CARES Act’s Substantial Relief Funds Create Fraud Risk

Provisions in the Coronavirus Aid, Relief, and Economic Security (CARES) Act signaled that the government intends to closely monitor the more than $2 trillion in relief funds, including loans through the Paycheck Protection Program. New developments confirm that businesses seeking these loans must understand the risks before accepting and retaining the funds.

The Small Business Administration’s (SBA’s) Paycheck Protection Program (PPP) launched on April 3, and the $349 billion in PPP funds was exhausted by April 16. On April 21, the US Senate approved an additional $310 billion in funds for the PPP, which the US House of Representatives approved on April 23 as part of the relief package signed into law on April 24.

Given recent scrutiny regarding businesses that have already received PPP funds and the potential for real future legal risks for businesses that seek or use these funds improperly, this LawFlash provides updated guidance on risks and risk mitigation best practices for businesses applying for PPP loans—or having second thoughts about loans they have received.

CARES Act Oversight Provisions

The significant funds available to businesses and individuals through government programs in the CARES Act and PPP carry an inherent risk of fraud, waste, abuse, and mismanagement. Accordingly, the CARES Act includes several provisions to fund existing Offices of the Inspector General (OIG) in several federal agencies, to create an Office of the Special Inspector General for Pandemic Recovery, and to establish a Pandemic Response Accountability Committee, all to promote transparency in the administration of the relief programs and to prevent fraud, waste, abuse, and mismanagement of funds made available under the CARES Act.

• Section 1107(a)(3) of the CARES Act directly appropriates $25 million in funding for the Small Business Administration (SBA) OIG for expenses associated with monitoring the administration of the hundreds of billions of dollars that the SBA can provide as economic assistance and loans to eligible businesses and self-employed individuals through the Keeping American Workers Paid and Employed program.
• Section 1109(i) of the CARES Act authorizes criminal penalties, under existing law, for fraud or other misconduct in seeking or using the SBA’s relief funds.
• Section 4018 of the CARES Act creates an Office of the Special Inspector General for Pandemic Recovery within the US Department of the Treasury to coordinate the auditing and investigation of the management and spending of funds under any program established under the CARES Act.
• Section 15010 establishes a Pandemic Response Accountability Committee to provide oversight of the funds made available under the CARES Act. The Pandemic Response Accountability Committee, consisting of several IGs, is responsible for preventing and detecting fraud, waste, abuse, and mismanagement of all funds made available to any nonfederal entity under the CARES Act. This responsibility includes the authority to conduct a comprehensive audit of all contracts the federal government enters into pursuant to the CARES Act.
• Finally, the CARES Act includes appropriations to the OIGs for all government agencies and departments receiving funds under the act to fund oversight and auditing of programs funded thereunder.

These provisions send a clear message that the government will seek out those who improperly draw on government funds made available through the PPP and other coronavirus (COVID-19) related relief efforts.

The Government Has Many Tools to Police Fraud: Take Time to Understand and Manage Your Risks

Given the significant impact the COVID-19 pandemic and related business restrictions have had on the American economy, many businesses and individuals have applied or will apply for one or more of the economic relief programs made available under the CARES Act. The programs established under the CARES Act, however, specify eligibility requirements for participation and approved uses for program funds. Many of the programs also require applicants to certify eligibility for participation in the programs.[1]

As a general matter, any businesses applying for federal funds should take care to ensure that applications, certifications, and any reporting to the government in connection with the funds, if required, are truthful. Applicants also should involve the appropriate legal, compliance, and business contacts to ensure appropriate use of government funds. This diligence is essential given the potential for criminal and/or civil liability arising from any fraud on the government, including the following:

• Potential criminal penalties (prison time and fines) for false statements in connection with the PPP, as authorized by the Inspector General Act of 1978, or under other laws criminalizing false statements or fraudulent schemes.
• Potential civil liability under the False Claims Act (FCA), which carries stiff penalties for individuals and entities who defraud the government. FCA allegations could arise from the fulsome government monitoring and auditing of compliance with program requirements, as provided for in the act, but could also arise from whistleblowers who may bring cases in the government’s name.
• Potential SEC enforcement activity focused on assessing a public company’s certification that the loan is necessary against public disclosures about the company’s financial condition.
• Potential criminal or civil liability could also arise from audits or investigations connected to the expanded oversight activities described above, including oversight activities by the Office of the Special Inspector General for Pandemic Recovery within the Treasury Department, which is required to report to Congress on the details of loans, guarantees, and investments funded through relief programs; or by the congressional Pandemic Response Accountability Committee. Among other things, that committee was made responsible for “expeditiously reporting to the Attorney General any instance in which the Committee has reasonable grounds to believe there has been a violation of federal criminal law.”

