SBA and Treasury To Issue Loan Necessity Questionnaires to Borrowers With Loans of $2 Million or More

November 17, 2020

By: Allan Grauberd and Benjamin Danieli

On October 26, 2020, the Small Business Administration (“SBA”) issued a notice to one of the primary bodies tasked with overseeing the forgiveness process under the Paycheck Protection Program (“PPP”); the Office of Management and Budget (“OMB”)1The notice, published on the federal register, seeks approval for the introduction of two new SBA forms designed to test borrower certifications that their PPP loan applications were a “necessity” imposed by the COVID-19 pandemic.  The two proposed forms, not yet available on the SBA’s website, are for for-profit (SBA Form 3509) and non-profit (SBA Form 3510) entities that together with their affiliates “received PPP loans with an original principal amount of $2 million or greater. . . .”

Pursuant to the regulations accompanying these two forms, borrowers who took out loans of $2 million or more as part of the PPP would be required to submit the form to their individual lender for ultimate review by the SBA.  This means borrowers subject to the regulations will have to gather and disclose a large volume of potentially sensitive business information.  Such information falls into two general categories; a Business Activity Assessment and a Liquidity Assessment.  The required disclosures concern details about a company’s assets, changes in revenues and operations due to the COVID-19 pandemic, ownership structure, profit distributions, and more.

The Background

Shortly after Congress passed the unprecedented economic bailout package under the Coronavirus Aid Relief and Economic Recovery Act (“CARES Act”) on March 27, 2020, the PPP began accepting loan applications.  The PPP, an essential piece of the CARES Act, was designed to assist small business that had fallen on hard times throughout the United States as a result of the COVID-19 pandemic.  Specifically, the PPP would provide fully funded loans backed by the U.S. Department of Treasury and delivered through the SBA and individual private lenders, to qualifying businesses.  PPP loan proceeds could be used for specified costs including

“payroll costs, costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave, and insurance premiums, mortgage interest payments, rent payments, utility payments, interest payments on other debt incurred prior to February 15, 2020, and to refinance an eligible SBA Economic Injury Disaster Loan.”

PPP loans were particularly attractive to borrowers because of their unique forgiveness feature.  If borrowers could show at the end of a specified “covered period"2 that they used loan proceeds for the specified costs only, then the entire sum of the loan borrowed would be forgiven; meaning that borrowers would not have to repay any of the proceeds.  There have been numerous changes to the forgiveness process, application forms used, and applicable exceptions and exemptions for various borrowers since the PPP began accepting applications in April of 2020.  More details on these updates and the ever-changing PPP landscape are available on our website.

Most recently however, the SBA is refocusing on a qualification requirement originally discussed in our April 29, 2020 article A Curveball by the SBA Unsettles the Application Process for the PPP Program and addressed again in our May 13, 2020 article Last Minute FAQ Creates Some Relief on Necessity Certification.  Namely, through the two new proposed SBA forms 3509 and 3510, the SBA is seeking to test whether borrowers, with loans of greater than $2 million, were actually in need of the funds by requiring them to submit specified documentation.  Our two articles noted above referenced the ambiguity of the “necessity” qualification and the fact that borrowers were not given any indication that alternate sources of financing needed to be considered before accepting loans until the publication of FAQ 31 on April 23, 2020, after many loans had been made already (and in many cases, funds spent).

The Necessity Requirement

Pursuant to the CARES Act, borrowers applying for PPP loans were required to certify on their initial PPP application that, “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  The PPP application form is available on the SBA’s website here.  Without making this certification, borrowers were not eligible and did not qualify for PPP loans.  The certification, however, was vague and ambiguous as to what the term “necessity” meant and what borrowers were required to show to meet the appropriate standard.

On April 23, 2020, the SBA and Treasury issued an FAQ which further detailed the necessity certification.  More specifically, FAQ 31 stated,

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. (emphasis added).

Shortly thereafter, on May 13, 2020, the SBA issued another update to its FAQ guidance.  FAQ 46 further addressed the necessity requirement.  FAQ 46 stated that borrowers with loans of under $2 million will be “deemed to have made the required certification concerning the necessity of the loan request in good faith.”  The FAQ however, did not provide much clarity on the requirements for borrowers with larger loans to meet the “good faith necessity” standard.  FAQ 46 stated,

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. (emphasis added).

The most recent version of the application FAQ is available on the SBA’s website here.  Since May, the SBA and Treasury had not again addressed the necessity requirement until the agencies’ proposed two new forms.

SBA Forms 3509 and 3510

The two new proposed forms seek additional information from borrowers which will assist the SBA in maximizing “program integrity and protect[ing] taxpayer resources” by determining whether a borrower’s “good-faith necessity” certification was accurate.  While the cover note to the form states that “[r]eceipt of this form does not mean that SBA is challenging that certification” it also states,

“Failure to complete the form and provide the required supporting documents may result in SBA’s determination that you were ineligible for either the PPP loan, the PPP loan amount, or any forgiveness amount claimed, and SBA may seek repayment of the loan or pursue other available remedies.”

