Borrowers of PPP loans of $2M or more will be required to complete a new form as part of the SBA review process, which appears to ask key questions about private equity ownership, market capitalization, quarterly revenue and COVID-related business impacts that happened after the PPP loan application and this unhappy question:
(Yes, the form was apparently designed byGeorge Strait as most of the questions have check-the-box answers like this.)
After studying the application, it appears that, as feared, SBA will be looking not only at the facts that existed at the time of PPP loan application, but also looking at how events actually unfolded for PPP borrowers after the fact. Most of you will be reading this on Monday morning, so it’s a good time to look at the Monday morning quarterbacking that SBA seems to be doing.
I should note that SBA has not, as far as we could find, officially released these forms, but we were able to locate the attached forms through online and other resources, which appear genuine and consistent with publicly-available information.
· SBA had previously announced that it would review all forgiveness applications for PPP loans with an original principal amount of at least $2M.
· As part of its OMB reporting requirements, last Monday SBA published a notice in the Federal Register listing the time requirements to complete the various PPP forms. That notice referenced two unreleased forms called “Loan Necessity Questionnaires”– 3509 for For-Profit Borrowers and 3510 for Nonprofit Borrowers.
· In an interview with S&P Global Market Intelligence, an SBA spokesperson indicated that the forms mentioned in the release would be were for borrowers of loans of “$2M and above”.
o Interestingly, the SBA notice references that these forms affect approximately 52,000 borrowers, which is 23,000 higher than reflected in the SBA-published loan data that shows only 29,000 borrowers who have loans above $2M.
o It’s possible that there are ~23k borrowers with loans of exactly $2M, or that a large portion of that number comes from individual borrowers of under $2M who have affiliated PPP borrowers that aggregate to $2m. But, that seems somewhat unlikely, and it’s hard to reconcile the numbers.
So, with the caveat that we don’t know for sure that these are accurate or final, here’s what we know about the forms, though for now we will focus on the form 3509, which is for business for-profit borrowers:
· It appears that lenders are to provide the forms to borrowrs, who then have 10 business days to complete the forms and submit the required but unspecified “supporting documentation”.
· The form consists of two main parts:
· A “Business Activity Assessment,” which includes many questions relating to impacts on business activity during the borrower’s covered period, which of course only occurred well after the borrower applied for its PPP loan and thus seem only loosely correlated, at best, to a determination of the borrower’s good faith mindset at the time it applied for its PPP loan.
· A “Liquidity Assessment,” which asks both whether the borrower (or its parent) had any public securities (and if so, its market cap) and as noted above, whether, the 20% or more of the borrower’s equity was owned by PE, VC or hedge funds or a public company but also then focus on how the borrower used its cash (not just PPP cash) – such as dividends, prepayment of debt, non-COVID cap ex, and (perhaps troublingly) whether the borrower had employees or owners with annualized comp in excess of $250k.
You can see the questions for yourselves in the pdfs (NOTE: I am unable to attach the PDFs, but please contact me if you would like a copy) but here are some observations on each of the two assesments:
· Business Activity Assessment
· The first quesiton asks for the borrower’s revenues for Q2 2020 and, for comparison, Q2 2019 or, if they are seasonal, the respective Q3s (or Q1 2020 for newer businesses). For nonprofit borrowers on form 3510, this is measured in receipts, including grants and donations.
o While this seems like a reasonable way to measure the actual impact of the pandemic on the borrower, it may bear little relation to what the borrower believed in good faithabout the “eonomic uncertainty” (which is what the CARES Act required) or what it thought was going to happen at the time of its application.
o It also may be largely irrelevant for borrowers who (a) were growing rapidly, where a return to Q2 2019 would be a signficiant decrease in actual activity or (b) borrowed in the PPP 2.0 wave, where the Q3 revenues might be a more relevant for the purposes that SBA apparently wants to use here.
o Ultimately, it remains to be seen whether SBA will deny forgiveness for borrower’s whose revenues were not actually signficiantly reduced.
· The next several questions ask whether the borrower was ordered to, or voluntarily, shut down or “altered its operations” and if so, for how long, why and whether it had any CapEx relating to those alterations.
o The three types of alterations that borrowers can check are interesting: (i) number of people in a location was limited, (ii) service was limited to outdoors, (iii) employee workspaces were reconfigured or (iv) other.
o As are the reasons for why a borrower voluntarily ceased or altered operations: (i) employee(s) contracted COVID, (ii) supply chain was disrupted or (iii) other. Interesting that SBA did not provide an option to address the customer demand-side of the equation, though borrowers can add that in the “other” box.
· The final substatntive question asks whether the borrower began any new capital improvement projects *NOT* related to COVID during the period from March 13 to the end of its forgiveness period. This is a bit of a puzzling question, and may be based on SBA thinking that a borrower who commenced such a project during such period must have had plenty of cash and thus didn’t “really need” the PPP loan.
· Liquidity Assessment.
