Read the "Necessity Checklist for PPP Loans (May 22),” prepared by Scroggin and Burns attorneys, Jeff Scroggin & Michael Burns here:
Checklist for Documenting PPP Loan Necessity
This checklist is intended to provide recommendations on ways to minimize the potential exposure to SBA claims that your PPP loan was not “necessary” and therefore a “false certification” was made to the SBA. The rules make it clear that the borrower (not the financial institution that approved the PPP application) has the obligation for certifying the correctness of the PPP application. Documenting “necessity” is particularly important to business owners who borrowed more than $2.0 million in PPP loans. They should anticipate significant scrutiny of their businesses by the SBA.
Items to be Completed ASAP
1. May 18th Repayment Deadline. Given the answer to FAQ #46, it would generally appear that repaying a PPP loan by May 18th did not make sense. In the majority of cases, retaining the low interest loan as a bet against future uncertainty makes sense, particularly given the loan is not personally guaranteed. However, there are countervailing issues, including, but certainly not limited to:
If the business owner squanders the PPP loan proceeds with questionable payments (e.g., paying large salaries to non-working descendants) or excessive personal benefits (e.g. buying a lake house with SBA funds) and the SBA determines that the PPP loan was not a necessity, the business owner might be personally subject to civil and/or criminal penalties if they are unable to repay the PPP loan.
SBA FAQ#45 notes that if the PPP loan is repaid within the safe harbor deadline (which was May 18th), the business would still be entitled to the Employee Retention Credit. Therefore, prior to the expiration of the safe harbor deadline, business owners (particularly those considering loans in excess of $2.0 million) should compare the benefits of the Employee Retention Credit to the risks of not qualifying for loan forgiveness.
Perspectives: There are other perspectives that need to be considered in any decisions, including:
If it is ultimately determined that the business does not meet the “necessity” standard for loan forgiveness, the loan may still serve as a low interest rate cash reserve for your business.
Loan forgiveness is worth more than just the non-taxable write-off of the PPP loan principal. If Congress changes the IRS’s position and the expenses attributable to loan forgiveness are deemed tax deductible, the economic value of loan forgiveness for state and federal tax purposes is substantially increased.
A competent third-party advisor may provide you more objective insights on what you should do to meet the “necessity” standard.
As noted above, every PPP borrower should document the “necessity” of obtaining the PPP loan, even those businesses that borrowed less than $2.0 million.
Recognize that HOW you present your information is just as important to WHAT you submit. For example, assume you had $6.0 million in cash on your balance sheet when you obtained your PPP Loan. Assuming that you are not violating any accounting standards, allocating that cash to various required “reserves” (for example, for existing litigation or required shareholder redemptions) may provide a better presentation.
2. SBA Frequently Asked Questions. Have your CFO, outside CPA and/or senior executives review the May 13, 2020 SBA Frequently Asked Questions and determine how the rules apply to you. In particular, review FAQ #31 and #46 on the necessity of obtaining the loan.
Note: The rules are changing constantly. Always check the SBA website to see if a revised set of FAQs or other guidelines have been issued.
Treasury Website. To obtain additional details on the applicable rules, review the Department of Treasury rules on PPP loans. See: https://home.treasury.gov/policy-issues/cares/assistance- for-small-businesses
SBA PPP Application. Reexamine your PPP Loan application. Many of these applications were done in haste and may have incorrect information in them. For example, did you properly report your affiliated businesses and business owners on the application? Do you clearly meet all the qualifications for the PPP loan (i.e., remember that lenders do not have legal responsibility for assuring that you meet the qualifications)? Review your SBA PPP application in light of the revised FAQs and newest SBA promulgations and determine how issues can be mitigated. If you find significant incorrect information, consult with legal counsel on how you can correct the information.
AICPA Report. Review the AICPA Recommendations, PPP Application and Forgiveness Processes checklist: https://www.aicpa.org/content/dam/aicpa/press/pressreleases/2020/aicpa-ppp- recommendations-letter.pdf.
