Summary of Guidance

An interim final rule published by the SBA on May 6, 2020, offers the following Q&A: 

[QUESTION:] Do student workers count when determining the number of employees for PPP loan eligibility? 

[ANSWER:] Yes, student workers generally count as employees, unless (a) the applicant is an institution of higher education, as defined in the Department of Education’s Federal Work-Study regulations, 34 CFR Sect. 675.2 and (b) the student worker’s services are performed as part of a Federal Work-Study Program (as defined in those regulations) or a substantially similar program of a State or political subdivision thereof. Institutions of higher education must exclude work-study students when determining the number of employees for PPP loan eligibility, and must also exclude payroll costs for work-study students from the calculation of payroll costs used to determine the PPP loan amount. The Administrator, in consultation with the Secretary [of Treasury] has determined that this is a reasonable interpretation of section 1102(a) of the CARES Act’s reference to “individuals employed on a full-time, part-time, or other basis. 

In providing this guidance, the SBA notes their interpretation of section 1102(a) is because students who participate in Federal Work-Study program are provided jobs as part of their financial aid and that the services provided by student workers are “incident to and for the purpose of pursuing a course of study.”

Ongoing questions remain

Since April 3, 2020, the date when a qualified lender could accept PPP applications, all eligible recipients who applied for a PPP loan had to make a good faith certification (as defined by Section 1106(a)(2)(G)(i)) that: (1) “the uncertainty of economic conditions” made the loan necessary to support the ongoing operations of the eligible recipient; (2) the funds would be used to retain workers or make mortgage, rent or utility payments; and (3) the eligible recipient did not either make or receive multiple PPP loans from other lenders. 

Almost immediately following the start of the PPP application period, numerous large, national businesses came under sharp criticism for allegedly receiving millions in PPP loans. Central to this rebuke was how some of these businesses could be eligible for a PPP loan given these companies’ apparently strong capital and liquidity profiles. In the aftermath of these reports, the SBA published two sets of FAQs, each containing specific answers to this criticism.

In the April 23 iteration of these FAQs¹, Question 31 provides: 

[B]efore 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.²

While this FAQ did provide additional considerations, such as the applicant’s ability to access liquidity sources sufficient to support ongoing operations, the guidance to date from the SBA and Treasury is silent on what steps and considerations an eligible recipient of a PPP loan should establish to support that its loan request—and certification thereto—was both “necessary” and “in good faith.”

Original Guidance - Necessity for PPP Loans

Many eligible recipients have applied and, in some cases, received PPP loans, and in all cases, these recipients signed a certification that: “current economic uncertainly makes this loan request necessary to support the ongoing operations of the Applicant.” (PPP Application Form). Moreover, each eligible recipient who made all certifications required as part of the Application Form also certified that: “the information provided in the application and the information provided in all supporting documents and forms [was] true and accurate in all material aspects.” 

The only guidance available at the time the first round of PPP funding was the statute—the CARES Act—itself. Thus, until FAQs were first published by the SBA on April 23, 2020, the only standard that a borrower had for consideration was whether or not “the uncertainty of current economic conditions [made] the loan necessary […] to support the ongoing operations of the eligible recipient.” 

In light of the FAQs, which were last updated on May 5, 2020, eligible recipients should consider their current business activity, their access to and their ability to access sources of liquidity (including but not limited to: firm capital, capital contributions by owners, and credit separate and apart from PPP funding), and whether such use of other sources of liquidity is significantly detrimental to the business. 

Should higher education institutions revisit PPP loans?

Some eligible recipients, including nonprofit organizations such as colleges and universities that had their PPP loans funded in the first round have been able to access their funds for almost a month now. And, many entities did what they believe was adequate due diligence at the time of their certification, especially given a lack of further definitions or regulatory guidance for the term “necessary” as used in the statute. 

Yet, the parameters has changed: 

• First, SBA published FAQ #31 (guidance relayed on access to liquidity) on April 23. 
• In addition to FAQ #31, the SBA also published FAQ #37, which provides: 
  • Q: Do businesses owned by private companies with adequate sources of liquidity to support the business’ on-going operations qualify for a PPP loan? 
  • A: See response to FAQ #31. 
• Also in the first iteration of the FAQs, SBA stated that “any borrower that applied for a PPP loan prior to the issuance of this guidance (April 23, 2020), and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.” (Note: On May 5, 2020, the SBA updated the FAQ #43 to extend this deadline to May 14, 2020.) 
• On April 29th, the SBA announced in an update to the April 23 FAQs that it will review all requests for forgiveness of PPP loans in excess of $2 million to “further ensure PPP loans are limited to eligible borrowers in need.” (see, FAQ #39) 
• On May 1, White House officials reported that President Trump agreed with Treasury Secretary Mnuchin that elite private schools with significant endowments should return PPP loan funds.³ While the comments made by the President and Secretary appear focused on K-12 schools with substantial endowments, these comments have certainly been noted within the higher education community. 

