Since the passage of the CARES Act and the SBA completing the first round of PP Loans, companies have been dealing with an ever changing set of guidelines interpreting the eligibility requirements for a PPP Loan and the eventual forgiveness of the Loan.  Unfortunately, no clear guidance is yet available.

On April 23, 2020, the Treasury Department issued its Question 31 to its Frequently Asked Questions guidance on the CARES Act, which states:

1. 1. 31. 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. [Emphasis added]

The Treasury Department further emphasized the “adequate sources of liquidity” issue on April 28 and 29 when it published Questions 37 and 39, as follows:

1. 1. 37. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: See response to FAQ #31.

1. 1. 39. Question: Will SBA review individual PPP loan files?

Answer: Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. Additional guidance implementing this procedure will be forthcoming.

This guidance abruptly focused the attention on the certification given by each borrower that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” and that the certification must be made “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].

Unfortunately, there is no real further guidance as to what all of this means. The fear is that the borrower’s decision to seek a PPP Loan, the rationale for making the certification and whether the certification was made in good faith will be judged in retrospect.    Are businesses and their owners required to evaluate their own wealth, liquidity positions, and borrowing capacity before making the certification when seeking a PPP Loan?  The CARES Act suspends the normal requirement that a borrower be unable to obtain credit elsewhere.  Thus, it appears that availability of funds on a line of credit loan or the ability to obtain a loan from a lender, are not the equivalent of having access to other sources of liquidity.  Further confusing is the caveat that available liquidity not be “significantly detrimental to the business.” Does that mean “significantly detrimental” to the current business owners in terms of dilution or the like, or does this important phrase instead mean just what it says — such alternative available liquidity is not “significantly detrimental to the business” the company?  Again, the SBA and Treasury have provided no clear answers.  The only thing that is clear at this point is that public companies, large private companies, portfolio companies of private equity funds and any other company that may be presumed to have “adequate sources of liquidity to support operations” will receive increased government scrutiny relating to the certification.

To satisfy the requirement imposed by this guidance, companies that have received a PPP Loan or are considering applying for a PPP Loan must determine whether the company has access to liquidity to support operations and, if it does, whether such access would have been significantly detrimental to the business.   If the answer to either of these inquiries is negative, then the company should compile all documents, correspondence, minutes, e-mail messages, research and notes that it relied upon in coming to such conclusion and that otherwise support the “good faith” obligation in making the necessary certification. The evidence amassed by the company should include information about advice sought from outside sources, including attorneys and CPAs.  This evidence will be critical in the event the PPP Loan obtained by the company is audited by the government.

In addition to the question of necessity for the PPP loan and alternate sources of liquidity, companies must ensure that they considered the affiliation rules (unless otherwise waived) in deciding whether to apply for or retain a PPP Loan.

Affiliate status for purposes of determining the number of employees of a business concern for PPP Loans generally works as follows:  Businesses are affiliates of each other when one controls or has the power to control the other, or a third party or parties control or have the power to control both.  There are four general bases of affiliation that the SBA will consider when determining the size of an applicant: (1) affiliation based on ownership; (2) affiliation arising under stock options, convertible securities, and agreements to merge; (3) affiliation based on management; and (4) affiliation based on identity of interest.  It does not matter whether control is exercised, so long as the power to control exists.  For determining affiliation based on ownership, a concern is an affiliate of an individual, concern, or entity that owns or has the power to control more than 50 percent of the concern’s voting equity.  The SBA will, however, deem a minority owner to be in control, if that individual or entity has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.  The Treasury Department has specified that where the minority owner waives or relinquishes these rights, it will no longer be an affiliate of the business.

There are two SBA-related affiliation rules — rules set forth in 13 C.F.R. § 121.103 (Section 103) and rules set forth in 13 C.F.R. § 121.301 (Section 301).  The CARES Act exempted certain business concerns seeking PPP Loans from the affiliation rules under the Section 103 rules, but did not address the affiliation rules under Section 301. In the Interim Final Rule published by the SBA on April 3, 2020, the SBA clarified that it is the Section 301 rules that govern affiliation for the PPP loan program and consistent with the limited waiver of the Section 103 affiliation rules would also make that waiver applicable for the Section 301 affiliation rules.

Those borrowers that determine, in light of the SBA’s recent guidance, that they had adequate sources of liquidity at the time of application and that accessing such sources would not have been significantly detrimental to the business can return the loan proceeds in full by May 7, 2020, and the company will “be deemed by SBA to have made the required certification in good faith.” The same holds for any company that determines that due to the affiliation rules it was not eligible to receive a PPP Loan.  This safe harbor was established to ensure prompt repayment of PPP Loan proceeds that were obtained “based on a misunderstanding or misapplication of the required certification standard.” Furthermore, it binds the SBA.