Lenders are getting some much-deserved rest after enduring nearly two weeks of processing applications for the Small Business Administration’s (SBA) Paycheck Protection Program (PPP), which ran out of funds in the early hours of Thursday, April 15 – tax day. The program has been sharply criticized by lenders and borrowers alike, citing confusing guidance and technological glitches with the SBA e-Trans system, to the overwhelming sense that the program was underfunded and biased given the expanded eligibility criteria.
By the time this article is published, U.S. Congress and President Donald Trump will have passed legislation allocating an additional $310 billion to the program. Once passed, the lending world will be thrown into a second round of PPP applications, this time with the benefit of experience and hindsight. Not only are banks and lenders taking this short opportunity to debrief the first round to ensure optimal compliance during the second, many are starting to look forward to the next phase of the program: forgiveness.
Lenders should continue to be cautious about liability
On April 2-3, 2020, the SBA published its Interim Final Rule (IFR) and Frequently Asked Questions (FAQs) that first addressed the subject of lender liability. Just days before the program was opened for applications, the Independent Community Bankers of America wrote to the Treasury and SBA secretaries, expressing grave concerns about the difficulty lenders would have in processing the number of applications, the speed in which underwriting was expected to be completed and great need for a quick distribution of loan proceeds.
These concerns went to the heart of a lender’s duty, under normal circumstances, to verify significant portions of the borrower’s application, calculations, and affiliation with other entities. Did the SBA really expect the lender to analyze the borrower’s payroll documentation? Were lenders expected to discuss a borrower’s affiliation, or argue over the lack of control an affiliate might have, with the borrower’s counsel? These options seemed extremely cumbersome for a Congressional mandate that seemed to require lenders to act within hours of a borrower’s submission.
In response to these concerns, the SBA modified their draft application by bolstering the borrower certifications and attestations.[ii] These modifications reassured lenders that they would not be required to “conduct any verification” of the borrower’s documents and the lender would be held harmless if the lender relied on the borrower’s documentation,[iii] in spite of the rule’s instruction that a lender is required to “confirm the dollar amount of average monthly payroll costs.”[iv] The SBA later clarified that the lender was not required to replicate the borrower’s calculations, and that the duty to confirm is fulfilled by merely providing a good faith review of the documentation submitted.[v] The shifted burden of compliance from lender to borrower suggests the creation of immunity for a lender which may, in the haste of processing applications, approve a borrower’s application based on calculations that were incorrect.
Now that the rush of the first round of PPP applications has ended and lenders have the opportunity to reassess in preparation for the next round of funding, lenders should caution their underwriters that the immunity extended by the IFR is not absolute. Lenders are still required to undertake some basic due diligence in processing and approving PPP loans. If even a minimal review of the application would put the lender on notice that the borrower is ineligible or committing fraud, then it is still the lender’s responsibility to work with the borrower to rectify the application, request the materials necessary to substantiate the application or to deny the application.[vi]
An example of a lender failing to undertake even basic due diligence occurs where the borrower identified an affiliate on its addendum, a company which was also a client of the bank, but failed to disclose any number of employees for that affiliate. The borrower, had it accounted for the affiliate’s employees, was clearly ineligible for the loan. It was also probable that the bank’s representative(s) knew that the borrower’s affiliate had a significant number of employees, and so the borrower’s failure to disclose an employee count should have raised a red flag requiring the borrower to make additional disclosures. Instead, the lender approved the loan, and the loan was ultimately declined by the borrower after it realized its mistake.
Other examples have arisen when the borrower’s calculations are not reinforced by supporting documents, such as the inclusion of ineligible payroll costs, or the failure to include costs related to an EIDL loan, which is required to be refinanced with a PPP loan. These and other similar glaring application processing issues should be internally identified, and lenders should discuss with their underwriters and loan officers about how to avoid wrongful approvals in the next round of loan applications.
