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Uncertainty Is Necessary for PPP Loans

MaryPat Davitz

May 08, 2020

Lack of clear guidance, vague guidance, conflicting guidance, “clarifying” guidance, unofficial interpretations on social media, and headlines seem to be contributing to growing uncertainty around the PPP loan program. Small business owners are concerned about tax impacts, forgiveness, accounting and possible criminal penalties to the point that many are uncertain about whether they should return the loan by the recently extended May 14 deadline.

While many areas of the program lack clarity, the most recent and time-sensitive confusion surrounds clarifying information published April 23, 2020 by the SBA as FAQ 31.

FAQ # 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 “current 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 (extended to May 14th) will be deemed by SBA to have made the required certification in good faith.

What is “necessary to support ongoing operations”?

Although FAQ #31 was intended to be a clarification, key terms are not defined clearly including what constitutes economic uncertainty and what is necessary not to mention how to define current business activity or ongoing operations. So many questions and so few definitive answers.

To address the issue of the certification that the loan must be “necessary to support the ongoing operations of the applicant”, borrowers need to understand what is necessary. As this term is not defined in the CARES Act or by other SBA guidance, it makes sense to look to existing tax law. For example, section 162 regarding business expenses, does not define necessary as absolutely vital for survival of the business. Rather, necessary means reasonable expenses. The term necessary was also considered by the Supreme Court in 1933 in Welch v Helvering where the court held that necessary business expenses merely had to be “appropriate and helpful”.

Then, there is the question of ongoing operations. There is confusion as to the timeline for ongoing operations and if this means insolvency or pre-pandemic performance. The definition of going concern or ongoing operations under generally accepted accounting principles in the US anticipates that a business will continue operations for more than one year from the date of issuance of the financial statements. This interpretation of ongoing operations indicates that borrowers should measure the impact of the economic uncertainty at the time of the loan over the next year to eighteen months of ongoing operations. In other words, are the PPP loan funds necessary to support the businesses financial condition over at least the next twelve months?

Remember the purpose of the PPP Loan?

Underlying all of the contradictory and confusing guidance and commentary, is the intended purpose of the PAYCHECK PROTECTION PROGRAM. PPP loans were intended to allow small businesses to retain employees by providing monies to maintain payrolls and cover certain related payroll costs over an eight-week period following funding of the loan. The program also provided loan forgiveness to allow those businesses to increase operating capital if they were profitable over that period to cover future expenses or revenue drops which may occur afterwards as a result of the pandemic. PPP loans are non-recourse which indicates that the program did not intend for small business owners to be required to consider personal resources before obtaining a PPP loan to retain its workforce.

What should business owners do? Document-Document-Document!

Document factors that you considered surrounding current business activity at the time of the loan request, including the following:

  • Current business financial information.
  • Current economic conditions (office and business closures, stay-at-home orders, declining revenues and other restrictions on business activity) impacting your business and customer base used in making projections and establishing expectations around ongoing operations.

Document factors and timeline in determining that funds are necessary to support ongoing operations.

  • Expectations regarding current business activity including projections and estimates of revenues and expenses and cash flows taking into consideration sources of liquidity readily available to the business at the time of the loan application.
  • Expectations of uncertainty beyond the 8-week period for using PPP loan funds.

Document rationale contemporaneously with changing conditions and guidance.

  • Thoughts and expectations at the time of loan request and updates throughout the pandemic, during the 8-week period to use PPP funds and beyond considering ongoing operations.  
  • Consider including dated information and correspondence related to preparing documentation of your considerations as evidence of good faith certification at the time of the loan application and use of loan proceeds.

Once you receive the loan it is also important to maintain a separate bank account and track the use of the PPP loan funds to determine forgivable amounts in accordance with the guidance (or lack thereof) relating to forgiveness. But, that is another topic for another day.

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