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The baseball season is on hold due to the COVID-19 crisis but that didn’t stop the Small Business Administration (“SBA”) from throwing a curveball to all Payroll Protection Program (“PPP”) loan recipients. Late last week the SBA issued new guidance regarding the requirement for PPP loan applicants to certify “loan necessity”. This certification was included in the loan documents you signed. The new guidance (issued April 26-29) came in the form of additional Frequently Asked Questions (“FAQs”) added to the SBA's PPP loan web site’s “Frequently Asked Questions for Lenders and Borrowers”. Specifically, the SBA added FAQs 31, 37 and 39.
Question 31: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?
Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers 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. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers 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. For example, 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. Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.
Question 37: 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.
Question 39: Will SBA review individual PPP loan files?
Answer: Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. To further ensure PPP loans are limited to eligible borrowers in need, 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. Additional guidance implementing this procedure will be forthcoming.
Unfortunately, this program has been riddled with questions and confusion from its roll out and through the loan application process (just ask your lender). The questions and confusion have continued as loan recipients look for clarification as to what the funds can be used for and, ultimately, what will qualify for forgiveness. Now, additional confusion and uncertainty has been added with this most recent guidance due to a lack of specific and objective metrics. What does “access to other sources of liquidity” and “not significantly detrimental to the business” actually mean? Compounding the angst for businesses is the looming May 7, 2020 “safe harbor” deadline to return loan proceeds if they do not meet the “loan necessity” standard and the threat of substantial fines and penalties for not satisfying that standard.
Congress’ intent in creating the PPP was to provide funding for small businesses impacted by the COVID-19 crisis. Specifically, this funding was to allow those impacted businesses to continue to keep their employees on payroll even though they may be closed by government order or see their revenue streams decline due to COVID-19 issues. It seems therefore, that businesses that have been ordered closed and those that have experienced revenue declines due to COVID-19 issues would fall within the intent of the program and will likely have an easier time satisfying the “loan necessity” standard. For those businesses that have not experienced revenue declines, the question of “loan necessity” is more complicated. We also believe that the SBA’s “access to other sources of liquidity” standard may pose a serious question for most businesses.
What should you do?
We recommend that all PPP loan recipients immediately evaluate and document the “economic necessity” of the loan proceeds. This should include:
An evaluation of current and projected revenues including analysis of “worst case” scenarios for a relevant time frame in light of the COVID-19 crisis,
An evaluation of potential revenue declines in the event of widespread employee absences due to COVID-19 illness,
Documentation of known customer losses and revenue declines, both temporary and permanent related to the COVID-19 crisis,
An analysis of the potential impact on the business’ ability to continue to pay employees due to actual and potential revenue declines
An analysis of the potential impact on the business’ ability to pay other operational expenses due to actual and potential revenue declines
An analysis of the potential financial impact due to possible supply chain disruptions including the need to purchase additional inventory to maintain revenue streams
An analysis of additional expenses that may be incurred for facility cleaning and safety and relocation of employees in accordance with COVID-19 related safety standards, and
Any other analysis and considerations as may be appropriate.
We recommend that all businesses document this analysis and related conclusions contemporaneously. It seems that nearly all businesses should include a statement regarding the inherent uncertainty of future economic conditions due to the COVID-19 crisis.
Additionally, we recommend that businesses document their access or lack of access to other sources of capital including additional capital contributions by owners, the ability or inability to borrow from other sources including existing lines of credit and the existence or lack of existence of business interruption insurance. This documentation should include analysis of appropriate financial ratios, existing debt covenants and, where appropriate, a written narrative as to how additional borrowing may be “significantly detrimental to the ongoing operations of the business.”
While none of these recommendations guarantee that any particular business will meet the ultimate scrutiny of the SBA and Treasury regarding the “loan necessity” standards, they should help demonstrate a business’ bona-fide effort to evaluate and establish the “loan necessity”.
Following its analysis, each business will be faced with the question as to whether or not it meets the requirements of the “loan necessity” standard. If the business determines that the loan is not necessary “to support its ongoing operations”, it should consider full repayment of the PPP loan proceeds immediately and preferably prior to the May 7, 2020 “safe harbor” deadline.
We continue to advise all clients to not assume that PPP loan forgiveness is automatic. This new guidance from the SBA certainly reinforces that caution. The final forgiveness rules still lack sufficient definition and still require additional clarification. PPP loan proceeds may have to be repaid in part or in full in some instances.