COVID-19 Legal Update: Risk of Investigation of PPP Loan Program Participants

Published May 2, 2020. Updated May 14.

Many businesses have been and are still struggling with the decision of whether to apply for a Paycheck Protection Program (PPP) loan and whether or not to return that loan by Monday, May 18[1]. This is because ongoing federal guidance has affected the substantive requirements for loan eligibility and includes a tangle of warnings and safe harbors related to whether borrowers certified in good faith that current economic uncertainty made the loan necessary – with one safe harbor calling for repayment of the loan in full by May 18. In deciding how to navigate this unusual and evolving situation, businesses applying for a PPP loan or deciding whether to return one should carefully examine their legal risk and take steps to minimize that risk.

With that in mind, we are providing legal updates and practical guidance to help businesses understand and manage the risk of investigation and liability from PPP loans. We plan to update this information as needed to respond to the evolving situation. 

Bottom Line: Practical Guidance

While businesses may need to move quickly to take advantage of PPP loans, they should not do so at the expense of careful diligence in submitting their loan application and adhering to the requirements of the program. Moreover, businesses that have previously received a PPP loan should update their analysis to take into account newly issued FAQs and should make a renewed determination of their need for the loan based on the latest guidance. This should include an analysis of:

• The prevailing guidance from the Small Business Administration and U.S. Treasury even if issued after the date of application.
• The eligibility of the company under PPP-specific size guidelines.
• The eligibility of the company under PPP-specific need requirements.
• The reputational risk to the company if the PPP loan or amount is publicly disclosed.
• The ability of the business to comply with PPP loan requirements going forward.
• The legal risks associated with participation in the PPP loan program.

In particular, with regard to eligibility under PPP-specific need requirements (particularly for loans above $2 million), businesses should take into account:

• The current business activity of the company including the ability to meet payroll and other obligations;
• The current impact of COVID-19 on the business; and
• The company’s access to other liquidity sources, including lines of credit, affiliated companies, capital markets, etc., in amounts sufficient to support ongoing operations in a matter that is not significantly detrimental to the business.

Businesses should document the facts supporting their eligibility for the PPP loan, as well as their careful consideration of each of the eligibility factors, to have a written record of the basis for the decisions to apply for (and to keep if already approved) the PPP loan. This should be based on the current activity of the business and not general concern about “what if things get worse in the future.”

Businesses should also exercise special care when collecting and verifying information that will be used to determine eligibility and apply for a PPP loan; when monitoring and documenting compliance with the program’s requirements; when sharing sensitive information relevant to the PPP loan over email; and when communicating with employees about any information relevant to PPP loan eligibility and compliance.

Ongoing Legal Developments

In response to media reports of abuse in the original round of PPP loan funding, on April 23, the SBA and Treasury issued FAQ #31 entitled, “Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” This FAQ response emphasizes that a business submitting a PPP loan application “must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application.” The FAQ cautions that “all borrowers should review carefully the loan certification that ‘[current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant],’” and warns that “[b]orrowers 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.”

FAQ #31 then explains, by way of example, that “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.” On April 28, the SBA and Treasury issued additional guidance clarifying that FAQ #31 applies similarly to privately held companies.[2]

Finally, the SBA then announced a safe harbor in the final sentence of FAQ #31: “Any borrower that applied for a PPP loan prior to the issuance of this guidance [April 23, 2020] 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 deadline was extended by FAQ #43 to May 14. On May 14, the deadline was extended again to May 18 by FAQ #47. By announcing this safe harbor, the SBA encouraged all borrowers to reevaluate their original application under the new standards of FAQ #31.

On April 28, the SBA and Treasury issued a joint statement announcing a special audit for all PPP loans over $2 million and certain other loans less than that amount: “To further ensure PPP loans are limited to eligible borrowers, the SBA has decided, in consultation with the Department of the Treasury, that it 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. Regulatory guidance implementing this procedure will be forthcoming.” This announcement was documented as FAQ #39 the following day.

On May 13, the final day before the safe harbor had been set to expire, the SBA provided more guidance on these issues in FAQ #46 entitled, “How will SBA review borrowers’ required good-faith certification concerning the necessity of their loan request?” The SBA expanded the safe harbor dramatically to include all PPP loans under $2 million: “Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.”

As for PPP loans of greater than $2 million, FAQ #46 reiterates that all of these large loans, and smaller loans “as appropriate,” will be subject to review by the SBA for “compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form.” With regard to the borrower’s certification of the loan’s necessity, FAQ #46 sets forth a standard of review and a procedure for borrowers who fail the SBA’s audit. The guidance states that “[i]f SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness.” FAQ #46 then provides another type of relief, stating that “[i]f the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request.”

This latest guidance in FAQ #46 contains a number of surprises and leaves plenty of questions unanswered. Borrowers of PPP loans of less than $2 million might now rethink their decision to repay their loan by the May 18 deadline – perhaps with the effect of punishing those who repaid promptly. Furthermore, it is unclear how FAQ #46 might apply to future PPP loans, creating an incentive for businesses to apply for PPP loans of less than $2 million in an effort to avoid the SBA’s automatic audit.

