On March 13, 2020, President Trump declared the COVID-19 pandemic of sufficient severity to warrant an emergency declaration for all states, territories, and the District of Columbia. Since then, the President, Congress, Treasury Department, and the SBA have ushered in many tax law changes, introduced several new tax credits, and implemented new loan programs. All of these were designed to assist businesses and individual taxpayers impacted by the pandemic. On March 27, the President signed the CARES Act, which set in motion many of these incentives for businesses and individuals.
One of the most significant stimulus provisions in CARES was the Paycheck Protection Program (PPP). PPP loans were a new type of SBA loan provided to all businesses that met certain eligibility criteria. Unlike many SBA loan programs, PPP loans required no collateral, no personal guarantees, no personal financial statements of owners, and the loans were made at a 1% interest rate over a two-year term, with the payments deferred for the first six months of the loan. Additionally, borrowers could effectively convert all or part of the loan to a grant by using the funds for payroll costs and other specific business expenses during the eight-week period following the loan distribution. In the statute, this is referred to as loan forgiveness.
Economic Uncertainty Certification - Application
In the initial PPP loan application, borrowers were required to make several representations and certifications. One of the certifications dealt with the current economic conditions of the borrower. Each borrower specifically certified in good faith the following:
“Current economic uncertainty makes the loan request necessary to support the ongoing operations of the Applicant.”
At the time of the PPP loan request, it is likely that many borrowers and their stakeholders were unsure of the future and the magnitude of the impact of the pandemic, as well as the economic impact of the shutdown of most of the country. At that moment, this certification appeared to most borrowers to be an easily attainable standard.
It was a very subjective test in a very unusual time. The focus of lenders, borrowers, and their advisors was very much on the calculation of the maximum loan amount and other application issues, so they dissected every bit of SBA guidance rushed out at an unprecedented pace. Within one week of the President signing the CARES Act, guidance was issued and lenders were processing PPP loan applications. The emphasis was to push PPP loan dollars into the economy while the country was shutdown, hopefully softening the economic impact of the pandemic.
Economic Uncertainty Certification – Several Borrowers Highlighted
PPP loans were designed for small businesses with under 500 employees, although there were exceptions for certain industries. Within weeks, the initial round of PPP loan funding appropriated by Congress ran out. Media reports of high-profile companies that received PPP loans started to surface through various sources. Well-known organizations like Harvard University, the Los Angeles Lakers, and Shake Shack were recipients of PPP loans. Soon after these reports came out, coupled with the reality that the loan funds were depleted, new SBA guidance emerged that the intent of the PPP loans was not for borrowers that had access to other capital. For example, Harvard was cited as having a large endowment fund. Shake Shack was a publicly traded company that could raise capital through stock or bond offerings.
The SBA responded by issuing guidance directed at borrowers. In their published Frequently Asked Questions (FAQs), #31, the SBA stated the following:
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.
Additionally, Treasury Secretary Mnuchin was quoted on April 23 saying that it was “questionable” whether some larger companies qualified for PPP loans. Additionally, he advised that companies that received PPP loans intended for small businesses would be “investigated” if it appeared they didn’t meet the economic need certification standard.
Economic Uncertainty Certification – Post Loan Confusion
The SBA guidance issued subsequent to the initial PPP loan fund being depleted caused much concern and confusion in the business community. Many businesses took PPP loans and had already begun spending the funds for eligible purposes. Most of these same borrowers assumed, based on their initial assessment of the published rules, that the terms of the PPP loan and the potential forgiveness made the loan a very attractive financing option for their business. The PPP loan could help keep them afloat through the shutdown and the likely recessionary period to come.
The SBA then issued guidance that permitted borrowers to review the new guidance and determine if they should repay their PPP loan. In the event borrowers repaid their loan by the deadline specified, the SBA would consider the borrower to have met the standard within the economic need certification. The deadline for repayment was extended twice by the SBA and ultimately set for May 18.
Some of the larger businesses specifically mentioned in media reports did in fact return their PPP loan proceeds. Recent reports, however, indicate that approximately 75% of publicly traded companies retained their PPP loan funds.
Economic Uncertainty Certification – Another Change: Safe Harbor Introduced
The SBA then seemed to change course again, and more guidance on this economic uncertainty certification was published in FAQ #46. FAQ #46 introduced a safe harbor providing that any PPP loan of under $2 million was deemed to have met the certification concerning the economic need for the loan.
The SBA had previously indicated their intent to review loan files of PPP loans over $2 million. Then, they further clarified in FAQ #46 that they will specifically review whether borrowers have an adequate basis for making the required good faith certification of economic need for PPP loans over $2 million. In the event SBA determines a borrower does not have an adequate basis of need, the entire loan balance will be due.
A checklist of factors for borrowers to consider in evaluating this economic uncertainty is available here.
Economic Uncertainty Study: What is this? Do you need one?
The initial guidance, referenced in FAQ #31, stated that borrowers should be prepared to demonstrate to the SBA the basis for their certification, upon request. While each borrower has a different set of facts and circumstances that likely provide a basis for their loan request, it is critically important that each borrower devote resources to documenting and retaining support for their PPP loan request. Further, if possible, borrowers should quantify each specific uncertainty they identify (to the extent a reasonable estimate is available). At the end of this thorough and complete analysis, business owners will have an Economic Uncertainty Study that supports the basis for their PPP loan.
From the guidance they have provided, the SBA intends to review the loan forgiveness file of every borrower with a PPP loan amount in excess of $2 million dollars. It is likely that SBA will review this file months, if not years, after the PPP loan was initially disbursed.
The certification language in the original loan application underscores that economic uncertainty and need must be present at the time of the loan request. SBA guidance and clarification were then rolled out in April and May of 2020. An Economic Uncertainty Study should focus on relevant facts, circumstances, and events that were the basis for the loan request on and around the time of the PPP loan request.
For instance, a business owner may have continuing operations and a backlog of work or orders that kept their business operating and profitable in the short-term. They may have had access to a line of credit at a higher interest rate. However, there may be uncertainty on the long-term impact of this pandemic on their business, the health of their employee base, their customer base, and on any changes that may be necessary to continue ongoing operations. It is reasonable for a business owner to consider the question of economic uncertainty to the end of 2020, the end of 2021, or even beyond 2021, should the virus continue to be a major health concern nationally. Thus, the PPP loan program could become a vital source of capital in future months or years.
An Economic Uncertainty Study for PPP borrowers of loan amounts in excess of $2 million dollars is a good investment. The stakes are high, as the SBA will review these PPP loan files. In the event the borrower cannot provide an adequate basis for the necessity of the loan, the entire PPP loan will become due and payable. Sikich advisors are available to assist borrowers in reviewing their situation and performing an Economic Uncertainty Study.
Next Steps – Assistance with an Economic Uncertainty Study
For PPP loans in excess of $2 million dollars, business owners are encouraged to work with an advisor to review the specific facts and circumstances that existed at the time of the loan request, as well as document the basis for economic uncertainty that may be requested by SBA during the audit process. This will help determine if any of the reasonable estimates of each identified factor can be quantified. In addition, an advisor can be a resource in reviewing Economic Uncertainty Studies for businesses that have completed their internal analysis.