It would be wise for lenders to keep in mind that the immunity granted under the IFR is not complete. While the IFR provides protection to lenders with regard to the Department of Justice or liability under the False Claims Act, it does not appear to protect the lender from any civil claims arising with respect to the loan’s approval. An example would be liability arising from downstream activity: securitization and sale of PPP loans that were approved based on the willful or reckless underwriting of the lender could result in civil liability, such as misrepresentations as to the quality of a loan pool.
A final reminder: even though the SBA interim rules allow lenders to avoid criminal or civil liability, lenders should be ever mindful of the social and reputational ramifications of their failure to conduct due diligence. In the world of social media, lenders must expect that businesses will announce the results of their PPP application. If the borrower discloses facts regarding its ineligibility and its determined that the award should not have been made, this news could generate a significant public relations issue for the lender. The court of public opinion has not been kind to even legitimate applicants that have been deemed unbefitting of the program. Two prominent examples of this frustration has been Ruth’s Chris Steakhouse and Shake Shack. It can only be expected that lenders will not be given any grace by the same public if they erroneously approve applications that would not otherwise be approved.
Lenders should begin to prepare for loan forgiveness
The IFR and other SBA guidance left much to be desired on the topic of PPP loan forgiveness, the premier benefit to the PPP loan. The Coronavirus, Aid, Relief and Economic Security (CARES) Act provides that up to 100% of the principal amount of the PPP loan plus accrued interest can be forgiven, but only if the borrower meets certain criteria. From what the SBA has released about the forgiveness process thus far, lenders will be primarily responsible for administering forgiveness applications, and for collecting and reviewing borrower documentation supporting the request for forgiveness.[vii] Even though the SBA and the U.S. Treasury are expected to promulgate additional rules related to loan forgiveness over the next eight weeks, lenders can start planning for the implementation of this next step by keeping certain considerations in mind.
It will be important for lenders to become familiar with the forgiveness eligibility criteria over the next few weeks, as the first borrowers covered periods will come to a close on or about May 29, 2020. Because of the lender’s responsibility in administering forgiveness applications, lenders should also be prepared to review the borrower’s supporting information and documentation more closely than the PPP application process. A borrower’s eligibility forgiveness is based on three factors:
- The expenditure of all loan proceeds during the covered period;
- The expenditure of all loan proceeds on only payroll and eligible expenses; and
- The retention of full-time employees (FTEs) and/or full-time employee equivalents (FTEEs) during the covered period.
The “covered period”
The borrower’s covered period begins on the date the first amount of the loan is disbursed to the borrower, and has no relationship to the borrower’s PPP application, the date of approval or the signing of the note.[viii] The covered period runs for eight consecutive weeks following disbursement, during which time the borrower must use all of the loan proceeds for covered expenses. Any amount of the loan proceeds expended after the covered period is not eligible for forgiveness.
Although borrowers are responsible for completing the application for forgiveness, lenders should stay in touch with their PPP borrowers by reminding them of important information, such when applications for forgiveness will be available, and giving them advance notice of documentation requirements prior to the close of the eight weeks.
Payroll and eligible expenses
The SBA was clear from its first IFR, the loan proceeds are primarily intended to cover eight weeks of payroll expenses, in an effort to keep Americans employed and out of the overburdened unemployment system. In keeping with this mandate, PPP loan proceeds used to pay eligible expenses other than payroll in excess of 25% of the loan principal will not be forgivable.
Lenders should not presume that simply because a borrower maintained full employment for the entire eight weeks, that the borrower has likewise met the 75% threshold. For example: Bob has 10 employees who each earn an annual salary of $50,000 per year (no benefits). Bob’s maximum PPP loan amount is $104,166.67 (equals salary multiplied by 10, divided by 12 months per year, multiplied by 2.5). Bob will incur $76,923.08 in payroll expenses during the covered period (equals $50,000 multiplied by 10, divided by 52 weeks, multiplied by 8). Bob’s payroll expenses represent 73.85% of his total loan amount. Assuming Bob uses the remaining distribution to pay other eligible expenses, Bob’s total loan forgiveness will be reduced to 98.85% if he is unable to use 75% on payroll expenses.
