PPP Application Issues; Updated PPP Volume

Good morning.  No meaningful updates overnight.  Treasury and SBA did again update their FAQ at some point late yesterday, but the changes are only in FAQ #1, which was originally posted on April 3, and mainly reinforce the point made yesterday that it is the responsibility of the borrower and not the lender, to get the calculations right (in this case re payroll).   

Some interesting information in a report in the American Banker (behind a paywall, sorry):

  • Lenders have submitted* 266,000 applications for $71B in loans
  • SBA indicates that lenders are required to provide borrowers with funds with five days of receiving an SBA loan number, which is issued when a loan application is submitted* to the SBA;
  • SBA also said that it will not promulgate a form of PPP note and that each bank may use its own form, which will likely be the next frantic action item as lenders must prepare and circulate forms of notes within that 5-day window; and
  • As you no doubt saw elsewhere, Congress and Secretary Mnuchin are working to add another $200-250M to the PPP fund, perhaps as early as Thursday. 

*I believe that when SBA says an application is “submitted”, it means that the application has been properly submitted and thus effectively approved for a loan.

A few updates on what we are seeing in the market and questions that we are getting:

  1. Most importantly, we are getting questions from borrowers who are not planning to use the loan proceeds for “payroll costs”.   That is NOT PERMITTED under the IFR.  Although the CARES Act provides that loan forgiveness is conditioned on using proceeds only for permitted purposes, the IFR goes further and requires that Borrowers use 75% of the loan proceeds for payroll costs.  See page 16 of the IFR:

“However, at least 75 percent of the PPP loan proceeds shall be used for payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs, the amount of any EIDL refinanced will be included. For purposes of loan forgiveness, however, the borrower will have to document the proceeds used for payroll costs in order to determine the amount of forgiveness. While the Act provides that PPP loan proceeds may be used for the purposes listed above and for other allowable uses described in section 7(a) of the Small Business Act (15 U.S.C. 636(a)), the Administrator believes that finite appropriations and the structure of the Act warrant a requirement that borrowers use a substantial portion of the loan proceeds for payroll costs, consistent with Congress’ overarching goal of keeping workers paid and employed. As with the similar limitation on the forgiveness amount explained earlier, the Administrator, in consultation with the Secretary, has determined that 75 percent is an appropriate percentage that will align this element of the program with the loan amount, 75 percent of which is equivalent to eight weeks of payroll.”

  • We know of at least one lender who has interpreted this to mean the borrower must certify that it will use the funds for permitted  purposes within the first 8 weeks after closing.  We understand that some borrowers are looking to borrow a PPP loan without necessarily having it forgiven and plan to  spend the funds for permitted purposes after the 8-week period.  The CARES Act says that “during the covered period [Feb 15 – June 30] an eligible recipient mayuse” the proceeds for the permitted purposes, and then the IFR imposes the 75% requirement above. 
    • It does not appear that there is a strict requirement that all proceeds be spent during the covered period.  It likely would be a strained (but not impossible) interpretation to read the nonrecourse exception to apply where a borrower uses the loan for permitted purposes beyond the covered period.  (The CARES Act says the PPP loan is nonrecourse “except to the extent that such shareholder, member, or partner uses the covered loan proceeds for a purpose not authorized under clause (i)”.)
    • However, borrowers who are intending to borrow a PPP loan while keeping operations shuttered or at greatly reduced levels may run a real risk of challenge to the certification that the loan is “necessary .. . to support the ongoing operations” of the borrower.  At the risk of stating the obvious, ongoing operations likely means what it says.   In light of the high demand for, and likely inadequate supply of, PPP financing, borrowers should tread carefully here.
  • Despite the guidance in yesterday’s FAQ, many lenders continue to insist on borrower ownership information for owners who aggregate to at least 51%, or for one lender 90%, of a borrower’s equity.  Some lenders are saying that this is being required by SBA.  Our Policy team is trying to gain insight and possibly assist on this.
  • A few of you have asked about “irrevocably” waiving control rights merely for the duration of the PPP loan.  Unfortunately, we believe that by analogy to SBA interpretations in other contexts, “irrevocably” means “permanently” without any sort of right (express or via “handshake”) to reinstate the control right in the future.   For investors not wanting to give companies unfettered rights, it may be possible in deals with multiple investors to amend the charter or agreement to lower the voting threshold so that no single investor (or group of affiliated investors) controls the vote.
  • Finally, we understand some companies are suggesting that because the “alternative size standard” (of $5M NI and $15M TNW) is not expressly mentioned in 121.301(a) that means that borrowers need not apply the affiliation rules to the that standard.  While the alternative standard is not mentioned there,  SBA SOP 50 10 5(K) in Section B.II.D.4 (page 92) captures it:

