The Small Business Administration ("SBA") caused great concern among most PPP loan recipients two weeks ago when they issued new guidance regarding the "loan necessity" standard. The SBA then provided a one week reprieve by extending the "safe harbor" repayment deadline to May 14, 2020 with the promise of additional guidance as to "how it will review the certification prior to May 14, 2020." And just in the nick of time that guidance arrived in the form of the SBA's PPP Loans Frequently Asked Questions ("FAQ") No. 46 on May 13, 2020.
46. Question: How will SBA review borrowers’ required good-faith certification concerning the necessity of their loan request?
Answer: When submitting a PPP application, all borrowers must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA, in consultation with the Department of the Treasury, has determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to this issue: Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith. SBA has determined that this safe harbor is appropriate because borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment than borrowers that obtained larger loans. This safe harbor will also promote economic certainty as PPP borrowers with more limited resources endeavor to retain and rehire employees. In addition, given the large volume of PPP loans, this approach will enable SBA to conserve its finite audit resources and focus its reviews on larger loans, where the compliance effort may yield higher returns. Importantly, borrowers with loans greater than $2 million that do not satisfy this safe harbor may still have an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance. SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form. If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request. SBA’s determination concerning the certification regarding the necessity of the loan request will not affect SBA’s loan guarantee.
Based on this new guidance, most PPP loan recipients can take a deep breath and relax.
For those who acted in good faith and whose original loan amount was less than $2 million, the simple fact that they applied for the loan now satisfies the loan necessity good faith standard regardless of the existence of lines of credit and access to other sources of capital. This only makes sense as many small businesses may need access to those lines of credit and other sources of capital to fund operating expenses as we come out of the current economic situation. If 75% of PPP loan proceeds are spent on payroll expenses and the remainder is used for other qualified expenses, most businesses will likely have their PPP loans forgiven.
For those who acted in good faith and whose original loan amount was more than $2 million, the fear of fines and penalties and referral to other government agencies for not meeting the "loan necessity" standard has been removed. This is good news. To help establish "adequate basis', those loan recipients should continue to contemporaneously document the need and rationale for the loan as we have previously written. In the end, their loan forgiveness will be determined by SBA. In the worst case scenario, the loan may not be forgiven and will have to be repaid.