United States of America: Public-Private Partnership Loans: An Overview of Advance Directives
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The Paycheck Protection Program (“PPP”) began with hasty legislation and a race for financial support in the midst of a pandemic. This race wasn’t straight as the Small Business Administration (“SBA”) and the US Treasury scrambled to build the program on the fly, releasing a series of FAQs and cutting-edge directives. Then banks tried to absorb this directive and build systems that could withstand an application attack. After several months and multiple waves of funding, companies completed their initial applications, banks completed eligibility determinations, and thousands of loans were successfully issued. With the initial scramble behind us, SBA and Treasury guidelines became more realistic in time for thousands of forgiveness requests.
Although the apparent chaos of the initial application process has ended and PPP funding has been fully spent, the true test of applications submitted since April 2020 is yet to come. Borrowers are now entering a new phase consisting of requests for forgiveness, audits, fraud reviews and enforcement. Given the apparent prospect of a 20/20 hindsight and the shaky grounding of guidance that agencies have developed under heavy pressure, this phase may be the toughest yet.
In short, not every conclusion made in the rush for PPP money was correct, and not every borrower really understood the nuances of small business rules as they raced the clock to obtain financing. The confluence of speed, dynamic routing, and hard rules will lead to a rejection of tolerance and serious conversations with banks and regulators.
Anticipating a rush in tolerance denial, the Small Business Administration recently revealed its new procedures for challenging unfavorable tolerance determinations. The Small Business Administration also audits larger and/or suspicious loans, making it clear that this review can continue even after the forgiveness decision has been made. This means that even companies that have received forgiveness are not necessarily clear. Meanwhile, the US Department of Justice (“DOJ”) has been busy prosecuting PPP loan fraud.
Companies that are disappointed by the Small Business Administration’s forbearance decisions, have received specific questions during an audit, or find themselves embroiled in an enforcement action, should review our previous advice regarding the specifics of the PPP loan program. Below, we’ve included the highlights:
- affiliation. This is easily the hardest part of PPP analysis and is the part that commercial borrowers are likely to be unfamiliar with. The affiliation rules that apply to PPP borrowers are those contained in 13 CFR 121.301. In general, if a company, along with its subsidiaries, has fewer than 500 employees, it meets one of the basic criteria for PPP eligibility. However, some clients benefit from the application of the alternative volume rule, which is based on the annual revenue and net worth of the borrower and its affiliates. Others, such as restaurants and hotels, are subject to industry-specific affiliation rules. However, the key to all of this is whether or not borrowers consider other entities owned and controlled by their affiliates when assessing eligibility. We describe size and affiliation rules here.
- Forgiveness process. Forgiveness accounts are not necessarily straightforward. We previously provided an easy checklist and observed the interaction between tolerance and recovery under federal contracts.
- Impact on mergers and acquisitions. In October 2020, the Small Business Administration issued specific guidance on how to continue merger and acquisition activity, and other activities that result in a change of control, when an interested party is the recipient of a PPP loan. We explored these requirements here and elaborated on other M&A considerations here. These requirements remain an ongoing concern, as many borrowers entering into transactions do not yet enjoy full exemption from previous PPP loans.
- Economic Assistance and Second Draw Loans Law. In late December 2020, the Economic Assistance Act extended the PPP program and allowed some borrowers to obtain a second PPP loan. The law and the implementing regulations of the Credit Standby Agreement also applied major changes to the PPP program retroactively to the initial loans. Importantly, this includes new permitted uses of the proceeds, including covering expenses for certain operations, damage to property, and supplier downtime; The cost of personal protective equipment for employees; and employee benefits costs. The law also amended tolerance procedures and introduced a simplified application for borrowers of $150,000 or less.
- PPP . Elasticity Law. In June 2020, Congress introduced changes to the PPP program in the form of the PPP Flexibility Act. This act, among other things, extended the time period for loan expenses from eight weeks to 24, changed the percentage of exempt costs attributable to payroll from 75% to 60%, and implemented additional safe havens to reduce exemption.
- essential. As of January 2021, borrowers of $2 million or more began receiving Form 3509, the “Necessity Questionnaire” from the SBA. This form is designed to check if a loan is “necessary to support ongoing operations”, which is one of the eligibility criteria for a loan. In July 2021, use of the model was discontinued, but necessity remains an issue ripe for scrutiny.
In short, we are not yet halfway to the PPP story. Now is the time when, in the calm that followed the PPP storm, regulators and enforcement agencies can do second-guessing, evasiveness, and challenge PPP borrowers. Given the nuances of this area and the many ways to get tolerance right (or wrong), it would be wise for businesses of all sizes to seek advice when questions begin and not delay until they are subject to enforcement action.
Due to the generality of this update, the information provided here may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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