Federal government is investigating: Was your PPP loan truly ‘necessary’?

Attorney Q&A with Bob Luttrell and Rick Mullins

Last week, the SBA updated its guidance on the Paycheck Protection Program to address questions from borrowers and lenders. One ambiguous answer has left some borrowers concerned that their loans may no longer qualify as “necessary” in light of the latest guidance. Borrowers must “certify” under penalty of civil or criminal action that the loan request is “necessary to support the ongoing operations of the Applicant.” Should PPP loan borrowers be concerned?

In this LINC Q&A video, McAfee & Taft business lawyer Bob Luttrell and trial lawyer Rick Mullins discuss the issues PPP loan borrowers should be aware of and how they can best be prepared for a possible audit and federal investigation.



Q: Why should PPP loan borrowers be concerned?

Bob Luttrell: The SBA has issued a number of frequently asked questions and interim final rules, which questioned whether certain borrowers could make a certification that the application was necessary and reminding borrowers that if a loan was not necessary, there are civil and criminal penalties for making false statements to government. In the FAQ on April 23rd, in question 31 — you’ll hear a lot about question 31 in this matter — the SBA suggested that businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations don’t meet the necessary standard to qualify for a PPP loan. And in an FAQ on April 28, they applied the same standard to privately held companies. And because of the rule changes and the questions that have arisen about the accuracy of that certification, the SBA decided to give borrowers time to reconsider and have a change of heart. And if they did, to have a safe harbor where there were no civil and criminal penalties, at least from the SBA. That period started on May 7th, then it moved to May 14th, then it moved to May 18th, and now the SBA has said that the safe harbor would be available to borrowers who repay their loan after an SBA audit, after the SBA made a determination that the loan was not necessary and after the SBA had requested repayment of the loan proceeds.

Q: Will my loan be audited?

Bob Luttrell: The SBA has said that loans under $2 million will not be audited because there’s a presumption that the loan was necessary. So I think anyone who has a loan of over $2 million should expect that at some point in the future — that may be weeks, months, years — that the SBA will audit the loan file and be coming back looking for documentation of the necessity of the application.

Q: Why is this an issue?

Bob Luttrell: Because false statements to the government, and government programs, are violations of the False Claims Act. And if the application was tendered to an insured financial institution and there were statements that were false, then that’s also subject to criminal and civil penalties.

Q: How do I decide that my certification is okay?

Bob Luttrell: The certification has to be made in good faith taking into account current business activity, the ability to access other sources of liquidity, sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. To the extent these conditions are met, having additional sources of liquidity is not automatically disqualifying. There are some questions a lot of borrowers have, if they happen to be sitting on a lot of cash now, does that mean that was not necessary? That if they have lines of credit, they’re not drawn on, does that mean that they have to draw down the lines of credit before this application was necessary? If their owners have liquidity personally, do they have to ask their owners to come out of pocket to make the loan application necessary? And there are no clear answers to those questions. So it has to be a judgment based on the facts at the time, and it has to be made in good faith based on the outlook at that time.

Q: If I made certifications on my loan in good faith, what happens when faced with an audit?

Rick Mullins: Well, at the point in time where a business is faced with an audit, they’ll get notification from the SBA that they’re coming in to do an audit, most likely that will be the process. At that point in time, the business needs to gather up all of the documentation that it has relied on throughout the course of having the loan and from the initial determination of whether or not a loan ought to be made. They need to gather up all of that information and get it in front of them and refamiliarize themselves with that information. What the SBA is going to be looking for is, number one, were you entitled to take the loan out in the first place? Were you honest when you made the loan application? Were are you being truthful? And they’re going to be trying to make the determination whether you should be able to retain the funds, are you going to be required to repay the money, and if you were going to be required to repay the money, are you going to be potentially referred to the Department of Justice for a False Claims Act or even worse, be referred to the Department of Justice for a potential criminal prosecution. And so at the point in time that a company is advised that it’s going to be audited, they need to quickly move together all the documentation that they should have retained throughout the pendency of the time since they took the loan out.

Q: What federal agencies are likely to investigate and prosecute false claims?

Rick Mullins: At this point in time, I would expect for it to be only the SBA and the Department of Justice. The way that it looks like it’s going to happen is if the SBA determines that there’s a reason to make a referral for a prosecution, then that’s going to go to the Department of Justice at some point in time. And so that’s most likely where any referral on this will go.

Q: What are investigators looking for?

Rick Mullins: So the way that the application for both obtaining the loan in the first place and then the application that you have to submit for the loan forgiveness, the way those are both written, I would expect the SBA to be looking for potential false claims and potential criminal liability at both stages. You are required to have made the truthful certifications in the initial loan application. They will definitely investigate obtaining government money and whether you were truthful about it. On the back side, on the loan forgiveness application, they will also be investigating whether you’re entitled to keep that money or whether it needs to be repaid. Under the False Claims Act, not only can you be liable for obtaining government money under false pretenses, you can also be liable under the False Claims Act for retaining money that you’re not entitled to keep. So if you have not been truthful on your loan forgiveness application, you can expect the SBA to make a referral to the Department of Justice potentially.

