[Updated May 6, 2020]
[NOTE: Effective May 14, SBA further extended the safe-harbor payment deadline to Monday, May 18th]
“To repay or not to repay” seems to be the question of the day. When the SBA posted FAQ #31 on April 28, it raised a whole lot more questions than it answered. As most of you know, the Paycheck Protection Program loans are intended to provide liquidity to small businesses and induce them to keep their people on the payroll rather than having those employees on furlough and collecting unemployment compensation. These loans are to be forgiven to the extent they are used to cover payroll, mortgage, rent, and utility costs over the eight weeks after the loan is made (with certain limitations beyond the scope of this article).
In the application for a PPP loan, the small business applicant is required to certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant”. In context, it seems pretty clear that the “current economic uncertainty” referred to is related to the COVID-19 pandemic and not to general uncertainty faced by businesses every day. The ostensible purpose of these forgivable PPP loans was (and is?) to enable small businesses to avoid (or perhaps delay) the employee furloughs, salary reductions, terminations, and other actions necessary to reduce operating costs, while allowing them to keep the lights on and pay rent on a timely basis, despite a current or possible future downturn in business related to the pandemic.
The necessity of these loans, to most small business applicants, seemed pretty clear until the SBA issued FAQ #31. FAQ #31 reads as follows:
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. [Now extended to May 14, per FAQ #43]
Various public officials have made it clear that companies which took loans and cannot properly make the “necessity” certification will find themselves in hot water. This, of course, was in the wake of the disclosure that some well-known large companies and organizations had received PPP loans. However, the answer to FAQ #31 makes it clear that ALL borrowers must make this certification.
Further, FAQ #39 was added on April 29 following the announcement by Treasury Secretary Mnuchin on April 28, making it clear that all PPP loans over $2,000,000 would be subject to an audit (including a review of the necessity certification) upon application for loan forgiveness.
Now, because of all of the uncertainty caused by the additional factors to be considered under FAQ #31, the threat of sanctions for improperly made “necessity” certifications, and the threat of audits, many PPP borrowers are questioning whether to repay the PPP loan amount by May 14 as referenced in FAQs #31 and #43 in order to avoid the now-elevated risk entirely.
If you’ll indulge me for a little bit of editorial before we jump back into the legal analysis, it seems harsh that a small business owner should be put in a position of feeling compelled to repay a loan that covered payroll costs it incurred only because the loan was made available to it to begin with. If the PPP loan had not been available, many or most small businesses would have reduced expenses by terminating employees or sending them on furlough, reducing hours, requiring use of paid time off, or making salary reductions. Now that these businesses have spent the money to keep employees on the payroll – money which they would not have spent – putting them in a position in which they feel compelled to repay their loans in order to avoid the uncertainty and risks that come with not repaying by May 14 shifts the burden of keeping the economy running from the government to small businesses. This runs counter to the intent of the CARES Act.
However, the situation is what it is and if you’re like most PPP loan recipients, you’re at least thinking hard about the repayment option as the May 14 deadline looms.
We suggest that you talk to your attorney and your other advisors about whether you can support the certification that “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant”. How is your business currently doing? Are you able to access other sources of liquidity sufficient to support your ongoing operations in a manner that is not significantly detrimental to your business?
You should analyze these questions as you would any other business opportunity or risk and document your analysis and conclusions thoroughly. The factors to be considered include:
- The uncertainty faced by your business due to the pandemic. For example, will your suppliers be able to consistently supply the goods and services necessary to operate your business? If your business is closed, when will it be able to reopen? When will the pandemic end? Will there be a resurgence and possibly new “stay at home” orders if cases don’t decline or actually increase? Will your customers be back when things settle down?
- How is your business performing year to date compared to prior years?
- Are there indicators (such as the experience of your peers and competitors in your industry) that more difficult times are ahead?
- Are there restrictions on use of your balance sheet working capital or access to your lines of credit? For example, does the loan agreement with your bank include a minimum net worth requirement that would prevent you from spending the cash on your balance sheet to keep employees on the payroll? Will the combination of any downturn you have experienced or will experience, combined with the borrowing needed to fund ongoing operations and payroll, cause the business to fail any debt to equity ratio covenants you have?
- What other reasons might there be to avoid reducing the assets on your balance sheet or increasing your leverage?
- What risks to your business are created by reducing your available working capital now?
- If you furlough employees, will you be able to get them back when the business calls for it or will they have left for other opportunities, perhaps with competitors?
Having done (and documented) this analysis, if you are not confident in your certification that the PPP loan was necessary in order to fund ongoing operations, you should strongly consider repaying the loan. Remember, though, that your certification is to be made in good faith, based on your reasonable analysis. You’re not required to prove that other funding was not available or that your business would not have made it through without the PPP loan. You’re not obligated to conduct a double-blind placebo controlled, randomized trial. It seems to me that most small businesses will be able to make the certification with relative ease if the questions above have been asked and answered. And, as in your favorite math classes, show your work. It may be important later to be able to explain what led to your decision.
If you’d like any assistance with this process or would like to discuss any of the above, we’re here to help.
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