Conversely, borrowers who received PPP loans of more than $2 million might now reassess the importance of repayment by the May 18 deadline to avoid legal risk related to their certification of necessity. Although by skipping this deadline they would forgo FAQ #31’s safe harbor of being “deemed by SBA to have made the required certification in good faith,” such borrowers would still get the benefit of the SBA agreeing in FAQ #46 that it “will not pursue administrative enforcement or referrals to other agencies” based on this issue if they wait to repay their loan until after the SBA’s audit. Indeed, it remains to be seen if those two outcomes would be any different in practice.

Another important question is how, if at all, the various safe harbors promised by the SBA and Treasury would influence the enforcement activity of agencies such as the Department of Justice (DOJ) and of whistleblower plaintiffs. As discussed below, allegations of improper PPP loans could lead to civil and criminal liability risk well beyond the realm of administrative enforcement by the SBA. For instance, although a PPP loan recipient of less than $2 million is now “deemed by SBA to have made the required certification [of necessity] in good faith,” the DOJ could take a different view in the face of evidence to the contrary. Thus, regardless of the amount of the PPP loan, a business should still exercise careful diligence in submitting its loan application – including the certification of necessity – and in adhering to the requirements of the program.

The SBA and Treasury FAQs are updated frequently and can be found here. Moreover, additional rules regarding eligibility and loan forgiveness are expected and would be published here.

Liability Risks

In the face of the ominous warnings by the SBA and Treasury, as well as the commencement of DOJ inquiries, it is important for businesses applying for a PPP loan or deciding about the repayment of their loan to understand the scope and nature of the legal risk when considering how to proceed. This may include both civil and criminal liability under statutes designed to punish fraud and abuse. Even businesses that ultimately repay their PPP loan in full rather than requesting forgiveness of the loan could face investigation and potential civil and criminal liability based on their application and whether they adhered to the program’s requirements – setting aside safe harbors related to enforcement initiated by the SBA.

A significant legal risk associated with PPP loans is the risk of civil liability under the False Claims Act (FCA), 31 U.S.C. §§ 3729-3733. Broadly speaking, the FCA creates liability for any person who knowingly submits a false claim for money to the government, causes another to submit the false claim to the government, or makes a false record or statement to get the false claim paid by the government. If found liable, such person may be forced to pay a civil penalty of between $5,000 and $10,000 for each false claim plus three times the amount of the government’s damages – in this context, three times the amount of the loan.

The risk of civil liability under the FCA is important for a number of reasons. First, in this context, the term “knowingly” includes not only actual knowledge of a falsehood but also “act[ing] in reckless disregard of the truth or falsity of the information.” Thus, a business’s inattention in the loan application or disregard of loan requirements could lead to serious legal risk down the road.

Second, even if federal enforcement authorities did not investigate a business, the FCA contains special provisions that enable a private individual to initiate a qui tam action against the business for an alleged FCA violation and then share in the damages awarded to the government if the business is ultimately found liable. U.S. Department of Justice statistics show that, as of 2019, more than 70% of all FCA actions were initiated by private individuals acting as whistleblowers. Given the focus of the PPP to support employees during the COVID-19 pandemic, it is easy to imagine how a dissatisfied employee observing imperfect business conduct in securing a PPP loan or applying loan proceeds could use that insider information to bring a qui tam action under the FCA.

Criminal liability is also another notable risk. The PPP loan application requires borrowers to make a variety of written certifications that plainly contemplate future criminal investigation and legal action for abuse of the program. This would include not only the signatory on the loan application but also anyone who aided and abetted or conspired in making the false statement. FAQ #31 explains how such a false statement could be the certification of the PPP loan request being “necessary.” However, businesses and individuals may also be investigated and held liable for a false certification of eligibility to receive the PPP loan, a false certification of how the funds will be used, or for any other false information provided in the application or supporting documents. These actions can be brought under several different criminal statutes that provide for various monetary penalties and, in some instances, incarceration.

Prosecutions arising out of the Troubled Asset Relief Program (TARP) from the 2008 financial crisis suggest that borrowers of emergency funding are likely to undergo intense scrutiny by federal investigators looking to identify any type of fraud and abuse. Even if a business was able to successfully defend such allegations, taking actions that invite a federal fraud investigation will cause the business to incur significant costs and reputational damage.

Reputational Risks

At this time, it is not certain, but seems likely, that the names of businesses receiving PPP loans will become public. A number of governmental officials have publicly called for this outcome. If a business is subject to legal scrutiny as described above, such investigations or litigation would mostly likely become public. For these reasons, a business should consider what reputational risk exists for it if its PPP loan becomes public. For some, this concern will be greater than for others.

[1] The original deadline of May 7, 2020, was extended by FAQ #43 to May 14, and then the deadline was extended again by FAQ #47.

[2] FAQ #37 is entitled, “Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” It reads simply, “See response to FAQ #31.”