Q: What are they most likely to prosecute?

Rick Mullins: I would expect most likely that they will be looking for some kind of civil liability. There’s a significant leap between civil liability under the False Claims Act to criminal liability for obtaining government money under false pretenses. So I would expect that most of the prosecutions would come under the False Claims Act — civil False Claims Act. I would expect also they may make a few examples out of pretty egregious criminal conduct just to send messages.

Q: How does “good faith” play into this?

Rick Mullins: So if the money needs to be repaid, good faith is going to come into it. Good faith and trying to do the right things, especially in the face of where you have fairly ambiguous and changing guidelines and rules since the inception of the PPP program, the good faith determination and good faith conduct is going to be important and that should prevent any kind of a referral for further action by the Department of Justice.

Q: What should we do if we receive notice that we’re being investigated?

Rick Mullins: So in addition to gathering up all the documentation that we’ve talked about previously, if you are under investigation then you need to contact counsel and get somebody on board to help you through an investigation. Then a company should not be investigated on its own without having legal counsel involved. If you’re being investigated by the Department of Justice for potential fraud, whether it’s civil or criminal, there are a lot of things that happen through an investigation process where you need expertise to be guided. The layperson, even sophisticated business people, need legal advice as they go through the process. And statements can be made inadvertently that are taken the wrong way. Documents may not be produced and gathered the way that they need to be. You can, instead of having counsel guide you on how interviews ought to be given and giving instructions on how to best approach interviews with the government, you could just show up and say things that are construed the wrong way. You don’t want to be involved in something where the ramifications are so potentially catastrophic without proper guidance by a lawyer who’s familiar with the process.

Q: What are the penalties?

Rick Mullins: Under the civil False Claims Act, the potential penalties if you were to have a trial and lose, the penalties would be a mandatory imposition of three times the actual damages, which here would be three times the loan amount. In addition, there would be fines and penalties that are mandatory of between $10,000 and $21,000 per claim. How many claims are at issue would be interesting here. Is the loan application itself a single claim? And then, a second claim where there are loan forgiveness misrepresentations that may have been made, that’s an additional claim. So the penalties here and the automatic judgment of three times the damages amount are pretty, pretty significant.

Q: How concerned should a PPP borrower be?

Rick Mullins: Based on the current guidance that’s been published by the SBA, if they investigate and they determine that a business was not entitled to the loan in the first place and the business repays the loan, that should be the extent of that.  The SBA has stated that it will not make a further referral to any other agency in the government if the loan is repaid. So under that circumstance, you know, repaying the loan is not something you want to have to do, but that should be the end of it, with respect to the government. There is a possibility even if the money is repaid and the government doesn’t pursue the issue any further, that what is called a qui tam relator or a whistleblower could pursue a claim on behalf of the government under the False Claims Act and try to receive a judgment in the amount of three times the amount of the loan plus the penalties and interest. The government would be entitled to some portion of that, so just because the government doesn’t pursue it doesn’t mean a whistleblower can’t. However, I would suspect that the likelihood of a whistleblower being able to be successful in the circumstance where the government has decided not to pursue it, that’s not a high likelihood of success.

Q: What should concerned borrowers be doing now to prepare for a potential investigation?

Rick Mullins: At this point in the process where we’re six weeks out from the big time the loans were initiated, what would be important right now would be to document what your decision-making process was, and what you relied on in terms of financial state of affairs to obtain the loan in the first place. And it would also be very important at this point in time to document your decision-making process. Why did you decide that you were entitled to the loan? It’s important to do it now because you want those types of things documented as close to the time of the event as you can. And as you go through the process of are you entitled to the loan going forward, you should document your review as changing regulations come out and guidance comes out, document why you still believe you’re entitled to the loan and why you shouldn’t have to repay it. That would be very important. And it would be helpful to obtain an advice of counsel to help you through that process and to help you understand the regulations and the statute. It would also be helpful if you received an outside accountant opinion as well, and to look at your financial state to help you document that you were entitled to obtain the loan and to keep it.

Bob Luttrell: It’s hard to be objective about our own certification. It’s hard to be objective about what we think. Consequently, I recommend that you get somebody that’s familiar with the issues to look over your documentation, maybe make some suggestions about how to improve it, so that when the audit day comes, then you’re prepared to provide the information necessary to the SBA to show them that the certification was in good faith.

This Attorney Q&A has been provided for information of clients and friends of McAfee & Taft A Professional Corporation. It does not provide legal advice, and it is not intended to create a lawyer-client relationship. Readers should not act upon the information in this Q&A without seeking professional counsel.