On April 23, 2020, the Small Business Administration (“SBA”) issued additional guidance on eligibility for the Paycheck Protection Program (“PPP”) by updating its “Frequently Asked Questions” (“FAQ”) release on the program, which can be found here and its Interim Final Rule on the Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility (“Interim Rule”), which can be found here. The FAQ release and Interim Rule cover several aspects of PPP applications that have vexed applicants. Here we discuss PPP applicants’ required certification that their PPP loan request is necessary. This is important for publicly traded companies but is an issue that requires attention by all PPP applicants, including private companies.

Necessity Certification Must Take into Account Ability to Access Other Sources of Liquidity; Public Companies May be Ineligible

In FAQ #31, the SBA stated that, although the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere,

“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.” (emphasis added).

The SBA, in FAQ #31, specifically addressed public companies and expressed doubt about certain public companies’ eligibility under the program by stating:

“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.” (emphasis added).

This guidance follows significant media and legislative scrutiny of announcements by a number of public companies that they have applied for, and received funds from, the PPP. Additionally, earlier last week, Senator Marco Rubio and Treasury Secretary Steven Mnuchin expressed concerns about these companies making the “necessity” certification. Senator Rubio, the chair of the Senate Committee on Small Business and Entrepreneurship, referred to “multiple reports of companies abusing the [PPP] program” and promised aggressive oversight of the use of the PPP, including the use of subpoenas. Secretary Mnuchin warned of “severe consequences for people who don’t attest properly to this certification.” He also explained that “we want to make sure this money is available to small businesses that need it, people who have invested their entire life savings.”

Guidance Raises New Questions, while Existing Questions Remain

While the guidance attempts to clarify what was already an ambiguously-worded certification, it raises additional questions for borrowers:

• What is the threshold for “substantial market value” for a public company?
  
  
• Does a public company that is currently unable to raise equity capital on favorable terms really have “access to capital markets” in a meaningful way?
  
  
• Should debt financing be considered “significantly detrimental” to a business as compared to equity capital since it burdens the borrower?
  
  
• If a borrower has undrawn but committed capital under its current financing arrangements, can it make the good faith certification required by the PPP application?
  
  
• If a borrower raises capital during this period (either prior to or after receiving the loan, during the coverage period) for other purposes (hiring new personnel, product development), is it required to give the funds back?

And there remain questions in interpreting the language in the certification, for example:

• Does “current economic uncertainty” include both the immediate financial impact on the company and the expected loss of future business as a result of anticipated economic downturn?
  
  
• Does “necessary” also mean “exclusive”, prohibiting borrowers that obtain a PPP loan from obtaining other funding for other necessary uses, such as R&D, product development, manufacturing and production, and sales and marketing?
  
  
• Does “ongoing operations” include previously budgeted plans for new businesses or growth or, rather, solely current and historical operations?

These are only some of the questions that borrowers will have to grapple with under the new SBA guidance, and applicants and borrowers should answer these questions with an appropriate level of care. The PPP loan application requires specific certifications and representations, and the CARES Act established a Special Inspector General for Pandemic Recovery to carry out audits to regulate waste, fraud, and abuse.

Borrowers must also certify they understand that knowingly making a false statement to obtain a guaranteed loan from the SBA is punishable, depending on the circumstances, by imprisonment of up to thirty years and/or a fine of up to $1,000,000.

Safe Harbor for Repayment by May 7 by Ineligible PPP Borrowers

Although President Trump signed additional legislation on April 24, 2020 providing $310 billion in additional funding for the PPP, public pressure is mounting for the aid to reach businesses with greater need and for organizations that received PPP loans to return the funds if they do not need them.

Against this backdrop, in FAQ #31, the SBA provided a safe harbor for businesses that have already applied for a PPP loan, by stating:

“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.”

Based on filings with the Securities and Exchange Commission, through the time of writing of this alert, over 220 public companies have borrowed over $870 million through the PPP. It is also likely that additional public companies have applied, and been approved, for PPP loans that will be disclosed in upcoming quarterly reports filed with the SEC.

In addition to the focus on requirements for publicly traded companies, the SBA, in its Interim Rule, has also addressed eligibility of private equity funds, hedge funds and certain of their portfolio companies for PPP loans. In discussing private equity funds and hedge funds, the SBA emphasizes that, because of the nature of their business, they are ineligible for a PPP loan.

Further, in the Interim Rule, the SBA addressed whether portfolio companies of a private equity fund are prohibited from being eligible for a PPP loan by affirming that the affiliation rules apply to applicants under the PPP:

“Borrowers must apply the affiliation rules [that apply to the PPP as set forth in previous guidance by the SBA]. The affiliation rules apply to private equity-owned businesses in the same manner as any other business subject to outside ownership or control.”

Therefore, certain portfolio companies continue to risk falling outside the employee caps for PPP loan eligibility. Moreover, in that context, the SBA reiterated the same point about the requirement of a good faith certification of necessity by portfolio companies:

“all borrowers should carefully review the required certification on the Paycheck Protection Program Borrower Application Form (SBA Form 2483) stating that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”

This reference emphasizes that the principles highlighted in FAQ #31 apply to entities that are not publicly traded. It is unclear from this response by the SBA whether the fact that a borrower is private equity-backed by itself has additional implications on an applicant’s eligibility and ability to make the necessary certification. However, in a facts and circumstances analysis, based on factors including the investors’ return requirements, market forces and limited purposes for which other funding may be available, and in light of the reality that private equity backing does not mean the borrower has access to capital for the paycheck protection purposes for which the PPP is intended, there may be a logical place for both the PPP loan and potential funding from other sources for different purposes. The SBA has stated it may provide further guidance in these areas.

What should you do now?

Businesses that have already applied for PPP funds should take this opportunity to reassess their financial condition and eligibility for the program before May 7, 2020, paying close attention to whether alternative means of financing are available. Applicants that are now uncertain as to their eligibility should consider with their advisors and their boards of directors whether they should maintain or withdraw their PPP loan application.

Borrowers that have received PPP loans and determine that they are ineligible would need to repay their loans by May 7, 2020 to take advantage of the good faith certification safe harbor.

New applicants should carefully review their eligibility under the new SBA guidance, keeping in mind that they will not have access to the safe harbor mentioned in FAQ #31, which is limited to borrowers that applied for a PPP loan prior to the issuance of the new guidance on April 23, 2020.

All applicants should keep in mind that their PPP application is not the last time that a certification will be required. The CARES Act provides that when requesting forgiveness at the conclusion of the 8-week borrowing period, borrowers are required to certify that their forgiveness documentation is true and correct and that the amount for which forgiveness is requested was used to retain employees or for other permitted uses.

Applicants should engage their advisors, management and boards of directors in reviewing the factors relevant to the applicant to determine whether to apply for a PPP loan, including making a good faith determination of necessity. Those factors can include, for example: cash on the balance sheet, cash flows and cash runway, access to additional capital and the terms of such capital, an analysis of the business as a going concern, financial forecasts, budget and business plan, planned headcount, and the economic need for the loan and its impact to the business and its operations. Applicants should document their board of directors’ review, determination and approval and be prepared to provide supporting documentation for their determination of necessity in obtaining the loan and to show the funds were used for permitted uses when requesting forgiveness.

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