PPP Loan Forgiveness Application. Review the PPP Loan Forgiveness Application at https://www.sba.gov/document/?program=PPP. The application provides additional information regarding forgiveness, but there are still a number of areas where additional guidance is needed.
Segregate PPP Funds. Place any PPP funds in a separate financial account and do not co- mingle the PPP funds with any other funds you have. Only disburse funds from the account for the following permitted purposes (to obtain loan forgiveness under the CARES Act) provided that at least 75% of the loaned funds are used for qualified payroll costs:
Payroll costs, (as defined in the CARES Act and in 2.f. of the Final Interim Rules) including costs for employee vacation, parental, family, medical, and sick leave. However, the CARES Act excludes qualified sick and family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act (Public Law 116–127) and payments made to independent contractors and sole proprietors.
Payment of rent
Payment of utilities
Payment of loan interest on debt obligations incurred before February 15, 2020
8. Document the “Necessity” of the PPP Loan. As soon as possible, prepare a preliminary report which documents the concerns of management over the pandemic and why obtaining the PPP loan was a “necessity” for the business. Provide copies of the report to your Board and to outside legal and accounting advisors. The report should include management’s discussions of the financial impact of the pandemic, the economic downturn, and the shelter in place rules, including discussions conducted internally, discussions with professional advisors and discussions by your Board of Directors (prepare minutes), with a focus on the following issues and data:
- Note: The standard under FAQ #31(which has not been revoked by the SBA) is how “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
o Focus on the benefits of the PPP Loan to your employees, the business and your community.
o Focus on how your business was or was expected to be negatively impacted by the pandemic and how the PPP loan alleviated some of that damage.
o Project how your gross revenue and net profits were expected to be diminished by the pandemic.
o Note: It is probable that the forgiveness of PPP loans will be tied to the necessity of obtaining the PPP loan. The report should be as of the date of PPP loan application. Your report can be instrumental in satisfying those requirements, particularly when it is updated to include post-PPP loan information (e.g., the loss of revenue, slowing payments of account receivables, supply chain issues, etc.).
- Project how many employees you would have laid off or furloughed because of a projected downturn in business. Preserve any contemporaneous documents that were created on the topic.
o Document how many employees the PPP loan program allowed you to retain on your payroll.
- o Document how many independent contractors (“ICs”) you regularly employ and how many remained as contractors during the pandemic. Note that while payments to ICs is not eligible for forgiveness, the loss of ICs, whether due to the ICs not accepting the work or due to an inability to pay, would demonstrate an effect on the ongoing operations of the business.
o Project how the loss of employees and ICs would have impacted your sales and profits.
In your report, provide copies of general economic and industry specific predictions from the time of your application for the PPP Loan, including media comments. For example: The New York Times front page headline on April 30, 2020 read: “Economic Damage Hints Far Worse is Still to Come.” The article noted that some economists expected 2nd quarter results to indicate that the GDP contracted at an annual rate of 30%.
Prepare financial information to support your PPP Loan, including:
o Compare your 2020 budget projections of profits and sales to actual numbers for all 2020.
o Compare your monthly profits and loss statements to the prior year
o Document how you intended to use the PPP funds and how the funds were spent. o Document any delays in receivables compared to the same month in 2019.
Document how many employees moved from working at the office to working at home and how many employees worked in your offices, by month.
o Document the dates that your business offices were unoccupied and the days when no work was done.
o Project how many employees would not have shown up for work due to their need (example: children at home from school), shelter in place rules or a desire to avoid contracting the virus.
o Document how long it will be feasible for employees to work from home, without material adverse impact on your business’s income (e.g., retail workers have a hard time conducting sales from home).
o Document the productivity your business lost from employees working at home. o Document potential and actual increased costs (i.e., laptops, internet connections, cybersecurity and insurance costs) and the business and financial risks of shifting to work from home.
o Document how many employees were on paid leave, without working an 8-hour day from the office or their home.
o Document how many rank and file employees are over age 60.
o Document how many employees contracted the coronavirus or the flu after January 1, 2020.
