Are you done with PPP? Yeah, you know … no, no, not me. Sigh. In recent weeks, we have seen a significant uptick in SBA rejections of forgiveness applications among clients, portfolio companies and acquisition targets. We are also seeing SBA inquiries that expressly indicate SBA is leaning toward whole or partial rejection unless a borrower is able to provide further information that will persuade SBA otherwise. Many borrowers, like their advisers who are already both sprinting and slogging through literally the busiest M&A year ever (Peak M&A indeed), are confused about how to respond while also wondering “What took so long?”
To answer that, it may be useful to explain how we got here. Explain!? No, there is too much. Let me sum up:
· The implementation of the PPP in mid 2020 was beset by delays, system crashes and confusing and contradictory rulesfrom SBA.
· Throughout multiple PPP extensions and upsizes, SBA prioritized new loan applications to get money out to beleaguered borrowers, successfully funding more than 11 million PPP loans for almost $800B. At the same time, SBA was tasked with implementing the RRF and SVOG, leaving it with little-to-no resources to process forgivenessapplications.
· By this summer, PPP and RRF were out of money and SBA was able to divert resources from processing new loan applications to (finally) reviewing PPP forgiveness applications. Through the summer and fall, we saw a great number of client and target loans forgiven with little, if any, follow up inquiry from SBA. This was cause for optimism that SBA seemed to be forgiving virtually all of even the larger PPP loans. Many of us were finally able to close the browser tab with the PPP rules that had been constantly open for 18 months.
· However … well, in case you’ve forgotten with PPP, there is ALWAYS a however …
· Many other forgiveness applications languished for long periods with no response whatsoever. We now believe that SBA had identified problems with many of these loans, but deferred acting on them. The SBA’s original proposed rule on the PPP appeal process had drawn significant commentary and criticism. Based on conversations with industry and government contacts, we believe that SBA decided to postpone issuing most denials of forgiveness until it could issue a revised rule with an improved appeal process.
· In September, SBA issued its final rule on PPP appeals. Shortly thereafter, we began to notice a dramatic increase in more detailed SBA inquiries and, eventually, denials of forgiveness.
In our work with PPP borrowers and their prospective buyers and investors, we have noticed a few trends in these SBA inquiries and decisions:
· One of the more common issues to date is the treatment of 1099 contractors, whom some borrowers had improperly treated as employees for PPP purposes.
· Borrowers are entitled to use the rules in effect when they applied for their PPP loan. Given the number of changes in these rules, it can be challenging to determine exactly what those rules were on the date of that application. In addition, many rules changed between the first round and second round, most notably the treatment of foreign employees. Borrowers who properly excluded foreign employees in their first round application have been surprised to learn that they were no longer permitted to exclude such employees when applying for their second round loan thus driving their employee count above 500 and possibly rendering them ineligible for their second draw PPP.
· Somewhat surprisingly, most of the issues have involved front-end eligibility for the loan itself rather than more nuanced accounting-driven issues regarding the use of proceeds. It is unclear whether SBA is not digging as deeply into those issues or … whether SBA has just further deferred loans with those issues to being even lower in the priority stack.
· In many cases, SBA appears not to be properly applying its own rules. For instance, there is significant confusion both with borrowers and within SBA itself as to the difference between the affiliation rules which applied for size eligibility and the concept of the “corporate group” which applied to limit the aggregate amount of PPP loans among borrowers who have a single parent entity. Loans among borrowers that are merely affiliated but that do not have a single common parent are not aggregated for purposes of the loan limit.
· That said, it is hard to discern a true pattern because the decisions seem to be wildly inconsistent. In many cases, PPP first round loans were approved for forgiveness while second round loans under nearly identical applications and facts are being denied (or vice versa). In addition, some borrowers are receiving inquiries or denials on loans where we are aware of other borrowers who successfully obtained forgiveness on virtually the same facts.
So, where does that leave us? First and foremost, there is still lots of good news here. SBA data indicates that it has approved almost 8.9 million (97%) of the 9.1 million filed forgiveness applications. Remember though that the overwhelming majority (8.3M of 11M) PPP loans were for less than $50k and thus subject to virtually no forgiveness scrutiny. Thus, it’s worth noting that the 200,000 forgiveness applications which have not yet been approved are for loans that are on average almost 20% larger than those already forgiven.
As we move forward, borrowers should pay close attention to SBA requests and think strategically about how to respond (if at all). We have seen several borrowers successfully persuade SBA to grant forgiveness by thoroughly and thoughtfully responding to the SBA inquiry.
· The most successful responses have included both financial information and a narrative description that helps SBA understand the borrower’s circumstances. Our advice has generally been to not just paint the picture for SBA, but to “paint it in crayon” so that it is easy to understand.
· Borrowers may want to request confidential treatment under FOIA of sensitive financial information contained in any PPP submission, including its responses to SBA inquiries.
· Finally, of a borrower receives a final negative decision, it has within 30 days to file an appeal.
A key takeaway here is sadly that no news is probably not good news. Even for more recently filed forgiveness applications, our anecdotal experience indicates that forgiveness approvals are coming quickly, while denials or detailed inquiries still come much more slowly. Thus, potential buyers and investors may be increasing skeptical of assurances from a target PPP borrower that its long-ago-filed forgiveness application is highly likely to be forgiven. In any event, all parties to such a transaction should take care to follow the now well-established SBA PPP change-of-control guidelines (escrowing the PPP amount, etc.). Even with the increase in forgiveness denials, PPP issues impacting deals seem to thankfully be settling into a relatively market position on reps and indemnities, absent the occasional issue around state tax deductibility and/or accounting treatment of loan amounts or forgiveness.
And on that hopefully final, final note on the PPP saga, I’ll say to all a good night. Wishing all of you the best during this Holiday (and deal madness) Season. I hope that you are able to get a break to enjoy time with your friends, family and loved ones. Onward and upward in 2022!