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Crisis Management

PPP Borrowers: 5 Ways to Mitigate the Risk of an Unfavorable SBA Audit or Enforcement Action


by Stephen R. Cook and Ashley L. Baynham

Government regulators, including federal law enforcement officials, will continue to be anxious to demonstrate their ability to identify and punish those they believe have abused the program.

Expedient legislation often comes at the expense of clarity, and the Paycheck Protection Program (PPP) is no exception. Congress created the PPP in the midst of the COVID-19 pandemic and the associated economic shut-down. The program’s goal is straightforward: “Provide a direct incentive for small businesses to keep their workers on the payroll,” primarily in the form of loans to qualified applicants. But while the PPP’s two-page “Borrower Application Form” is short, it requires applicants to make numerous “certifications,” some of which contain broad language susceptible to varying interpretations. The application underscores the importance of these certifications by warning that if the contents of the application and supporting documents are not “true and accurate in all material respects,” the applicant may be charged with one or more federal crimes.

This warning should not be dismissed casually. While loan applications submitted to financial institutions are typically signed “under penalty of perjury” and carry at least an implicit possibility of criminal prosecution for false statements, the PPP is a new creation, born of necessity and controversy concerning its magnitude and the speed of its roll-out. The government has already indicted several individuals suspected of fraud, and launched investigations into others. Government regulators, including federal law enforcement officials, will continue to be anxious to demonstrate their ability to identify and punish those they believe have abused the program.

How can a PPP borrower, or prospective borrower, mitigate this risk?

First, and most obvious, be thoroughly familiar with the certifications and requirements of the PPP and how they may apply to your business. Although the program is still in its infancy, it is likely that most enforcement action taken against borrowers will be premised upon a material misstatement in the application (or supporting documents) that cannot be excused by any vagaries in the language of the statute—i.e., garden variety fraud. Carefully reviewing the plain and obvious requirements of the program, and documenting contemporaneously your compliance with those requirements, will reduce significantly the risk of government enforcement action. Borrowers should pull together and memorialize all of the documentation supporting their necessity certification, as well as all other representations contained in the application. In the event of an audit, the SBA may require more documentation than was required by the lender to issue the loan, so the more fulsome the documentation at the outset, the better. This is particularly important for applicants seeking a PPP loan of $2 million or more, as discussed below.

Second, borrowers should document any legal advice that they received in connection with their application. A legal opinion sought in good faith may be a defense to a regulator’s later claim that the applicant intended to defraud the government.

Third, stay abreast of the SBA’s published guidance interpreting the certifications required of applicants. Beginning on April 3, 2020, the SBA, in consultation with the Treasury Department, provided guidance concerning the PPP in the form of answers to Frequently Asked Questions (FAQs).At last count, the SBA and the Treasury Department have updated the FAQs 16 times and have issued 15 interim final rules.

One of the most significant concerns identified by borrowers is the lack of clarity surrounding the so-called “necessity” requirement. All applicants are required to certify that “[c]urrent economic uncertainty makes th[e] loan request necessary to support the ongoing operations of the Applicant.” But “one man’s luxury is another man’s necessity,” and it is unclear what “necessary” means in this context. Must a PPP loan be the only option available to “support the ongoing operations of the Applicant”? What if a PPP loan is simply the best option, or the most economical; does that qualify as “necessary”?

On April 23, 2020, the SBA’s answer to FAQ #31 explained that to make the financial necessity certification in good faith, borrowers must consider their “current business activity” and “ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” While the SBA’s answer provides some guidance on what an applicant should consider when evaluating the necessity of a PPP loan—i.e., other sources of liquidity that may be available—the FAQ does little to help an applicant determine whether those “other sources” are sufficiently viable or economical as to extinguish the “necessity” of the PPP loan. What can an applicant do to mitigate the risk inherent in a good-faith, but necessarily subjective, certification of necessity? Again, document everything. In this case, that documentation should include a memorialization of the internal analysis and rationale used by the borrower to conclude that the PPP loan was necessary, together with all of the documentation relied upon in conducting that analysis and reaching that conclusion.

Fourth, be familiar with the benefits and limitations of the PPP’s safe harbor provisions. On May 13, 2020, the SBA issued FAQ #46, which created a new safe harbor provision for borrowers with PPP loans of less than $2 million.(Other safe harbor provisions excused failure to comply with the necessity requirement if the loan was repaid by May 18, 2020.)For loans of less than $2 million, the SBA will deem the borrower “to have made the required certification concerning the necessity of the loan request in good faith.” The SBA justified this seemingly arbitrary $2 million safe harbor cut-off by noting that “borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment.”

Conversely, borrowers with PPP loans in excess of $2 million are not only excluded from the safe harbor, but the SBA has said that they “will be subject to review for compliance with program requirements.” If the borrower is found not to have had an adequate basis for the necessity certification, the SBA will seek repayment of the loan balance. Failure to repay the loan balance upon notification by the SBA may result in SBA enforcement action, and potential referral to other government agencies for further civil and/or criminal enforcement actions.

Importantly, this safe harbor provision does not guarantee that borrowers with loan amounts below $2 million will be free from government audit. This safe harbor is merely a presumption that the necessity certification was made in good faith—a presumption that can be overcome if, for example, a government regulator or whistleblower discovers evidence of misstatements anywhere in the application. In an Interim Final Rule released on May 22, 2020, the SBA made clear that any loan, regardless of amount, may be subject to audit. Areas of review include eligibility of the borrower to participate in the PPP (including assessment of the certifications made by the borrower), calculation of loan amount, proper use of loan proceeds, and calculation of the loan forgiveness amount.

Finally, in the event of an audit, government subpoena, congressional inquiry, or whistleblower complaint, consult with counsel qualified to assess and mitigate any civil, criminal, or reputational risk to you and your company. Evaluating whether a company meets the requirements of the various certifications, whether a company acted in good faith, and whether previous advice of counsel can be relied upon are nuanced issues on which a borrower needs the advice of qualified counsel.

Former federal prosecutor, Stephen R. Cook is a partner and Practice Group Leader of Brown Rudnick's White Collar Defense & Government Investigations practice group. Ashley L. Baynham is a Partner in Brown Rudnick’s White Collar Defense & Government Investigations group.