Federal Lawsuit Attacks SBA Paycheck Protection Program Guidance as Contrary to the CARES Act

COVID-19 Update

On May 4, 2020, three Paycheck Protection Program (PPP) borrowers that received $750,000 in first-round funding sued the Small Business Administration (SBA) and the Treasury Department in the U.S. District Court, Central District of California. They allege that SBA regulatory guidance contradicts certain provisions of the CARES Act and, therefore, is ultra vires and void.

The lawsuit focuses on the PPP Frequently Asked Questions (FAQ) guidance and, in particular, questions and answers issued on April 23 and April 28 in an apparent response to publicity regarding PPP loans made to companies some believed should not have been made eligible for the program, such as publicly traded restaurant chains. 

Under the provisions of the CARES Act, companies are required to certify in good faith on their PPP application that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” FAQ 31 suggests such businesses revisit whether the loan was, in fact, “necessary.” FAQ 31 acknowledges that the CARES Act suspended the requirement that borrowers must be unable to obtain credit elsewhere, but then goes on to say that borrowers must certify in good faith that their loan request is necessary to support ongoing operations, taking into account “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.” While the FAQ briefly attempts to distinguish this requirement from the similar requirement that was explicitly waived by the CARES Act, there is also an implicit acknowledgment that this guidance represents a significant shift: Any borrower with adequate sources of liquidity to support ongoing operations might be considered not to have made the requisite certification in good faith. Under SBA guidance, borrowers that applied for a PPP loan prior to this guidance and subsequently determined that they had adequate sources of liquidity at the time of application and that accessing such sources would not have been significantly detrimental to their business are allowed to repay their loans before May 7 (now extended to May 14) without penalty. This “safe harbor” was established to ensure prompt repayment of PPP loan funds that were obtained “based on a misunderstanding or misapplication of the required certification standard.” FAQ 37 responds to a question about the eligibility for PPP loans of businesses owned by private companies with adequate sources of liquidity by pointing back to the answer to FAQ 31. 

Notably, these FAQs were issued after many companies, including the three plaintiffs in this suit, had followed the rules as laid out by the CARES Act and its subsequent regulations and received their PPP loans. Additionally, prior to the issuance of these FAQs, many of these companies, including all three plaintiffs, had already used some or all of their loan funds to satisfy payroll obligations and pay other fixed costs allowed under the PPP.

Plaintiffs admit in their complaint that they have access to other credit facilities but argue that because PPP loans can be forgiven if certain conditions are met, these loans were the only way for them to access the liquidity necessary to retain their employees without incurring debt that could be significantly detrimental to their business. Plaintiffs argue that the loans were applied for in order to save American jobs and are being used to save American jobs, fulfilling the intention of the CARES Act. 

These three businesses are not alone in feeling whipsawed by changing federal policy. Many companies that have received PPP loans are now evaluating whether to repay them by the May 14 deadline. This creates a great deal of angst among borrowers of such funds—these borrowers not only must determine that they had “access” to liquidity to support operations, but also must determine whether such access would have been “significantly detrimental” to their businesses. As Treasury Secretary Steven Mnuchin has announced publicly that the SBA plans to conduct a “full audit of every loan over $2 million,” borrowers that choose not to return PPP funds by the safe harbor date and that are unsure of the application of the guidance should compile all relevant documentation that supports their conclusion not to repay such loan proceeds, in order to have it available should the government audit their loans.

Manatt will continue to monitor developments in the SBA Payment Protection Program and in other COVID-19 relief programs. Our COVID-19 resources are available at https://www.manatt.com/covid-19.

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