SBA Guidance on PPP Audits, Disbursement Option Period, E-Tran Glitches

On Tuesday, SBA and Treasury issued their 37thFAQsixth IFR, and a joint press release.  Before going into what those do say, it is worth noting what they do *not* address:  forgiveness. The politicized sound and fury surrounding several hundred public-company borrowers seems to have unfortunately distracted Treasury and SBA from providing desperately-needed forgiveness guidance to more than 1.5 million qualified PPP borrowers.  We are fielding an increasing volume of questions from frustrated PPP borrowers, many of whom are now one quarter of the way through their 8-week forgiveness period and who are left guessing at basic, fundamental questions such as whether they can pay employees bonuses and whether forgiveness expenses are calculated on a cash or accrual (or other?) basis.  We hope to see such guidances soon and will provide updates when we get it.

Turning to the substance of what was issued:

  • FAQ (#37) reads in its entirety: “37. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan? Answer: See response to FAQ #31.”
    • FAQ #31 is the one cited below that purports to create a new eligibility standard by noting for example that it is “unlikely” that “a public company … access to capital markets” would be able to make the required eligibility certification. Thus FAQ #37 clarifies, lest anyone have any doubt, that the reference to the example of public companies in FAQ 31 was, yes, literally just an example and that the same logic applies to private companies.
    • This includes portfolio companies of PE, VC and other private investment funds, which we had already noted under IFR 4. Thus, this should likely be seen as another warning shot to portfolio companies owned by investment funds and other well-capitalized stockholders.
  • The joint statement commits to writing the comments made by Secretary Mnuchin on CNBC, but makes it clear that SBA may also review loans under $2M “as appropriate”:

“To further ensure PPP loans are limited to eligible borrowers, the SBA has decided, in consultation with the Department of the Treasury, that it willreview 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.” (Emphasis added. We will be on the lookout for the additional guidance.)

  • The IFR on Disbursements (aka IFR 6) (SIX!!) addresses some questions on disbursements in a way that creates some extended option value for borrowers and helpfully clears up a couple ambiguities.
    • IFR 6 prohibits lenders from making multiple disbursements of a borrower’s PPP loan and instead requires the full amount to be disbursed in a lump sum within 10calendar days after the lender receives the SBA loan number. In a footnote, SBA clarifies that if the 10th day is not a business day, the period is extended to the next business day
    • IFR 6 also says that “lenders are not responsible for delays in disbursement attributable to aborrower’s failure to timely provide required loan documentation, including a signed promissory note. Loans for which funds have not been disbursed because a borrower has not submitted required loan documentation within 20 calendar days of loan approval shall be cancelled by the lender …”
    • This means that applicants who been approved for a loan but have not yet delivered the final signed note and loan document now essentially have a20-calendar-day option window in which to decide whether to accept the loan by delivering such documents, or to reject the loan due to eligibility or other concerns. Such applicants can also use such window to delay their loan disbursement and thus the start of their 8-week forgiveness period in order to align such period with expected timing of expenses or otherwise. Note that for some applicants, such 20-day window may extend beyond May 7, perhaps giving them a little more time to make their final decision about whether to accept the PPP loan.
    • Interestingly, IFR 6 provides that a lender will not receive a processing fee for loans that are cancelled before disbursement or that are “cancelled or voluntarily terminated and repaid after disbursement (including if a borrower repays the PPP loan proceeds to conform to the borrower’s certification regarding the necessity of the PPP loan request).”
      • Read literally, this would mean that lenders don’t get a fee on any loan that is repaid rather than forgiven. It seems exceedingly unlikely that Treasury/SBA actually mean this. I assume that they instead were trying to cover only disbursed loans that are repaid during the safe harbor window through May 7.
      • The IFR also requires lenders to report any such cancellation (before or after disbursement) to SBA. While it does not say so expressly, the lack of the fee on such a loan and SBA’s requirement that such cancelled loans be reported seem to imply that SBA does intend to recyclesuch loan amounts and make them available to other borrowers.