Document the ages of your management team and indicate members who may be considered “at risk” with health issues (e.g., diabetes, kidney, liver, heart and lung issues).
o Project how the loss (due to the virus) of any at risk management member would jeopardize the ongoing operations of the business.
Document the adverse impact of the current environment to your business relations.
o Document by name how many customers have ceased to be open and those who went completely out of business during the pandemic.
o Document by name suppliers who are no longer providing you product or services that your business resells or whose delivery of products and services have slowed down.
Project your expected cash needs and uses in the coming year.
o Document your sources of any potential additional market loans and how those funds were projected to be used during the current economic downturn, along with the renewal date for any commercial loans.
o Document the uses of any lines of credit over the prior year.
o Project your working capital and capital expenditure needs for 2020, given the impact of the pandemic.
o Document the cash on hand and project the expected needs and potential uses of those cash funds during the current economic downturn.
o If the cash amount is significant, consider documenting the “reasonable needs of the business” that a prudent business would maintain, using the terms of Treasury Regulation section 1.537-1.
o Document whether your current insurance coverage covers claims made by employees and third parties claiming they were infected with the virus due to your fault.
o For example, the reserves might include:
1) Protection from uninsured product liability claims.
2) Reserves to expand the business, buy other businesses and obtain competitive advantages, such as buying discounted inventory from suppliers.
3) Reserves to acquire stock of deceased shareholders and purchase of shares held in qualified retirement plans, like ESOPs.
- Document discussions with the business’s bank officers on the foregoing matters.
Preserve internal emails and communications with your lender on the PPP loan.
Note in your documentation that you are trying to make determinations in a relative scarcity of data because the impact of the pandemic is still (and will be for months) rumbling through your business and the US and worldwide economies, resulting in the business having to project economic needs in an unknowable vacuum.
Document Board meetings. Document the reasons for the PPP loan as outlined above in Board minutes for the Company. Make sure to document in corporate minutes (prepared by your legal counsel):
- Any Board discussions before the application for the SBA loan application was submitted.
- Consider holding a Board meeting before the safe harbor deadline expires to have the Board discuss in detail the reasons that the PPP loan was a necessity that will not be repaid or why the loan should be repaid
- Professional Advisors. Consult with your professional advisors on these matters and the documentation process. In extreme cases consider obtaining a legal opinion letter but note that the process can be cumbersome, and costly.
Things to Avoid
Questionable Payments. Beware of indirect use of the PPP funds or funds that were freed up by the PPP loans for payments that could be considered “questionable purposes.” Recognize that SBA audits and Department of Justice investigations may view these activities in the worst possible light. For example:
Increased salary, bonuses and benefits for owners of the Borrower or their affiliated parties (e.g., children and parents).
Payments to family members who provide no services to the business.
Increased rent or other payments to affiliated entities owned by owners of the borrower or their affiliated parties.
Making of equity disbursements such as redemptions, dividends, stock purchases.
o Note: Such payments might be more acceptable if made pursuant to a legally binding agreement entered into as soon as possible before the PPP loan was entered into – if the agreement was signed after the passage of the CARES Act, expect greater scrutiny.
Making significant loans from the business to owners or their affiliates.
Paying off significant loans that the business owes to the business owners or their affiliates.
Making loans from affiliated parties that are secured by the assets of the business.
Based upon recent outcries in the media, significant payments made before the PPP loan can also raise questions with the SBA (e.g., large salary payments to owners, large dividends, capital purchases). The argument against a company obtaining a PPP loan after such large expenditures is that the company made the mistake of depleting its cash availability and does not need the government to bail it out.
o If significant expenditures have been made, document why they were a necessity (e.g., a legal buy-sell agreement that triggered a purchase from a deceased shareholder’s estate).