· The first question is probably the obvious one, how much cash (and equivalents) did the borrower have as of the last day of the calendar quarter before it applied for the PPP loan. For many borrowers who applied early in the process, this would be measured as of December 31, 2019, which could present a very misleading liquidity picture for a variety of seasonal and other timing reasons.
o For nonprofit borrowers, form 3510 goes on to ask whether the borrower holds any assets in any “endowment funds” and for the value of its non-cash investments, which seems pretty clearly to be aimed at ferreting out some of the institutions with large endowments that President Trump criticized for taking PPP loans. In fact, the next question specifically asks whether the borrower is a “school, college and university” and, if so, what its annual tuition is and whether it offered tuition assistance for 2019-20.
o Non-profit borrrowers are also asked whether they are a health care provider and, if so, what their program service revenue was for Q2 2020 vs Q2 2019 (or, if they are seasonal, the respective Q3s).
o All non-profit borrowers (including schools and health care providers) are asked whether they offered discounts on their services due to COVID-19.
· Next, SBA asks whether a borrower has paid any “dividends or capital distributions” between March 13 and the end of its covered period.
o The question exempts tax distributions by a “partnership or S-corporation” (don’t worry, this should cover LLCs too, which are tax partnerships; remember that SBA is stuck in the 1950s re capital strucures), in an amount limited to actual tax liaiblity on profits in the first three quarters of 2020, 110% of the pro rata share of last year’s “tax liability on distributions” (too bad if you had phantom income, I guess?), or the pro rata share of tax liaiblity on total distributions in 2020 (which seems somewhat circular, but may be aimed at non-capital distributions of profits or guaranteed paymens?). It’s also not clear whether we are using the greatest or least of these measures.
o While the tax exception is oddly phrased, this question is not a surprise as SBA has been focused on ensuring that borrowers are not paying their owners to the detrminent of employees and, as we have predicted, is apparently looking askance at borrowers who were able to make such distributions.
· Similarly, the next question asks if the borrower prepaid any debt before it was “contractually due” during that same period. Note that while debt that was accelerated by a lender would likely be deemed to have been “contractually due,” debt that was prepaid as part of a change of control might not neatly fit into this exception for fairly technical reasons (e.g., in most cases buyes of companies with outstanding debt will pay the target debt via the funds flow immediately prior to closing of the sale in order to avoid triggering the default (and to deliver the company debt-free).
· The next two questions ask whether any of the borrower’s employees or owners were compensated at an annual rate in excess of $250k (annualized), and if so how many of each and how much in total was paid to each such cohort. This is not supported by the CARES Act and is a strange question that may be be based on some sort of assumption that a borrower who could afford to pay such highly compensated personnel such amounts may not have “needed” the loans. This question could signal that forgiveness may be especially challenging for law firms and other professional service firms who borrowed PPP loans.
· The next series of questions ask about the for-profit borrower’s equity captialization and ownership:
o Whether the borrower or a parent had publicly traded stock, and if so its market cap on the date of the PPP applicaiton.
o If the borrower was privately owned what was the book value of its shareholder equity as of the last day of the calendar quarter before it applied (again, using 12/31could create some interesting answers here).
o Is the company a subsidiary (at least 50% owned by) another company, and if so who is the parent and is it incorporated outside the U.S.
o Is the company an affilate or subsidiary of a foreign state-owned enterprise? (I’m guessing that under the current administration, borrowers who would need check yes here may want to just not apply for forgiveness.)
· And of course, the borrower is asked whether 20% or more of its equity is owned by a public company, or a PE “firm”, VC “firm” or hedge fund (SBA tries to eliminate any ambigutity from its use of this phraase in its FAQs by adding “or any fund managed by any such firm”). This is not a surprise and likely signfiies enhanced scrutiny of these borrowers, as we all expected.
o Remember that the former head of DOJ’s Civil Division—the unit with primary responsibility for CARES-related False Claims Act lawsuits—tipped his hat to this during a laundry-list speech of DOJ’s COVID/FCA priorities back in June (our Investigations team notes that DOJ is definitely looking for some “exemplary” cases in this area):
Our enforcement efforts may also include, in appropriate cases, private equity firms that sometimes invest in companies receiving CARES Act funds. When a private equity firm invests in a company in a highly-regulated space like health care or the life sciences, the firm should be aware of laws and regulations designed to prevent fraud. Where a private equity firm takes an active role in illegal conduct by the acquired company, it can expose itself to False Claims Act liability. A pre-pandemic example is our recent case against the private equity firm Riordan, Lewis, and Haden, where we alleged that the defendants violated the False Claims Act through their involvement in a kickback scheme to generate referrals of prescriptions for expensive treatments, regardless of patient need. Where a private equity firm knowingly engages in fraud related to the CARES Act, we will hold it accountable.
· Finally, the forms ask whether the borrower has received any other CARES Act benefits and, if so, what and how much. I had originally assumed this was designed to ferret out prohibited use of the ERTC. But the question specifically “exclude[es] tax benefits.”
Remember that we can’t be sure that these are the official or final forms, but those of you with companies who have $2M+ PPP loans should start receiving something like this from your banks soon. We’d love to see copies of them if they look different, and of course, please let us know if we can help with them.