“4. The Applicant business may qualify under either the industry small business size standards or the alternative size standard. To qualify under the alternative size standard, the Applicant (including affiliates) must meet the following:

a. The maximum tangible net worth may not exceed $15 million; and

b. The average net income after Federal income taxes (excluding any carry-over losses).”

That’s all for this morning.  Please let us know what you are seeing and hearing from lenders and, as always, let us know if we can help. 

We hope that all of you are safe and healthy and for those of you celebrating Passover today, Chag sameach

SBA PPP FAQ -UPDATED 04.06

Good morning.   Last night SBA and Treasury issued yet another FAQ guidance on the PPP Loan program.  It has become this April’s “tradition unlike any other”.  The latest version helpfully incorporates a number of points made in the Klein memo that we circulated yesterday, and clarifies that the $100k limit only applies to cash comp; but also provides an interpretation on FICA (employer-side is always out).  Here are some quick thoughts, and please note the paragraph at the end about the seemingly increased risk of potential False Claims Act claims. 

  • Affiliation; Ownership; Risk Shifting.  Sorry, no, they did not repeal any of the control tests that are impacting VC and PE portfolio companies. However:
    • Interestingly, FAQ#4 expressly says that lenders are not “required” to make any independent determination of a borrower’s affiliation and that lenders are “permitted to rely” on borrower’s certifications.  Reading this in conjunction with FAQ #18 which says that lenders are not “required to collect, certify or verify beneficial ownership information” for existing borrowers for whom they have previously collected ownership information. 
      • Read together, it seems that the clear intent of SBA and Treasury is to (A) expedite the completion of PPP application paperwork by the banks and (b) put the onus and risk of accuracy of application information (including need, payroll and affiliation) and squarely and exclusively on the borrowers (see more on this below).
      • FAQ #18 goes on to say that banks do not even need to this collect this information for existing customers for whom they have NOT previously collected ownership info “unless otherwise indicated by the lender’s risk-based approach to BSA compliance” (which unfortunately may cause many banks to simply stay the course and require it).
      • We have encountered several banks requiring detailed ownership information from existing borrowers even where no affiliation is claimed.  We suggest such borrowers recontact their banks ASAP and point to this new FAQ #18.
    • If a minority shareholder “irrevocably waives or relinquishes” its problematic covenant veto rights, then it will no longer be deemed an affiliate.  We have been working with several clients who were wondering if it would be possible to waive such covenants for the duration of the loan.  These FAQ do not say that such a waiver would NOT work, but such an approach must now be seen as more vs a permanent waiver.  (FAQ #6). (As a reminder, these are generally veto rights relating to operation of the business or the ability to prevent a board or SH quorum).
  • Size Standards.  SBA and Treasury have now formally adopted the analysis suggested in the Klein memo from yesterday’s email, which is included below. Several of you applied yesterday under this interpretation and can now point your lender to FAQ #2.  Thus, the applicable standards are:
    • Not more than 500 employees (see more on this below);
    • Meet the applicable NAICS employee-based standard;
    • Meet the applicable NAICS annual receipts-based standard; or
    • Meet the “alternative size standard” of net income of not more than $5M and tangible net worth  of not more than $15M  (Note that these standards remain at $5 & $15, because they were not increased when the SBIC size standards were increased).
  • $100k Comp Limit.  Trying to clarify what has been one of the most confusing questions, FAQ #7 clearly says that the exclusion of comp in excess of $100k “only to cash compensation, not to non-cash benefits, including:
    • employer contributions to defined-benefit or defined-contribution retirement plans;
    • payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; and
    • payment of state and local taxes assessed on compensation of employees.”