Accordingly, any eligible recipient, including higher education institutions like colleges and universities, who received funding should carefully consider their facts and circumstances in light of FAQs 31, 37, and 39, and take appropriate steps (where determined necessary) in light of this May 14 date. 

What is really at stake here?

While it is likely that no penalty would result with full repayment of loans by May 14, 2020, the question remains as to what, if any, penalties might be imposed and result could arise for not satisfying the  that the PPP loan was necessary to support ongoing business operations.

• Possible risks associated with false statements or certifications made by PPP applicants to obtain a guaranteed loan from SBA include potential exposure to liability under the federal False Claims Act, 31 U.S.C. sections 3729 et seq. (FCA). As set forth in more detail in our recent CARES Act Client Alert and podcast, the FCA creates liability for anyone that knowingly submits a false claim or record to the government to obtain government funds. The FCA also prohibits knowingly or improperly avoiding or failing to repay an obligation to the government. Under a “false certification” theory of liability, a false representation of compliance with PPP certifications can represent the false claim or statement necessary to trigger potential FCA liability. Further failure to return funds by the safe harbor date – May 14, 2020 – or misstatements in order to obtain loan forgiveness under the program also may trigger potential liability.
• Several aspects of the FCA create significant risk for educational institutions and other entities receiving PPP funds:
  • First, under the FCA, the “knowing” submission or use of false claims/statements does not require specific intent to defraud the government or even actual knowledge that a statement is false; to the contrary, statements or records made with “deliberate ignorance” or “reckless disregard” for whether representations are true or false satisfy the FCA’s definition of a “knowing” violation. In other words, persons applying for or receiving funds must keep abreast of SBA guidance on necessity and other certifications and ensure they are compliant and have documented the basis for certifications.
  • Second, while statements made by the U.S. Department of Justice suggest that the government is committed to pursuing claims,⁴ potential risk also arises from within. The FCA’s qui tam or “whistleblower” provisions allow private citizens to bring FCA suits on behalf of the government, and these most often are employees or former employees. In addition to current and former employees, whistleblowers often include competitors or others who may know about the institution’s operations, such as professors, other professional staff, and even students. Whistleblowers (or “relators”) who file suit under the FCA have significant incentives to bring actions, potentially receiving up to 30 percent of any recovered damages or settlement proceeds.
  • Third, generally speaking, the allegedly false claims and statements satisfy the FCA’s “materiality” element when there is evidence that the government would not have made the loan in the first instance, or would have demanded repayment of the loan, had it known the applicant’s “true” circumstances. For example, if SBA would have denied or required repayment of a PPP loan in the event it knew about the applicant’s economic resources and related circumstances, then the applicant’s certification that the funds are necessary to support ongoing operations potentially could constitute a “material” false claim/statement.
  • Fourth, those potential recoveries can be punitive. The FCA allows the government to recover treble damages – triple the government’s actual damages – as well as civil penalties, which range from $11,181 to $22,363 per false claim. The Department of Justice obtained more than $3 billion in settlements and judgments from civil cases involving fraud and false claims against the government in the fiscal year ending September 30, 2019. Following that influx of significant government funds under the CARES Act, we expect those recoveries to increase in the coming years.
• On a video town hall held on May 4, 2020, SBA attorneys stated that they believe the focus will be on “intentional acts.” Said differently, examination as to whether or not there was a “good faith effort” on the part of the applicant as to the “certification of necessity” at the time the loan was approved.⁵
• SBA officials also commented that, “absent an allegation of fraud or misrepresentation” borrowers would “pay back the loan plus interest,” assuming that the borrower could show good faith.”⁶
•  In addition to the possible civil and criminal penalties, eligible recipients should also consider the public relations impact that news it received PPP loan monies could have for the entity. As the last tranche of funding is allocated, more focus may arise as to which public and private entities were able to obtain PPP loans. 

Establishing good faith regarding necessity: Best practices

There is no guidance within the CARES Act as to what constitutes good faith. Notwithstanding, eligible recipients should carefully consider whether, both at the time the loan was funded as well as when forgiveness may be sought, it undertook a good faith effort to determine that the loan and the use of loan proceeds were “necessary […] to support the ongoing operations of the eligible recipient.” 

Although CARES Act does not define either “necessary” or “good faith”, other agency authority and judicial guidance relevant to the Department of Treasury may prove helpful. Keep in mind, however, that the SBA is an independent federal agency and that reference to the statute and regulations relevant to the Department of Treasury may not be the ultimate standards applied on a going-forward basis.