While the CARES Act has new oversight tools, the government is not new to investigating and prosecuting fraud on the government during times of crisis. The government did so after the Civil War by passing the FCA, and it actively pursued fraud in connection with federal stimulus funds in the Troubled Asset Relief Program (TARP) and after funding other disaster relief programs. Additionally, the US Department of Justice (DOJ) and SBA traditionally have aggressively pursued businesses and individuals who misrepresent eligibility for funds reserved for small businesses or other specific categories of businesses.

New applicants for PPP loans must understand the criminal and civil implications that attach to seeking and taking government funds because the government has many years after the current crisis to investigate funds that are being requested and distributed in a matter of days or weeks.

In thinking about these risks, businesses must take time to consider whether they are the type of business for which PPP funds are intended from a common-sense perspective, not just a regulatory analysis. It is all too easy for stakeholders to generate lists of the companies that were at the front of the line to receive PPP funds, and the media has begun to do just that. Government watchdogs and prosecutors will start with these very lists, asking basic questions about whether the companies that received PPP loans seem like the companies for whom the PPP loan program was designed. If a business does not pass that initial common-sense test, it may be a target for further scrutiny and investigation.

New Applicants for PPP Loans

Applicants for PPP funds should be aware that requests for and use of PPP funds will be scrutinized by lenders, the SBA, Congress, federal prosecutors, potential individual whistleblowers, and/or the media. These stakeholders will be testing whether PPP funds were provided to legitimate, eligible businesses and whether those businesses used the PPP funds only for appropriate purposes.

Applicants for PPP loans, therefore, must pay close attention to PPP eligibility requirements and the limitations on use of PPP funds. An applicant must certify,[2] among other things, the following:

• It is “eligible to receive a loan under the rules in effect at the time [the] application is submitted that have been issued by the [SBA] implementing the Paycheck Protection Program under [the CARES Act].”
• “All SBA loan proceeds will be used only for business-related purposes as specified in the loan application and consistent” with PPP rules.
• “Current economic uncertainty makes this loan necessary to support the ongoing operations of the Applicant.”
• “The funds will be used to retain workers and maintain payroll” or for other purposes authorized by the CARES Act.

Eligibility

Eligibility may seem straightforward, but can require a careful analysis of nuanced SBA legal and regulatory requirements about a business’s size, its affiliation to other businesses, its status as a for-profit or nonprofit, and whether the business may be ineligible because of what it is (e.g., certain private clubs, life insurance companies, or businesses that meet other specific criteria) or whether it has special eligibility for these SBA funds because of operating hotels or restaurants.[3] A business applying for PPP funds must assess and then certify that it is eligible.

SBA and DOJ have proven very capable of bringing cases against businesses that misrepresent eligibility for SBA funds. For the PPP loans specifically, DOJ has already initiated criminal proceedings against two individuals who claimed to have dozens of employees earning wages at four different business entities at a time when DOJ alleges there were no employees working for any of the businesses. In cases involving the PPP, we expect that DOJ and SBA will start by looking at a business’s certification as to eligibility. Then, they will investigate the basis for any certifications by the business and how the business operates in practice to evaluate whether it was truly eligible based on its size and ownership structure. Recent investigations include the following:

• In March 2018, a communications company paid more $12 million to settle FCA allegations that the business misrepresented that it was not majority owned by another company when it certified that it was eligible for small business contracts with government defense agencies.[4]
• In February 2019, two construction companies paid $3.6 million to settle FCA allegations that the companies misrepresented their control and management structure to appear eligible to participate in the SBA 8(a) Program.[5]
• The DOJ has also pursued criminal prosecutions of individuals who misrepresent eligibility for programs designed for small businesses. For example, in November 2019, a Florida man was convicted of fraudulently obtaining government contracts reserved for small disadvantaged businesses by “fraudulently using proxy and pass-through companies” to hide his business’s otherwise ineligible status.[6]

Necessity

In an April 21 press conference, Treasury Secretary Steven Mnuchin reminded businesses about the importance of business certifications to the SBA on this issue. As he made clear, the intent of the PPP is “not for big public companies that have access to capital.” This was not surprising and is consistent with the SBA’s history of targeting SBA loans to small businesses that are not usually able to access capital through other means.