We know that at least one bank was taking a different approach and counting some or all of the above amounts against the $100k limit.  Again, borrowers who encountered that should contact their banks to present this FAQ.  Presumably, that same standard will apply to determining which $100k employees “count” for the forgiveness math, but stay tuned for more guidance on that.

  • FICA is OUT.  Contradicting the IFR, FAQ 16 makes it clear that the employee side of FICA is in, but the employer side is out and thus NOT included in either the borrowing base or the forgiveness amount.  FAQ #17 helpfully says that if you applied under the interpretation in the IFR, you can continue to rely on the IFR, you do NOT need to reapply or fix your application.  Note that this may result in some of your loan not being forgiven, because I think that reliance will only apply to the application and perhaps the amount; not forgiveness.
  • How to Count Employees; Measurement Period for Borrowing Base and Employee Count.
    • FAQ #3 reiterates that the 500 employee standard applies only to employees whose “principal place of residence is in the US”.  This perhaps means that employers can exclude employees on temporary work visas, but please consult an employment lawyer before making that determination.   In theory, this also means that large multinational companies with small US operations could qualify for a PPP, because even though the affiliation rules would apply, employees outside the US would not count against the size standard.  That seems to be a permissible, but aggressive, approach.
    • FAQ #14 clarifies that borrowers may use either 2019 or the TTM period before loan application to measure (A) payroll costs for the borrowing base and (B) calculating the average number of employees for the size standard, but also allows:
    • Seasonal employers to use the average number of employees over “the same time [seasonal?] period”, presumably the same time period against which the employer is borrowing (I don’t think they mean to allow peak-season borrowing and off-season employee size count); and
    • Also, new businesses formed after June 30, 2019, may use average employee counts for Jan-Feb, 2020.
  • Details:  1099s Still Out; PEOs OK
    • Employers still can’t count 1099 payments in the loan amount or forgiveness.
    • Employers using PEOs can still apply, and helpfully notes that if you can’t get a 941 from the PEO, a “statement” of applicable payroll costs from the PEO will suffice.

Yesterday, I mentioned FOIA.  Today’s f-word is FCA:  the federal False Claims Act.  Our team is working on a more formal alert on this topic (also called “qui tam”), but the basic gist from my limited corporate-lawyer understanding is:

  • The FCA allows both the government and individual whistleblowers to bring claims against persons who knowingly, or with reckless disregard for the truth, submitted false claims to the federal government. 
  • PPP Loan applications and forgiveness calculations will be submitted by lenders to SBA and thus are subject to the FCA.  The FCA plaintiff’s bar is likely to be watching the PPP and licking it’s chops.
  • The risk of a false statement (or a statement judged later to have been false) is not simply having to repay the loan rather than having  it forgiven.  Potential FCA losses include treble damages, penalties and payment of attorneys’ fees.   
  • Whistleblowers and the plaintiffs’ bar are incentivized to bring such claims because they can recover 15-30% of the damage award plus attorneys’ fees. 

Virtually every borrower and investor that we know is taking a careful and thoughtful approach to this.  That said, we know that some borrowers, in the face of unclear, shifting and uncertain guidance, have debated submitting applications under the most favorable reading of the various guidances and assuming that the lender and/or SBA will sort it out and process the loan correctly.  These FAQ seem to be an acknowledgement that the volume of loan applications (already more than 10-20x all of 2019) makes that simply impossible and that the government may take an approach similar to the 2008 crisis where it “paid and then chased” and ultimately recovered more than $13B in FCA damages under TARP, much of that based on whistleblower complaints.

Borrowers cannot rely on their bank or the SBA to protect the borrower from an inaccurate application. Thus, applicants should be extremely careful in submitting PPP loan applications and should keep meticulous records in using PPP proceeds.  Although the present circumstances may be exigent and dire, borrower statements may be subject to second guessing in the harsh light of morning after the fact when things have settled down.    If that’s not enough, I will leave you with this cheery tweet from over the weekend:

Be careful out there.  Let us know if we can help.