• “Necessary” has many definitions. In one of the earliest U.S. Supreme Court cases that considered the meaning of the phrase “ordinary and necessary” the Court held that certain deductions for expenses claimed by a taxpayer were “necessary” because they were “appropriate and helpful.”⁷ In light of FAQ #31, however, it seems doubtful that all an eligible recipient would need to show is a good faith effort to determine that the loan would be “appropriate and helpful.” 
• On a video town hall held on May 4, 2020, SBA attorneys addressed how an eligible recipient should best show it made a good faith determination that a loan was necessary. These are the key questions raised by SBA Attorneys on this call: 
  
  • What was the level of current business activity at the time the loan was sought? 
  • What was the ability of the eligible recipient to access current liquidity to support current and ongoing business operations? 
  • Could the eligible recipient have obtained capital elsewhere at the time of certification? 
  • Could the eligible recipient have secured access to liquidity elsewhere at the time of certification? 
  • Was the lack of capital and/or liquidity elsewhere legitimate? 
  • Did the eligible recipient undertake due diligence when determining if an entity had sufficient capital and/or access to liquidity? 
  • Was there any intention on the part of the eligible recipient to mislead? (This point was emphasized by the SBA Associate General Counsel, Mr. Klein.)
• If the eligible recipient did have access to capital or liquidity at the time of the application (such as an endowment), key decision makers, including directors and officers, should memorialize the factors discussed and considered at the time of certification. 
• While it is impossible to determine with absolute certainty what will constitute good faith, drawing from judicial cases that have examined whether or not a taxpayer has acted in good faith, some courts have been persuaded that a taxpayer seeking independent evaluation of their circumstances suggests good faith. Some of these cases refer to this inquiry as “an investigation,” which may be further indicia that an eligible recipient should consider independent advice when undertaking this evaluation.⁸
• Even if the eligible recipient has access to capital and/or liquidity, what detrimental results would result if that capital and/or liquidity is used? 
• Eligible recipients should consider the impact of any reductions in operational costs when determining if PPP loan funds are necessary to support ongoing business operations. 
• Eligible recipients should also consider how the SBA has looked at the concept of “necessary” in administering other transactions, such as the Economic Injury Disaster Loan. To the extent possible, eligible recipients should consider, in consultation with their counsel, seeking input of their financial advisors, including their accountants and lenders. 
• Loan recipients should consider documenting the efforts they undertook to learn about and understand the eligibility requirements (including reference to the resources considered and relied upon), efforts to ensure satisfaction of those requirements, and an explanation of why they believe those requirements have been satisfied. This contemporaneous documentation may assist in justifying the applicant’s decision-making rationale in the event of a subsequent audit, governmental scrutiny, or litigation. 

Conclusion

While the interim final rule published on May 6, 2020 provides clarification that student workers will not count as employees where the eligible recipient is an institution of higher education and the student worker’s services are performed as part of a Federal or State work-study program, colleges and universities must still decide if the certification made at the time of loan application (and application for loan forgiveness) were in good faith and necessary to support ongoing school operations. 

Certainly, institutions of higher education will continue to experience the devastating economic consequences of widespread interruptions, restrictions and closures caused by the COVID-19 pandemic in the months and, perhaps, years to come. While monies available under the PPP have provided a lifeline to some of these institutions, others may elect to return their funds based on concerns raised since the CARES Act was enacted. 

With little known authoritative guidance as to how the SBA will impose penalties and other available sanctions on eligible recipients who certified their eligibility for PPP funds, entities who received these loans are now left to answer this question: Does the extent to which an entity can establish its need for PPP loan funds outweigh the unknown risks in keeping the money? 

The best answer at this point rests in how well an eligible recipient can show the extent to which it exercised good faith in determining that the PPP loan was necessary to its ongoing operations, and that the access to any other available capital would be to the clear detriment of the borrower. 

Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.

For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com.

1. Small Business Administration, 'Paycheck Protection Program Loans Frequently Asked Questions (FAQs)'  Available at www.sba.gov/ (last updated May 3, 2020).
2. Id.
3. Politico, 'Trump believes elite K-12 schools should return federal rescue loans, aide says', Available at www.politico.com/ (last accessed on May 6, 2020). 
4. The FCA imposes liability for knowingly presenting a false or fraudulent claim or making a false record or statement material to a false or fraudulent claim. A defendant can also be liable under the FCA for a “reverse false claim” if it knowingly makes or uses a false record or statement for the purpose of avoiding or decreasing an “obligation” owed to the federal government. 31 U.S.C. section 3729(a)(1)(G).
5. Comments of John Klein, Associate General Counsel, SBA, and Sam Lee, Attorney, SBA on a webinar held on May 4, 2020. Note that the speakers also raised that there could be a focus on whether or not a good faith effort was made at the time loan forgiveness was sought by the borrower. 
6. Id.
7. Welch v. Helvering, 290 U.S. 111, 54 S. Ct. 8 (1933)
8. Gordon Kaufman, et ux. v. Commissioner, TC Memo 2014-52 (2014).

Client Alert 2020-306