Reconsider whether you should go forward with major capital expenditures or business expansions that are proximate to obtaining the PPP Loan.
12. Publicity. Unless required to by law, do not provide any public or media information about your PPP loan and restrict any access about the PPP loan to key employees.
- Note: Information about your PPP Loan can be obtained from the SBA by someone filing a Freedom of Information Act request.
What Happens Next?
Borrowers need to understand that the PPP Loan rules and their subsequent implementation have been put together in haste, with nominal oversight by the SBA and lenders of the applications. It is anticipated that the forgiveness of PPP loans, particularly those in excess of $2 million, will be heavily scrutinized by the lenders and the government. For example, will loan forgiveness be tied to the satisfying of a “necessity” standard as reflected in FAQs #31 and #46?
Borrowers should anticipate that additional SBA, Treasury Department, and IRS clarifications will be made on how the PPP loans and their forgiveness are handled. Staying current on the SBA rules is a necessity for any borrower in the PPP loan program, especially those borrowers who intend to apply for forgiveness of their PPP loan. Legislation may also change the PPP loan program. For example, Senator Ron Johnson has proposed legislation providing that the forgiveness of a business’s PPP loan will be dependent upon reductions in its income.
Hopefully, in the next few weeks we will see clarifications of the criteria for forgiveness of PPP loans and whether and how the government expects businesses to establish the necessity of obtaining PPP loans.
What do You do Next?
The May 18th safe harbor for repaying a PPP Loan has passed. But it is still worthwhile to consider submitting an application for loan forgiveness and if the forgiveness is unsuccessful, repay the PPP loan. FAQ #46 appears to provide that even on loans over $2.0 million, repayment of an unforgiven loan will result in no prosecution for violating the necessity standard for the loan. “If the borrower repays the loan after receiving notification from SBA [that forgiveness was denied], 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.”
Prepare weekly or bi-weekly reports on the use of PPP loan funds and their use for qualified loan forgiveness purposes. Maintain the requirement that at least 75% of the PPP Loan funds must be paid for qualified payroll costs (unless Congress or the SBA change the rules).
Prepare your PPP Loan report as noted above and maintain supporting information (e.g., on- going financial statements).
o As a part of your report, create the baseline information that caused your business to apply for the PPP loan.
Assign one or more senior staff to:
o Update the data in your PPP loan report at least monthly showing general economic and industry specific information along with detailed financial information about your business.
o Keep current on changes being made by Congress, SBA, Department of the Treasury and the IRS to the PPP loan program, especially changes to the PPP loan forgiveness rules.
o Coordinate with qualified outside advisors who can draw on other resources in making decisions regarding the PPP loan programs.
Review and complete the PPP Loan Forgiveness Application and have a qualified third party examine your forgiveness application before you submit it.
Caution: Unless contrary factors exist, do not rush into filing the loan forgiveness application. Create a preliminary version of the forgiveness application and provide copies to your outside legal and accounting advisors. Particularly for business’s having a PPP loan of over $2 million, evaluate the risks of the forgiveness application (e.g., how is the government treating “false certifications” on the necessity of the PPP loan?), once the government has provided more details.
o The best policy is to avoid being either the first or last submitter of the forgiveness application. It is probably better to wait until lenders and the SBA are fully engaged with the flood of forgiveness applications.
o Delay may work in your favor as detailed promulgations from the SBA and/or additional legislation from Congress on the loan forgiveness rules hopefully become available. There are also a number of lawsuits that may provide insights.
o The CARES Act provides that a lender must respond to the filed PPP Loan Forgiveness Application within 15 days, but there is some indication that the response period may have been extended to 60 days.
o The SBA PPP Loan Forgiveness Application has an expiration date of October 31, 2020.
The PPP Loan rules change frequently and are often contradictory. It is imperative that you and your advisors stay current on the current rules and laws.
To read Julie Jason's books, go to https://juliejason.com/books/julies-books.