Last Updated: May 13, 2020
UPDATE: On May 13, the SBA and Treasury Department released FAQ #46, which provides that:
- Any borrower that, together with its affiliates, received PPP loans with a principal amount of less than $2m will be deemed to have made the necessity certification in good faith.
- With respect to borrowers that, together with their affiliates, received PPP loans of $2m or more, if the SBA determines the borrower lacked an adequate basis for the necessity certification and, in response, the borrower repays the loan, the SBA will not pursue administrative enforcement or referrals to other agencies based on the necessity certification.
The SBA and Treasury Department also extended the amnesty date from May 14 to May 18 (FAQ #47).
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In recent weeks, the certification required under the Payroll Protection Program (“PPP“) that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” has caused confusion and anxiety among PPP loan recipients.
In response to widely-publicized accounts of large publicly-traded businesses (Ruth’s Chris, Potbelly, and Shake Shack) and wealthy privately-owned businesses (the LA Lakers) receiving PPP loans, the SBA and Treasury Department released FAQs relating to the “necessity” requirement of PPP loans, bringing this issue to the forefront. This note provides a brief summary of the current state of the necessity requirement and tips for businesses to evaluate and address that requirement.
The SBA and Treasury Department indicated that they intend to provide additional guidance prior to May 14, 2020. We will update this note once that guidance is released.
What is the Necessity Requirement?
The PPP loan application requires applicants to certify, among other things, that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The SBA and Treasury Department subsequently released two FAQs directly relating to that certification:
“31. 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.”
“37. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?
Answer: See response to FAQ #31.”
The SBA and Treasury Department have since extended the amnesty date from May 7, 2020 to May 14, 2020 and indicated that they intend to release additional guidance regarding the necessity requirement prior to May 14 (FAQ #43).
The lack of clarity in those rules, together with the heavy-handed punishment for false certification described in the PPP loan application, have given many loan recipients pause and emphasized the importance of exercising caution in making the necessity certification.
Breaking Down the Necessity Requirement
Neither the certification or the FAQs provide objective criteria for necessity, but the following points can be distilled:
- Applicants must make the necessity certification in good faith.
- In making the certification, applicants must evaluate both (a) their access to other sources of liquidity to support operations, and (b) if there are other sources of liquidity, whether they would be significantly detrimental to the business.
- PPP loans provided to large public companies will be subject to heightened scrutiny, however the principle applies equally to businesses that are owned by private companies and presumably other privately-owned businesses. On a related note, the SBA and Treasury Department released guidance providing that private equity and hedge funds are not eligible for PPP loans, but portfolio companies of private equity funds are eligible if they meet the PPP’s requirements.
- Companies must be prepared to demonstrate their basis for the necessity certification upon request.
In essence, to be eligible for a PPP loan, (a) the business must be adversely impacted by the COVID-19 pandemic and face economic uncertainty, (b) the loan must be necessary to support the business’s ongoing operations, and (c) the business must not have other sources of liquidity or, if it does, those sources of liquidity would be significantly detrimental to the business.
We note that the requirement regarding other sources of liquidity is particularly unclear. That requirement seems to conflict with the text of the CARES Act, which provides that PPP loans are not subject to the SBA’s typical requirement that borrowers be unable to obtain credit elsewhere.
At this time, it seems unlikely that merely having access to other sources of funds would make a business ineligible for a PPP loan. This will likely be a balancing test based on the facts and circumstances. However, if a business has access to other funds, it should be prepared to explain why the use of those funds is impractical or could be significantly detrimental to the business. We are hopeful that the SBA and Treasury Department will clarify this requirement in its upcoming guidance.
What to do if you Received a PPP Loan
Businesses that received a PPP loan and have become confident that they do not meet the necessity requirement should consider returning the loan by May 14 in order to receive amnesty. That will result in no harm, no foul and the business can move on.
However, most businesses will find themselves in a gray area regarding the necessity of the loan. Those businesses should await further guidance. In addition, all business with a PPP loan should carefully document their consideration of the necessity requirement and related guidance as well as their conclusion that the loan is necessary. This may take the form of a memorandum outlining, among other things:
- The impact of COVID-19 on the business and the related economic uncertainty that the business is facing.
- The manner in which COVID-19 is expected to adversely affect the business’s ongoing operations. For example, is the business likely to experience a reduction in work/business? Would the business potentially have to lay off employees in the absence of the loan?
- Whether alternative sources of liquidity are available on reasonable terms and not significantly detrimental to the business. If so, are those sources readily available and sufficient in the absence of a PPP loan?
Treasury Secretary Mnuchin announced that any loan over $2 million will be subject to a full review by the SBA before being forgiven. But no PPP loan is immune. A thorough memorandum including those points, any other relevant considerations, and supporting documentation will help a business demonstrate that it made the necessity certification in good faith if required by the SBA.
Conclusion
Businesses that received PPP loans should carefully assess and document the necessity of their loans under the standards established in the PPP and subsequent guidance. Businesses who find themselves in the vast zone of uncertainty should maintain and reassess their loans following the release of additional guidance. Any business that concludes it does not meet the PPP’s necessity requirements should return the loan by May 14 in order to avoid potential fines and penalties.