On April 23, the SBA issued updated PPP Loans Frequently Asked Questions (FAQs) to further address PPP loan eligibility for large companies with adequate sources of liquidity. Given the expected interest in this guidance, we repeat it here:

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.

With this additional guidance from the SBA, businesses that are applying for loans now or have received them already must now consider the following:

• New applicants must use the new guidance to test whether they can make a truthful certification that the loan is necessary while taking into account current business activity and access to other sources of liquidity. When evaluating liquidity, applicants must assess whether it is sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. Additional guidance on this also appears below.
• Existing loan recipients must also review the new guidance. Given the circumstances under which it issued, this is an area where the SBA is concerned that businesses may not have gotten this analysis right during the initial wave of applications for PPP funds. Businesses that received funds already should consider (1) the basis for the certifications provided at the time of the loan application and (2) the basis for a determination now that they can keep the loan proceeds in light of the clarification about economic need. For a business that cannot truthfully meet the clarified standard for economic need, the business can repay the loan in full by May 18,[7] and the SBA will consider the necessity certification to have been provided in good faith.

Under this rubric, large businesses or small entities owned by large businesses are not necessarily precluded from applying for PPP loans, but they must be able to truthfully establish need that fits within the guidance. Businesses will be well advised to consider fact-specific questions, as well as the big picture and how this will look in the eyes of the government if it comes calling.

In recent years, the DOJ has prioritized the pursuit of “fraudsters who . . . misrepresent[] their eligibility for small business contracts and deny[] [those] opportunities for legitimate small businesses.”[8] As Assistant Attorney General Jody Hunt explained, the government “will not hesitate to take action against [businesses that] fraudulently obtain contracts intended for small businesses.”[9]

The SBA takes a similarly heightened vigilance in policing need in the context of disaster relief funds. As the government has stated, an attempt to fraudulently obtain disaster relief funds “is white collar . . . looting” that deprives relief from “people who actually need assistance,”[10] and the DOJ and SBA have pursued criminal charges against those who defraud SBA disaster relief programs through fraud or false statements.[11]

Where the government eventually investigates a business’s decision to apply for and keep funds with the SBA’s new guidance, it will scrutinize the initial certification and the determination that the business could keep the loan funds under the new guidance. The SBA also now instructs that borrowers must be prepared to demonstrate the basis for their certification upon demand. Any business assessment that is scrutinized will have to be sound both from a financial perspective and as compared to the application of a mom and pop business that did not receive funds because—in the government’s view—larger, better funded businesses got there first. On this front, many businesses have already decided to repay funds, and that may be a prudent, though painful, decision that businesses have to consider before the safe harbor period ends.

In past comments, Secretary Mnuchin intimated that SBA would consider referring businesses for criminal prosecution where they wrongfully certify as to necessity. During interviews on the morning of April 28, Secretary Mnuchin stated the following:

There was a borrower’s certification that people had to initial and it said that the loan request was necessary to support the ongoing operations. And if that certification is inaccurate people will have criminal liability. . . . We’re not going to be able to check all the loans before they go out the door, but before we forgive these loans, we’ll check every single one over $2 million. So anybody that took the money that shouldn’t have taken the money: one, it won’t be forgiven, and two, they may be subject to criminal liability, which is a big deal. I encourage everybody to look at this and pay back these loans now so we can recycle the money if you made a mistake.

Subsequently, in a joint statement with SBA Administrator Jovita Carranza, Secretary Mnuchin warned that audits were on the way for “all loans in excess of $2 million, in addition to other loans as appropriate.”

On May 13, however, SBA issued a new FAQ to explain how it will audit necessity certifications for loans below and above $2 million. This guidance walked back the threats of potential criminal liability arising from SBA’s audits, but does not eliminate all risks associated with a business’s certifications. In light of the significant departure from past public comments regarding enforcement of the PPP “necessity” certification, the guidance in its entirety is set forth below:

46. Question: How will SBA review borrowers’ required good-faith certification concerning the necessity of their loan request?

Answer: When submitting a PPP application, all borrowers must certify in good faith that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA, in consultation with the Department of the Treasury, has determined that the following safe harbor will apply to SBA’s review of PPP loans with respect to this issue: Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.