The cover note also explains that individual lenders will provide the form to the applicable borrowers and that the form must be submitted “within ten business days of receipt from your Lender,” an extremely short period given the information that must be submitted.  Specifically, the form requires that borrowers submit additional information falling into two general categories; a Business Activity Assessment and a Liquidity Assessment.  The required information for each category is highly detailed.

For the Business Activity Assessment, borrowers are required to submit information including, among other things:

  • Gross revenue in specific quarters of 2019 and 2020 depending on when the borrower entity was in existence;
  • Whether a borrower was ordered to shut down by state or local authorities as a result of COVID-19 and the start and end dates of such shutdown order(s);
  • Whether a borrower was ordered to “significantly alter its operations by a state or local authority,” the start and end dates of such alteration order(s), and details describing how a borrower’s business was altered;
  • The amount of additional cash outlays required by alteration orders;
  • Whether a borrower voluntarily shut down or altered operations since the beginning of the COVID-19 pandemic (March 13, 2020), the start and end dates of such voluntary closures or alterations, and details concerning why a borrower voluntarily shutdown or altered operations; and
  • Whether a borrower began any new capital improvement projects between the beginning of the COVID-19 pandemic and the end of their covered period not due to COVID-19 and the approximate cash outlays for those projects.

For the Liquidity Assessment, borrowers are required to submit information including, among other things:

  • A borrower’s cash and cash equivalent assets as of the last day of the calendar quarter immediately before the it applied for a PPP loan;
  • Payment of dividends or other capital distributions (other than pass-through estimated tax payments) between the start of the COVID-19 pandemic and the end of a borrower’s covered period and the amounts of such distributions;
  • Prepayment of debts between the start of the COVID-19 pandemic and the end of a borrower’s covered period and the amounts of such prepayments;
  • Whether a borrower has, and how many, employees with annual compensation and total compensation (including gross salary, gross wages, gross tips, gross commissions, and allowances for dismissal or separation) greater than $250,000;
  • Whether a borrower was a publicly traded company or was owned, by greater than 20%, by any publicly traded company, on the date of its PPP loan application;
  • If a borrower was not publicly traded, then information on its book value as of the last day of the calendar quarter immediately before the date of its PPP loan application;
  • Whether the borrower was a subsidiary (i.e., was at least 50 percent of borrower’s common equity, or equivalent equity interest, owned by) of another company (the parent company), and the location where the parent company is organized;
  • Whether private equity or venture capital firms or hedge funds had a greater than 20% ownership stake in a borrower at the time it applied for a PPP loan (the implication being an inquiry into whether funds could have been provided by such firms or funds); and
  • Funds received from other CARES Act programs excluding the PPP, the names of those programs, and the amounts received under those programs.

Lastly, the form also includes three certifications which filers must initial.  Most important among them, is the certification stating that “knowingly making false statements” on the form can be punishable by up to thirty (30) years in prison and a fine of not more than $1,000,000 if borrowers make false statements to a federally insured institution.

The proposed questionnaires are a potentially large hurdle for borrowers with larger PPP loans, as the required documentation will likely be voluminous.  Further, if adopted, these questionnaires will likely require significant amounts of time to accurately complete with possible time intensive information gathering.  While the questionnaires have not yet been adopted and are not yet available on the SBA’s website, PPP borrowers with loans of greater than $2 million should begin collecting the required information now, as the deadline to return the form is only 10 business days.

Please contact Allan Grauberd at (212) 554-7883/agrauberd@mosessinger.com or Benjamin Danieli at (212) 554-7848/bdanieli@mosessinger.com, if you have any questions regarding the most recent changes.

This article is current as of November 17, 2020 and reflects the state of the relevant laws, regulations, and guidance to that point.  Any subsequently issued, legislation, rules, and guidance by Congress, the United States Treasury, the Small Business Administration and other various government agencies may change the information contained herein.  While this article is meant as a useful resource concerning matters arising under the Paycheck Protection Program, it should not be considered legal advice for any specific situation.

 

[1] The OMB is a governmental entity existing within the executive branch of government and is tasked with assisting the President “in meeting his policy, budget, management and regulatory objectives and to fulfill the agency’s statutory responsibilities.”  See https://www.whitehouse.gov/omb/.

[2] A borrower’s “covered period,” as adjusted by the Paycheck Protection Program Flexibility Act (June 5, 2020), includes an 8 or 24 week period beginning on the date of PPP loan disbursement during which a borrower may use PPP loan proceeds for costs specified in the CARES Act and further detailed in various SBA and Treasury Interim Final Rules and FAQs.  See Paycheck Protection Program, Loan Forgiveness for additional details.