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New Treasury Guidance on Certification of Necessity for Paycheck Protection Program Loans

New Treasury Guidance on Certification of Necessity for Paycheck Protection Program Loans Background Decorative Image

On April 23, 2020, the Department of the Treasury (“Treasury”) and the Small Business Administration added FAQ 31 to the Frequently Asked Questions (“FAQs”) on Paycheck Protection Program (“PPP”) loans. The new guidance addresses the required certification that a PPP loan is necessary to support the applicant’s operations.  In light of the new guidance, PPP loan applicants should carefully consider whether they are eligible borrowers, and PPP recipients should assess whether to retain the funds and document the necessity or return the funds.

FAQ 31 addresses the rising concern that large companies are taking advantage of the PPP:

Question:  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 “[c]urrent 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.

The statement that 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” has understandably raised concerns among PPP loan applicants and PPP loan recipients that are public companies or other entities with some access to capital. Adding to these concerns is the clear pressure for borrowers to repay the loans in full or risk being deemed not to have made the certification of necessity in good faith.

Furthermore, Treasury made clear in an interim final rule released on April 24, 2020, that private equity funds and hedge funds are not eligible for PPP loans. Portfolio companies of private equity funds may nevertheless be eligible borrowers provided they satisfy applicable eligibility requirements, including the certification of need taking into account FAQ 31. The interim final rule refers to the May 7 repayment date as a “safe harbor” allowing borrowers to “promptly repay PPP loan funds that the borrower obtained based on a misunderstanding or misapplication of the required certification standard.”

The Standard for Necessity in the CARES Act

There is no bright-line test for determining the necessity of a PPP loan. While it is challenging to determine the precise standard, the CARES Act includes three provisions relevant to the assessment.

First, the CARES Act expressly removed the SBA’s “credit elsewhere” test: “During the covered period, the requirement that a small business concern is unable to obtain credit elsewhere . . . shall not apply to a covered loan.”

The SBA has provided guidance on its long-standing “credit elsewhere” test. In general, an applicant is eligible for SBA assistance if it is unable to obtain credit on reasonable terms from non-federal, non-state, and non-local government sources. The test takes into account both the liquid assets of the business, its owners, and guarantors, and whether credit could be obtained elsewhere on reasonable terms and conditions. Given the removal of this requirement in the CARES Act, the “credit elsewhere” test is not the standard for PPP eligibility.

Second, the CARES Act provides that “an impacted borrower is presumed to have been adversely impacted by COVID-19.”

Third, the CARES Act requires that PPP borrowers certify in good faith “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.” The FAQ released April 23 appears to be the only guidance interpreting this certification.

FAQ 31 explains that applicants making the PPP loan certification should “tak[e] 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.”

These provisions provide the conceptual guardrails of the necessity analysis:

no credit elsewhere   <   PPP loan necessity   <  adversely impacted by COVID-19

To certify that a PPP loan is “necessary” to support ongoing operations, an applicant should have a financial position worse than merely “adversely impacted by COVID-19” (since that condition is presumed), but an applicant could have a financial condition better than a company unable to obtain “credit elsewhere” under the ordinary SBA test. As FAQ 31 suggests, a PPP applicant could have other sources of liquidity but be unable to access those sources without significantly damaging the business.

Documenting the Good Faith Determination of Necessity

FAQ 31 states that “a company should be prepared to demonstrate . . . the basis for its certification” of necessity. A company keeping PPP loan funds, therefore, is best advised to document its good faith determination that the funds are necessary to support ongoing operations in light of other access to capital. This documentation can take the form of an extensive memorandum to the file describing:

  • The company’s perspective on “the uncertainty of current economic conditions.”
  • How the company’s “ongoing operations” have been impacted by the economic uncertainty. Does the company expect a significant reduction in its business or work?
  • Likely business risks and effects expected to occur in the near term, assuming the economic uncertainty persists. Is the company unable to retain, recruit or train employees?
  • Any “other sources of liquidity” and planned uses for those sources, with an explanation of why additional financial support is necessary to avoid significant damage to the business. For instance, if available capital would not be used to keep workers employed, it is important to document the basis for other priorities.
  • The unavailability of other sources of liquidity on reasonable terms in light of market conditions. For example, would capital raises be on terms unfavorable to the company?
  • The reasons that the loan is necessary to “support the ongoing operations” given the economic uncertainty, likely risks and effects, as well as the other sources of liquidity and planned uses. Consider whether the company would have to lay off employees or reduce compensation without a PPP loan.

An internal memorandum to the file, with supporting documentation, should assist companies in demonstrating that their PPP certification was made in good faith. The memorandum should thoroughly address each aspect of the required certification.

Finally, in light of the potential for future investigations and enforcement actions, as well as public relations or political challenges, it is important that the use of PPP loan proceeds be carefully documented. In addition, extreme hygiene should be used in all emails regarding the loan proceeds and reasons for applying.  Emails or other written communications contradicting or compromising the need for the funds are not advised. Discretionary spending during the loan period should be very limited:  company retreats, charity golf sponsorships, retention bonuses, and other discretionary spending could be interpreted to show that the PPP funds were not necessary.  If a company has the financial strength to execute near-term acquisitions or spend growth capex, the PPP funds may not have been necessary.

Please visit our Coronavirus: Preparation & Response series for additional resources we hope will be helpful.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.