SBA has determined that this safe harbor is appropriate because borrowers with loans below this threshold are generally less likely to have had access to adequate sources of liquidity in the current economic environment than borrowers that obtained larger loans. This safe harbor will also promote economic certainty as PPP borrowers with more limited resources endeavor to retain and rehire employees. In addition, given the large volume of PPP loans, this approach will enable SBA to conserve its finite audit resources and focus its reviews on larger loans, where the compliance effort may yield higher returns.

Importantly, borrowers with loans greater than $2 million that do not satisfy this safe harbor may still have an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance. SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form. If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request. SBA’s determination concerning the certification regarding the necessity of the loan request will not affect SBA’s loan guarantee.

SBA’s approach to these audits is a recognition not only of the significant burden SBA may face auditing the 2.7 million PPP loans made as of May 14, but also the difficult and uncertain environment in which businesses are assessing fluid and uncertain economic conditions occasioned by the COVID-19 pandemic.

Practically speaking, this guidance is significant for at least two reasons:

1. It establishes a safe harbor in which SBA will deem all PPP borrowers of less than $2 million to have made the required “necessity” certification in good faith.
2. While confirming that SBA will review all loans in excess of $2 million, the guidance clarifies that where SBA audits and determines that a borrower lacked a good faith basis for the required “necessity” certification, the SBA will not pursue administrative enforcement or criminal penalties against the borrower so long as the borrower repays the loan if SBA requests it to do so.

This guidance provides some welcome clarity to SBA’s auditing plans and relieves some concerns over the prospect of criminal liability for PPP borrowers arising from SBA audits or referrals to DOJ. That said, this new approach does not reduce all risks associated with PPP loans or a borrower’s necessity certification. Importantly, SBA’s commitment to not seek administrative enforcement or criminal penalties by its terms applies only to SBA’s review of PPP loans in excess of $2 million. It does not, on its face, eliminate the possibility of any government investigation, nor does it eliminate the potential that a private whistleblower could allege in FCA litigation that a borrower falsely certified as to necessity for a PPP loan.    

In the weeks since PPP loans started hitting bank accounts, one thing has been certain: The public and the press are watching and taking a keen interest in which companies are receiving PPP funds and how much. Even with the May 13 guidance, PPP borrowers should carefully assess the basis for the “necessity” certification they have provided in support of their requests for loans, and would be well served by ensuring such certifications are made truthfully and in good faith.

Using Funds and Seeking Forgiveness

The “overarching” purpose of the PPP is to ensure that small businesses keep their “workers paid and employed” during the economic uncertainty caused by the COVID-19 pandemic.[12] Program funds may be used for the enumerated uses identified in the CARES Act and Section 7(a) of the Small Business Act. PPP funds used for payroll costs (including both cash compensation and certain benefit costs) and to pay rent, utilities, and mortgage interest are 100% forgivable during the first eight weeks after the loan is received, subject to a few restrictions.

Loan forgiveness can be reduced if the loan recipient does not maintain its employee full-time equivalent (FTE) headcount, or reduces cash compensation by more than 25%. The implementing regulations to the PPP require that at least 75% of loan proceeds be expended on payroll costs.

Borrowers are responsible for establishing appropriate use of PPP funds. To mitigate risks related to potential government enforcement, borrowers should take care to document the amounts spent on authorized costs and to use that documentation in support of any request for the loan amounts to be forgiven. At the time of any application for forgiveness, businesses should also take steps to ensure that the loan was necessary to guard against any future concern or allegation that PPP funds were a windfall, not a lifeline for paying employees.

Borrowers should also pay careful attention to forgiveness-related representations and requirements in any loan documents signed with lenders. When it comes time to seek forgiveness for PPP loans, borrowers should take care to make sure that they are able to comply with lender contractual requirements while also complying with SBA guidance on forgiveness, once it is available.

Having Second Thoughts About Your Application or Loan?

Many stakeholders are taking an active interest in which businesses have sought and received PPP loans. Some businesses may have filed applications quickly and later learned they were not eligible; others are now evaluating the April 23 FAQ regarding economic need and may be concerned about whether they can, in good faith, demonstrate need.

