Update on the Shifting Regulations Under the PPP

The Government has recently issued a complex set of 48 Frequently Asked Questions (FAQ) regarding Paycheck Protection Program (“PPP”) loan eligibility and forgiveness. These guidelines differ substantially from the text of the CARES Act that originally authorized the PPP.

The PPP waives the “credit not available elsewhere” test that ordinarily prevents SBA borrowers from obtaining loans if they can borrow from private lenders. CARES Act Section 1102, codified at 15 U.S.C. § 636(a)(2)(36)(I). However, the PPP does require that the borrower certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Id. at § 636(a)(2)(36)(G)(i)(I). Although subjective, this test appears easy to satisfy on its face, but subsequent guidance complicates the analysis.

After controversies arose from PPP loans to large companies such as Ruth’s Chris Steak House, the Treasury issued the following guidance:

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.

FAQ #31. The assumption that a restaurant company would be able to obtain financing in the capital markets in current market conditions is questionable. Nonetheless, large companies should be wary of requesting PPP loans or forgiveness.¹ Further, the FAQ now suggest that “private companies with adequate sources of liquidity to support the business’s ongoing operations” may not qualify for a PPP loan. FAQ #37. Thus, companies that are held by larger companies or private equity groups, or businesses that are otherwise well capitalized, may be deemed ineligible for PPP loans.

Lastly, the Government has now announced an intent to determine eligibility for purposes of loan forgiveness based upon the statutory and regulatory provisions in place at the time of the borrower’s loan application. 85 Fed. Reg. 33004, 33006 (to be codified at 13 C.F.R. Pt. 120). Given the Government’s intent to apply the law existing at the time of the loan application to the forgiveness analysis, the Government would seem to have no reason to continuously extend an amnesty period as it rolls out new guidance.²

As a result of these statutory and regulatory provisions, we see several conflicting concepts. First, the CARES Act removes the “credit not available elsewhere” requirement and allows borrowers to obtain PPP loans regardless of whether they have other sources of credit. Second, the Government issues guidance that suggests that publicly traded or private equity companies are not eligible for PPP loans because they can access the capital markets. Third, the Government announces an amnesty designed to encourage borrowers to return their loans based upon purported clarifications of the CARES Act by the SBA and Treasury. See e.g. FAQ # 47. Lastly, the Government announces that in reviewing forgiveness it will apply the statutory and regulatory provision in place at the time of application. 85 Fed. Reg. 33006. All of this shows genuine confusion by the Government itself about which standards will be applied by which agencies to which borrowers. This undermines the purposes of the CARES Act by creating additional regulatory uncertainty on top of the economic uncertainty that triggered the need for the PPP loans in the first place.

The fundamental problem with the PPP is that no underwriting is conducted before the loan is approved, disbursed, and spent, to definitively determine that a borrower is eligible for the loan and also for forgiveness. The PPP provides no incentive for lenders to engage in any due diligence, other than reviewing the borrower’s documents for sufficiency on their face. Instead, in an effort to ensure rapid distribution of PPP loans, the CARES Act effectively immunizes lenders from liability for underwriting if they have received documentation that appears, on its face, to comply. In other words, the lenders are not responsible for verifying the representations of the borrowers. Further, the guidance states that:

The outcome of SBA’s review of loan files will not affect SBA’s guarantee of any loan for which the lender complied with the lender obligations set forth in paragraphs III.3.b(i)-(iii) of the Paycheck Protection Program Rule (April 2, 2020) and further explained in FAQ #1.

FAQ #39. In other words, the lender guarantee will remain and the risk of nonpayment will not be shifted to the lender, even if the loan is later determined to be improper. Rather, the Government will refuse to allow forgiveness and may even seek aggressive recoupment from the borrower and its principals.³

Unfortunately, the PPP rules create substantial risk to businesses who receive loans. Ironically, such risks are most acute for the businesses that are most impacted by Coronavirus. Businesses that experienced a mild downturn but intended to continue operating regardless of the PPP face little risk. If these businesses apply for and receive a PPP loan that is later determined not to be forgivable, then they simply have to repay a loan incurred for operations that they would have undertaken without the PPP. However, a severely impacted business might truly be unable to operate during the Coronavirus without a PPP loan. A severely impacted business, which would have scaled back operations or shutdown (temporarily or permanently) during Coronavirus will, if it receives a PPP loan, continue incurring payroll and other costs during the loan period, even if it would not have continued operations and incurred those costs without the PPP loan. If the business is later deemed ineligible for a loan, and its revenues during the loan period are not sufficient to otherwise cover its payroll and other operational expenses, then the business has incurred payroll and other expenses for the additional period of the PPP loan without receiving loan forgiveness. In other words, a business might operate in reliance on the PPP loan, incur payroll and other expenses that could have been avoided, and then later not receive the forgiveness that made that arrangement practical. In this circumstance, a surprise determination that the loan is not forgivable would be devastating.
¹Notably, Ruth’s Chris and other large restaurant chains are only eligible for PPP loans due to a specific statutory exemption to the 500 employee limit for PPP eligibility created for the hospitality industry. See e.g. FAQ #24. The only purpose of this provision was to allow restaurant chains to claim PPP funds, exactly what was complained of in the ensuing scandal.
²It is possible that the Government intends to apply the law at the time of the loan application only to forgiveness but to apply the evolving regulatory guidance to civil or criminal penalties. However, this approach would provide the benefit of the plain meaning of the statute only to loan forgiveness while basing civil and criminal penalties on the evolving, conflicting, and unclear regulatory guidance. Because this would have the backwards result of applying a more favorable law to the forgiveness analysis but then basing regulatory or criminal penalties on guidance issued after the borrower applied for a loan, a court is likely to reject such an approach on due process grounds.
³The PPP’s waiver of a personal guarantee and nonrecourse provision only applies to eligible recipients.