose of the CARES Act. Congress could have defined “necessary” to mean “my business will go into bankruptcy or be forced into liquidation without a PPP loan,” but Congress very clearly did not intend for that standard to apply. Absent that standard, it is difficult if not impossible to articulate a fair, objective standard by which businesses should be judged.
In order to determine whether to return the funds, businesses should consider the following:
Real and potential impact on the Company’s financial position due to current economic uncertainty in the absence of PPP funds;
The Company’s cash on hand and ability to use that cash on hand without a negative impact; and
The Company’s access to public markets and other lines of credit.
If a company decides to keep the funding, we recommend that the company prepare a detailed file containing the following:
Projected or actual use of the loan funds;
Financial projections based on alternative economic scenarios that model finances, headcount, and wages without the PPP funding and with the PPP funding;
Layoffs/wage reductions specifically eliminated or deferred due to PPP funding;
If other sources of liquidity are available, the current and future detrimental impact that use of such funding sources would impose on the business;
The company might evaluate its prior history or its industry’s prior history from the 2008/2009 financial crisis, keeping in mind that one leading US investment bank speculated that the short-term impact of this crisis will be four times worse than the 2008/2009 financial crisis; and
Press coverage of businesses in the same industry that are laying off workers, closing operations, and reducing compensation.
As of the date of this writing, Treasury had most recently updated its FAQs in the late afternoon of Tuesday, May 5, with the addition of FAQ #43, copied above. Borrowers with concerns over the certification requirement should pay close attention to forthcoming guidance, particularly the promised guidance on how the SBA will evaluate the good-faith certification process.
Please contact Will or your HSB attorney with any questions or comments.
For additional resources on COVID-19, please access HSB’s resource page.