Typically, an analysis as to eligibility or necessity would end at the time of an application and it would be judged based only on the laws, regulations, and guidance that existed on the application date. That general approach would not require applicants or borrowers to adjust course based on subsequently issued guidance. But these are not typical times. If you have applied for PPP loans and you cannot, in good faith, support the truthfulness of your certifications as to eligibility (including size and affiliation to other businesses) or as to economic need, contact your lender to suspend or withdraw the application. If you have received a loan already, repay the amounts or be prepared for potential scrutiny and/or liability, especially if the SBA’s new guidance suggests that your business is not eligible for a PPP loan.[13]

Secretary Mnuchin announced on April 21 that the SBA may “give people the benefit of the doubt” if there were any misunderstandings about PPP certifications and a borrower immediately pays back the loan. Those borrowers “won’t have liability to the SBA and to Treasury, but there are severe consequences for people who don’t attest properly” because of the government’s interest in getting PPP funds to the right small businesses. The April 23 SBA guidance confirms that ineligible borrowers may repay any PPP loan received in full by May 7, 2020 to “be deemed by SBA to have made the required certification [of eligibility] in good faith.” This is, in essence, a “get out of jail free card” that expires soon, and should be carefully considered by any business concerned that its certifications for the loan will not withstand the scrutiny that may come.

Best Practices for Mitigating PPP Risks

Given the potential risks, there are some steps businesses can take to demonstrate reasonable diligence in seeking and using PPP loans, including the following.

Support Certifications Regarding Eligibility

• Closely review any close question about eligibility for PPP funds under the law, the interim final rule, and SBA legal and regulatory requirements for which businesses are eligible.[14]
• Maintain a record of the basis on which eligibility certifications are made in applying for a PPP loan, including the government guidance that was used to assess eligibility.
• Maintain documentation regarding any changes in investments or relationships with other business entities that may affect eligibility or the eligibility certification.
• Consider disclosing, as an attachment to the PPP loan application, any description of steps taken to establish eligibility (e.g., any amendments to governance documents to irrevocably change control rights between affiliates).
• Follow good guidance in completing portions of the loan application relating to the maximum loan amount and document the methods and rationales used in calculating the loan request.

  Support Certifications Regarding Necessity

• Closely review any close question about whether PPP funds are necessary given the law, the interim final rule, and the SBA’s guidance.
• Document the economic uncertainty the applicant is experiencing that makes it necessary to apply for PPP funds intended for small businesses. Documentation could, for example, track a decline in available funding through orders, ongoing business operations, or changes in the circumstances of a business’s customers.
• Assess access to alternative sources of liquidity and whether those are sufficient to support all or some ongoing business activities.
• Document sources considered and reasons such sources were not utilized, including any explanation of why utilizing such sources would be detrimental to the business. Understand, in this assessment, that any investigation here will likely start with an assumption that other available sources of funding mean the business does not need these PPP loan funds. Unless liquidity is only available under clearly draconian terms, exercise caution in a continuing certification as to economic need.
• Companies could also ease future scrutiny by documenting current conditions affecting their specific business, e.g., local or state actions impacting which businesses can operate and/or that limit how customers may continue to use the business’s services.

  Track and Document the Authorized Costs Paid Using PPP Funds

• Assign a specific person or department to track and monitor how PPP loan proceeds are used.
• Document and/or establish controls to ensure PPP loan proceeds are used only for authorized purposes.
• Establish a process to document and approve all expenditures of PPP loan proceeds.
• Document, in real time, when and how authorized costs are paid using PPP loan proceeds.
• Conduct a self-audit to review how PPP loan proceeds are used.

What Remains Uncertain

The SBA’s regulations and guidance for the PPP have evolved and may continue to do so—especially as Congress continues to make additional PPP funds available and stakeholders get a clearer picture of which businesses received or are receiving loans.

Businesses should pay close attention to the regulations implementing those programs—and any guidance as it evolves—to ensure compliance with all program requirements and restrictions. Businesses must also make sure they can pass a common-sense test that the public and government prosecutors will use when asking whether a business was really the type of business for which these limited federally forgivable loans were intended.

Coronavirus COVID-19 Task Force

For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Chicago
Megan R. Braden
Tinos Diamantatos 

Houston
B. Scott McBride
John W. Petrelli

Miami
Alison Tanchyk

New York
Kelly A. Moore
Martha B. Stolley
Daniel B. Tehrani

Philadelphia
Meredith S. Auten
Andrew T. Budreika
John C. Dodds
Lisa C. Dykstra
Rebecca J. Hillyer
Ryan P. McCarthy
Zane David Memeger
John J. Pease, III
Eric W. Sitarchuk

Washington DC
Douglas W. Baruch
Giovanna M. Cinelli
Brad Fagg
Kathleen McDermott
Scott A. Memmott
Kenneth J. Nunnenkamp
Jennifer M. Wollenberg
Howard J. Young