In all cases of forgiveness, lenders should calculate the maximum forgivable amount for each borrower before reviewing whether the borrower retained employees or can recoup on reductions based on employee rehires.
Full-Time employees and FTEEs
Forgiveness is clearly tied to the retention of employees and, as a result, forgiveness awards can be reduced by the borrower’s failure to retain employees. The CARES Act defined two formulas for reducing a borrower’s forgiveness award based on the borrower’s reduction in the number of FTEs or FTEEs, or the borrower’s reduction of an employee’s wages or salary.
It is not known whether the SBA will clarify the definition of an FTEE or reference a definition within its existing rules or standard operating procedures. For now, the best guidance has been to rely on the definition contained in the Affordable Care Act, which defines a full-time employee as an employee that works 30 hours or more per week, and full-time equivalents as a combination of employees who would not individually qualify, but when combined, are considered a full time employee. Until the SBA confirms the definition, any lender-promulgated worksheets should disclaim the method of making such a determination.
Borrowers forgiveness awards can also be reduced based on a failure to maintain full-time employees at 75% of their average rate of pay (conversely, pay cannot be reduced by more than 25%). This reduction does not apply, however, to any employee making over $100,000 annually. Verification that the borrower has conducted each calculation – the employee retention and the employee wage calculation – should be requested by the lender.
Borrowers and lenders should be reminded that the total amount of loan forgiveness “may not exceed the total amount of the principal on the PPP Loan or pool of loans.”[ix]
Good record keeping and bookkeeping will be key to maximizing loan forgiveness. Lenders should anticipate borrowers providing a number of documents to review in processing the forgiveness application, including, but not limited to, payroll reports and tax filings (Form 941), state unemployment insurance filings, documents confirming employee benefits contributions, and documents verifying rent, utility, and eligible interest payments (cancelled checks, receipts, mortgage statements).[x] Lenders are responsible for requesting any other forms or documentation they deem necessary to verify the expenditure of employees, payroll or eligible expenses.
Lenders should consider developing a loan forgiveness template or spreadsheet that will assist themselves and borrowers in calculating the forgiveness amounts and compiling the documentation necessary to adequately support the application. Although the SBA’s IFR states that a lender “does not need to conduct any verification if the borrower submits documentation supporting its request for loan forgiveness,”[xi] but again, as discussed above, it does not appear to be a blanket-immunity for lenders to neglect obvious miscalculations or ignore missing documentation. Unlike PPP loan applications, lenders have up to 60 days to process the forgiveness application from the date of submission, which gives lenders a significant amount of time to review borrower documentation.
In order to ease the reporting requirements for forgiveness, lenders should consider requiring any future rounds of PPP loan applicants to open and maintain loan funds in an account held by the lender. By keeping the loan funds on deposit with the lender, the lender is able to create a record of withdrawal activity such that the borrower is supplying documentation as to the recipient of withdrawn funds.
In the event lender immunity is weakened by additional guidance or legislative action by the U.S. Congress, lenders should be aware of potential problems with confirming calculations of eligible forgiveness amounts:
- Anticipate that borrowers may decrease the hours of their part-time employees, rather than conduct layoffs or furloughs. The decrease in part-time employee hours will impact the calculations of an FTEE (which could result in showing an FTEE layoff), rather than the reduction-in-pay calculations. Carefully review borrower’s documentation for reductions in hours versus reduction in pay.
- Anticipate that some borrowers will opt to reduce hourly wages or salary, as opposed to hours-worked, which will require the borrower to calculate each employee’s reduction percentage to be verified by the lender.
- Lenders and borrowers alike are continuing to wait for further guidance from the SBA on the June 30 rehire clause. The CARES Act incentivizes employers to rehire employees by June 30 in order to comply with FTE/FTEE employee-retention requirements of forgiveness. However, it is possible that the SBA will attempt to dissuade borrowers from padding their employment records by rehiring employees for a day or two in order to achieve additional forgiveness, by requiring rehired employees be kept on the books for a specific period of time.
