The Paycheck Protection Program (“PPP”) created by the CARES Act, P.L. 116-36, provides forgivable loans to small businesses, those with under 500 employees and those that otherwise meet SBA size standards. The program is administered by the SBA, in conjunction with Treasury but this vital program has not been without bumps.
Even after an understandably rocky start, the Administration has continued self-immolation. Much of this self-inflicted wound is the result of the Administration changing the rules as time passes, in fact, changes that in many instances contradict prior guidance. The best, but not sole, example concerns the economic uncertainty certification required as part of the loan application. As enacted on March 27, 2020, Sec. 1102 of the CARES Act requires PPP loan applicants to certify “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient[.]” At the time of enactment and during the initial loan application period, neither Treasury nor the SBA provided guidance as to what was required to make the above certification. However, in the days that followed, both organizations began to arguably overreact to news of large companies reviving significant PPP funds.
After considerable angst amongst all borrowers, subsequent FAQs indicated that companies that received a loan with an original principal amount of less than $2 million will be “deemed” to have made the certification in good faith. Treasury and SBA have indicated in FAQ 39 that those with loans in excess of that amount, however, will be reviewed as to all the certification elements of their applications. Those applying for forgiveness will note that the recently released application specifically requires borrowers to check a box indicating whether the principal amount of the loan, including loans to affiliates, was over $2 million.
The question remains, should borrowers document the necessity of their loans before SBA asks and if so how? It seems for those who borrowed over $2M the answer has to be yes. To have to remember and collect data from as much as 3 years before seems problematic. And while there has been no concrete guidance to date as to what that documentation should look like, as we speak to clients, there are a few factors that ought to be considered.
Maintaining Employment and other Good Uses of Loan Proceeds
In our view, how the loans were utilized will remain the key factor in how the SBA will look at a borrower. Congress and SBA rules have described the overarching goal of the PPP as “keeping workers paid and employed” and loan forgiveness is tied to the amount of the proceeds which are spent on payroll costs while employment and payroll reductions correspondingly reduce the amount or the loan which may be forgiven.
One way in which a borrower can show the necessity of the loan is to preserve documentation that shows how the loan enabled the business to preserve employment and payroll or other items that were permitted uses for the loans. Similarly, if a borrower reduced employment prior to the receipt of the loan and then rehired some or all of its workforce, that may constitute evidence that the loan was necessary to maintain employment. Obviously, the documentation required by the new guidance on the forgiveness process needs to be maintained.
In addition, a number of businesses have recently considered whether to return some or all loan proceeds in advance of May 7, May 14 and May 18 deadlines from Treasury and SBA. Thoughts and communications relating to those considerations may be useful to preserve as well.
Health of the Business
If a business has suffered since the outbreak, that should be well documented as well. This includes periods before and after the loan and the loan forgiveness. Reductions in revenue as compared to either the period before the downturn or a similar period during the previous year will help demonstrate need. Similarly, reductions in requests for bidding, new contracts or requests to stop work on existing contracts will demonstrate a business’s economic uncertainty.
Businesses should also note the impact of stay at home and similar orders which may have prevented them from operating or caused them to operate at reduced capacity. Any factors which show harm to the business in the wake of the pandemic’s onset are facts which can support the certification. It needs to be noted that we have many clients that were deemed essential and so continued work but were very concerned with 3 to 6 months down the road when existing projects are completed. Will new housing continue, will business design and construction, etc. continue as existing work is done? Concerns in this area need to be documented.
Liquidity and Access to Capital
The chief indicator that Treasury and SBA have used to identify companies they believe may be unlikely to make the certification is a company’s access to capital and sources of liquidity. In a fit of what can only be called seller’s remorse, Treasury and SBA have placed emphasis on these factors even though PPP dispensed with the usual SBA requirement that borrowers demonstrate an inability to obtain a loan elsewhere. As with other elements pertaining to the certification, the borrower’s frame of mind at the time of the loan application is going to be crucial. Borrowers should preserve any written communications made during the lead up to the loan, formal or informal, which indicates their uncertainty.
These could include concerns about the ability of sources of liquidity to last the length of the downturn. If a borrower has a cash cushion that can last a few months, but expects the downturn to last longer, it may make sense to tap the PPP loan to cover initial costs and reserve the existing cushion for what may come next. Borrowers should also note consideration of the ramifications of taking a loan that would not be forgiven. Businesses may have legitimate concerns over accepting a stop gap loan that would not see the business through the downturn and ultimately lead to repayment difficulty for the borrower. To the extent that borrowers considered other available loans, the preferential terms of a PPP loan may prove relevant to the certification as well. Borrowing at 1% with deferred payments for six months, to say nothing of forgiveness, may improve a borrower’s long term survival outlook.
Borrowers that have received loans in excess of $2 million should be prepared to demonstrate that they made the loan certification in good faith. To the greatest extent possible, that demonstration should be made through contemporary documentation which considers the need for the loan and the ramifications of the unknown length of the downturn. We continue to work with clients to ensure that they have begun to collect and retain what is necessary in these areas. Businesses should consult their trusted advisors on the best ways to document their loan certifications.