How To Avoid Federal Criminal and Civil Penalties in Connection With Applications for PPP Loans

The Small Business Administration’s (SBA) Paycheck Protection Program (PPP) is a forgivable loan program created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The purpose of the PPP, which has a $349 billion limit, is to help eligible borrowers affected by the coronavirus pandemic keep their employees on the payroll. Under the PPP, small businesses and self-employed taxpayers may fill out an application to obtain forgivable loans to cover payroll and other eligible expenses such as rent and utilities. Applicants must provide information such as all owners of 20% or more of the equity of their company, payroll costs, and number of employees to obtain a loan. Notwithstanding the benefits of the PPP, small businesses and self-employed taxpayers should be aware that applying for a PPP loan may involve federal criminal and civil risk. Federal prosecutors are getting primed for these cases: On March 19, 2020, the Department of Justice ordered every U.S. Attorney’s Office to appoint a Coronavirus Fraud Coordinator.

False statements or other fraudulent conduct in connection with a PPP loan may subject a violator to significant federal criminal liability in a number of ways. The PPP itself specifies that applicants must certify the application and indicates applicants may be penalized for “knowingly making a false statement to obtain a guaranteed loan from SBA,” and knowingly using the funds for unauthorized purposes. PPP, Borrower Application Form at 2. The application states that knowingly making a false statement is punishable by a maximum of (1) five years’ imprisonment and/or a $250,000 fine under 18 U.S.C. §1001 (making false statements) and 18 U.S.C. §3571 (sentence of fine); (2) two years’ imprisonment and/or a $5,000 fine under 15 U.S.C. §645 (false statements to SBA); and (3) 30 years’ imprisonment and/or a $1,000,000 fine, if submitted to a federally insured institution, i.e., virtually any bank, under 18 U.S.C. §1014 (false statements to banks with respect to loans). False statements in a PPP application may also subject violators to up to 20 years’ imprisonment and a $250,000 fine for wire fraud (18 U.S.C. §1343) and mail fraud (18 U.S.C. §1341), and up to 30 years’ imprisonment and a $250,000 fine for bank fraud (18 U.S.C. §1344), among other things. It is thus crucial for small businesses and self-employed taxpayers alike to be aware of and understand the numerous potential legal pitfalls during the application process.

One such pitfall relates to representations concerning company ownership; applicants should be particularly cautious when making these representations. For example, the PPP loan application requires that the applicant disclose the identity of each 20% or more equity owner of the company. And, the SBA maintains an enumerated list of entities that are presumptively excluded from applying for a loan under 13 C.F.R. §120.110, including if the business is located in a foreign country. In addition to properly identifying the company owners, applicants must answer questions regarding the owners’ past and current involvement with the criminal justice system. If certain criminal history is present, the applicant is not eligible for a PPP loan.

Applicants must therefore conduct relatively deep due diligence on their owners to avoid running afoul of the eligibility criteria—and to be able, at the very least, to fall back on a defense of good faith if the application nevertheless contains errors.

Another pitfall relates to the size qualifications for applicants. The SBA has clarified as recently as its April 15, 2020 FAQ that a “small business concern” is not solely restricted to those enterprises with 500 or fewer employees but that PPP applicants must qualify as eligible under section 3 of the Small Business Act, 15 U.S.C. §632. See PPP Loans, Frequently Asked Questions (FAQs) (last visited April 21, 2020). Specifically, applicants should be cautious when calculating their number of employees and certifying that they are (1) an independent contractor, eligible self-employed individual, or sole proprietor, or (2) employ no more than the greater of 500 or more employees or, if applicable, the size standard in number of employees established by the SBA for the applicant’s industry. Applicants should pay careful attention to this requirement to avoid fraud liability. For example, employees of all affiliates must be included when determining the size of a business. (The affiliation rules are waived for: (1) businesses within North American Industry Classification System (NAICS) Code 72 (e.g., hotels and restaurants with 500 or fewer employees); (2) franchises with codes assigned by the SBA; and (3) businesses that receive financial assistance from small business investment companies (SBICs).) Also, the total employee calculation is the average number of people employed for each pay period over the last year; an employee must be included regardless of the number of hours worked or temporary status.

To be sure, the riskiest section of the PPP application is that applicants must certify that the “current economic uncertainty makes this loan request necessary to support the ongoing operations.” Borrower Application Form at 2. However, the SBA does not define the nature or extent of the required impact to operations that would make the loan request “necessary to support the ongoing operations.” Id. (emphasis added). And, while the SBA’s most-recent FAQ, mentioned earlier, provides some guidance, applicants should conduct a thorough analysis of their present financial condition before submitting an application. Because of the significant responsibility undertaken in certifying a company’s financial need, it is a best practice for businesses to submit the financials and application to the board of directors for review and approval. Doing so ensures that the signatory has the full support of the company and helps to substantiate the appropriate good-faith request.

In addition to ensuring that their applications do not expose them to federal criminal and civil penalties, public companies should disclose to shareholders whether the companies applied for a PPP loan and/or received a PPP loan. The Chairman of the Securities and Exchange Commission, Jay Clayton, recently stated that he encourages companies to “disclose where they stand” in order to limit speculation about companies’ need for capital and their earnings power. Dave Michaels, SEC’s Clayton Says Companies Should Disclose Need for Bailout Funds, The Wall Street Journal (April 7, 2020). In line with that recommendation, companies have been filing Form 8-Ks disclosing that they have entered into PPP loan agreements. Relatedly, investment advisers to private equity funds should consider disclosing to their fund investors if portfolio companies have received PPP loans.

Reprinted with permission from the April 27, 2020, edition of the New York Law Journal. © 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 - reprints@alm.com.

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