As a final remark about forgiveness procedures, lenders do have the option to require the SBA to purchase the anticipated forgiveness amount of a PPP loan or pool of PPP loans at the end of week seven of the borrowers’ covered period.[xii] This procedure was seemingly set up to protect the liquidity of community banks, by expediting forgiveness funds into the hands of lenders. In making its request, the lender will be required to submit a report to the SBA, which will include the borrower’s application form (SBA Form 2483) and supporting documentation submitted with the application; the lender’s application (SBA Form 2484); a narrative detailing the assumptions used in determining the forgiveness amount, as well as alternative assumptions considered and why they were not used; information obtained from the borrower since the loan was disbursed that the lender used to determine the expected forgiveness amount (which should include the same documentation required to apply for forgiveness, as described above); and any additional information the SBA Administration may require. The lender’s report is required to conclude that at least 75% of the borrower’s loan proceeds was used for payroll costs.[xiii]
Once the report is submitted, the SBA is required to purchase the expected loan forgiveness amount of the loan or loan pool within fifteen (15) days of receiving the lender’s report and a finding that the forgiveness amount is reasonable.
Lenders should stay well-informed of further SBA guidance and anticipated rule-making for the forgiveness portion of the program. Changes to both loan and forgiveness applications are expected to continue, as legislators confirm the fourth round (and debate possible later rounds) of stimulus funding. Anticipated future rulemaking is expected to focus on the rigidity of forgiveness rules, such as adjustments to the 75/25 rule, allowing borrowers to meet the rule by extending the covered period, and extending the term of the loan beyond two years.
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[i] Interim Final Rule (“IFR 1”), published April 2, 2020, https://home.treasury.gov/system/files/136/PPP–IFRN%20FINAL.pdf
[ii] As of April 2, 2020, the Borrower must certify the following: “the Applicant is eligible to receive a loan under the rules in effect at the time this application is submitted that have been issued by the Small Business Administration (SBA) implementing the Paycheck Protection Program under Division A, Title I of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (the Paycheck Protection Program Rule).”
[iii] IFR 1, 3.c., p. 24.
[iv] IFR 1, 3.b.(iii), p. 21.
[v] See, Paycheck Protection Program Loans, Frequently Asked Questions (“FAQs”), dated April 15, 2020, Questions 1, 4.
[vi] See, FAQs, Question 1, “If the lender identifies errors in the borrower’s calculation or material lack of substantiation in the borrower’s supporting documents, the lender should work with the borrower to remedy the issue.”
[vii] Interim Final Rule, Additional Eligibility Criteria and Requirements for Certain Pledges of Loans (“IFR 3”), published April 14, 2020, https://home.treasury.gov/system/files/136/Interim-Final-Rule-Additional-Eligibility-Criteria-and-Requirements-for-Certain-Pledges-of-Loans.pdf.
[viii] For purposes of a PPP Loan, the “covered period” is an eight-week period which begins on the date of the first disbursement of loan proceeds. IFR 1, 1.d.(iii).
[ix] IFR 1, 4.e., p. 27; IFR 3, 1.f. states that accrued interest will also be forgiven at the time the application is made.
[x] IFR 3, 1.b.-c., g., pp. 6-8, 13-14.
[xi] IFR 1, 3.c., pp. 24, “The lender does not need to conduct any verification if the borrower submits documentation supporting its request for loan forgiveness and attests that it has accurately verified the payments for eligible costs. The Administrator will hold harmless any lender that relies on such borrower documents and attestation from a borrower.”
[xii] IFR 1, 4.e., pp. 26-27.
[xiii] IFR 1, 4.e., p. 26, “At least 75 percent of the expected forgiveness amount shall be for payroll costs, as provided in 2.o.”