This additional option period comes at a useful time.  Just as many borrowers are debating whether to repay their loans prior to May 7, many, PPP applicants are having significant second thoughts about whether to accept PPP loans due to concerns about political fallout and the risk of their eligibility being second guessed in 20-20 hindsight.  The venture-backed online media company Axios announced that it was returning its $5M PPP loan, publishing a thoughtful analysis that describes the dilemma facing many companies who believed they were doing the “right and prudent thing” by applying for a loan but now face a “politically polarized” “public debate about the worthiness of specific industries or companies.” 

The Axios post succinctly describes what we have seen in our PPP work with many portfolio companies and their investors. In late March and early April as PPP was just coming online, those companies and investors were aggressively pursuing application strategies and calculations, especially in the early days when people assumed that an affiliation fix was coming. After it became clear that SBA was not going to change to the affiliation rules, the community spent the next 2-3 weeks on the “Great De-affiliation Race,” working to quickly modify investment structures by having investors “irrevocably waive” control rights with the goal of rendering companies eligible for a PPP loan before the funds were exhausted. More than a few portfolio companies seized on this as an opportunity to remove even more covenants that were likely required, thus gaining a little more operating flexibility free from investor consent rights (at least until their next equity raise). These companies and investors are now caught up in the same backlash facing the public companies, and many are second-guessing their PPP proceeds or applications. Most feel confident that they acted appropriately and that they met, and still meet, the program requirements, but are simply worried about the reputational risk, headaches and costs involved in potentially having their motives and eligibility second-guessed either publicly in the media or in an SBA audit or investigation (or both).

On the other hand, WSJ notes that the SBA faces a daunting challenge as its inspector general’s office, with only 90 auditors and investigators, must now review more than 25,000 loans of more $2M plus however many $2M loans are made in PPP 2.0, not to mention the balance of the ~2 million smaller loans already made and those yet to come. That article even goes a step further, seemingly providing a how-to-manual for borrowers wanting to:

“game the system, betting that SBA will be overwhelmed and unable to detect fraud. For instance, an employer who lays people off could fill out payroll forms indicating the money is going for salaries, kick back a portion of the funds to workers collecting unemployment insurance and keep the rest.”

We do not advise such an approach. But the “backlash to the backlash” seems to be growing larger, as many commentators question whether some of these guidances and media statements are actually enforceable under the language of the CARES Act.  For now, most potential borrowers seem to be playing it safe in order to avoid potential headlines, but there may well be future legal challenges to the scope and enforceability of some of these recently-issued FAQs and guidance.

Finally, SBA announced that as of Tuesday afternoon it had approved more than 500k PPP 2.0 loans totaling more than $55B. This means that the entrant in the pool who guessed that the funds would expire Monday night (truly impressive) has been eliminated, as have the 3-4 entrants who guessed that funds would run out on Tuesday. Most of the remaining entries are clustered between Friday and Tuesday.

Those early guesses might have been more accurate had the E-tran system not crashed and “flatlined” literally 10 minutes after opening Monday morning. President Trump referred to this as “a glitch” but other delays plagued a system that even after being upgraded was simply not designed to handle this volume, resulting in “extremely disappointing” and “entirely predictable” delays leaving lenders “deeply frustrated” . Bank of America reportedly has submitted more than 184,000 applications to SBA and had only 1,000 of them approved. Several frustrated bankers posted pictures of their E-tran screens on twitter, with one suggesting that this should be the SBA’s new logo:

P.S.  IFR 6 also provides that:

·         For borrowers who have previously received a partial disbursement of a PPP loan, the balance must be disbursed within 10 days after April 28, and the 8-week forgiveness period was deemed to start as of the date of the first partial disbursement.

·         Any PPP proceeds used to refinance an EIDL loan should be sent directly to SBA.

P.P.S. On Monday SBA also published and then updated on Tuesday IFR 5 on seasonal employers which allows seasonal employers to calculate PPP borrowing base using any consecutive 12-week period between May 1- September 15, 2019.  This appears intended to help farming and agricultural businesses who hire workers during harvest periods, which are later than the March-June periods referenced in the CARES Act.