Updated: Apr 2
When applying for a Payroll Protection Loan (PPP), the CARES Act required borrowers to certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” In the first half of 2020, it didn't seem difficult to meet this burden. Most organizations waited with bated breath to see how the COVID-19 coronavirus and ensuing consumer and government responses would affect their business.
However, when the SBA conducts their inevitable audits of the loans (including all loans with a value over $2M), they will be conducting their review with the benefit of hindsight. If they determine that the loan itself was not "necessary", or the loan value was excessive, Borrowers could be faced with a number of dire consequences - including the repayment of the already-forgiven loan.
What Determines Loan 'Necessity'?
On October 7, 2020, the SBA and Treasury issued fresh guidance on PPP loan administration. This guidance included the following guidance on interpreting the 'Necessity' certification in the originating PPP loan application:
"[B]orrowers 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...Borrowers must make this [necessity] 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."
The guidance provides an example, showing that a public company with substantial market value and access to capital markets will unlikely be able to make the required necessity certification in good faith.
How Will the SBA Measure 'Necessity'?
The SBA's assessment of a good faith certification of necessity is likely to depend on the individual circumstances of each Borrower. However, liquidity, the availability of alternate credit, and incoming revenue are all likely to be considered.
The Treasury's example of the public company with substantial market value and access to capital markets demonstrates that liquidity will be a consideration in assessing the loan's necessity. Although COVID-19, and consumer and government responses thereto presented widespread economic uncertainty, the loan must have been necessary only to "support the ongoing operations" of the Borrower - not their survival, not their desire to meet budget forecasts, and certainly not their profit. Accordingly, if, at the time of the application, the Borrower had cash, liquid assets, or options to create liquidity, sufficient to simply 'keep the lights on' for a reasonable period of time despite the economic uncertainty, an SBA auditor may determine that the loan (or the size of the loan) was not necessary.
The availability of alternate credit is also likely to be considered when assessing the necessity of a loan and its value. The CARES Act suspended the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), so the mere availability of alternate credit is not necessarily fatal to a good faith certification that a PPP loan was necessary. However, just because the unavailability of alternate credit was removed from the PPP loan eligibility criteria does not mean that it can't or won't be considered when assessing the loan's necessity.
SBA auditors are also likely to examine the capacity of incoming revenue to "support the ongoing operations" of the Borrower. The government has already demonstrated a distaste for 'double-dipping' through its prohibition on government contractors seeking forgiveness of wage expenses covered by emergency funding made available to government agencies to keep contract employees "on a ready state". Likewise, if a Borrower expected to continue to receive operating revenue sufficient to support its ongoing operations, then an SBA auditor may find that the PPP loan was not necessary. If the Borrower is a government contractor and they continued to receive contract revenue, they may also be disciplined for double-dipping. However, as the guidance states that the Borrower's assessment of the economic necessity of the loan must have been made "at the time of the loan application", it's possible that the economic uncertainty at the time of the application made it impossible to determine whether typical revenue would continue. This is true also for government contractors, as many contracts were subject to 'Stop Work' orders, and section 3610 funding may have only become available or approved after the PPP application was submitted. Accordingly, the point-in-time qualifier in the good faith necessity certification may offer modest protection from the scrutiny of an SBA auditor assessing necessity with the benefit of hindsight.
What Should I Do If I'm Concerned My PPP Loan Wasn't Necessary?
First, don't panic! Remember that the necessity certification you gave in the loan application must be construed based on the circumstances, knowledge, and reasonable expectations available at the time of the loan application.
However, given the lag-time between the loan application and an SBA audit, and the consequences for a failed audit, it is important to formally assess and document all loan eligibility elements right away. An internal audit can pre-empt and resolve any issues that might later be discovered by an SBA auditor. It can also help to determine whether it is safer to repay the loan funds instead of applying for forgiveness.
If you are concerned that your PPP loan might not have been 'necessary' within the meaning of the CARES Act, contact Out-House Attorneys, LLC. Our corporate consulting service deploys attorneys with Executive and PPP Loan experience to audit your loan, and prepare the documents and evidence needed to prove to an SBA auditor that your loan was necessary.
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