On October 26, the Small Business Administration (SBA) published a notice in the Federal Register seeking approval from the Office of Management and Budget to release two new forms to be sent to borrowers under the Paycheck Protection Program (PPP) in preparation for audits by the agency. Because these audits have significant legal implications for borrowers such as disqualification and potential civil and criminal liability, entities that obtained PPP loans should consult counsel and exercise great care in answering questions on the forms.
SBA has created separate forms for nonprofits and for-profit loan recipients. For-profit borrowers will receive Form 3509, and nonprofit borrowers Form 3510. While the SBA has not published the forms, the media has distributed Form 3509. Form 3509 states that it is designed to “maximize program integrity and protect taxpayer resources” and that the information to be submitted by the borrower “will be used to inform SBA’s review of your good faith certification that economic uncertainly made your loan request necessary to support your ongoing operations.” This language is in reference to the statutory language under the CARES Act, embodied in the PPP loan application form in the form of a certification made by the borrower applicant when submitting the loan application. As a result of the publicity regarding PPP loans made to purportedly financially solid companies such as Shake Shack and the Los Angeles Lakers, the SBA and Department of the Treasury announced that the SBA would audit all PPP loans in excess of $2 million to determine whether the borrower’s certification that the loan was necessary can be substantiated. The notice in the Federal Register provides for a 30-day comment period prior to the forms’ final issuance.
Business Activity and Liquidity Assessments
The SBA designed each form to be sent to a PPP borrower by its lender. The borrower must complete it within 10 business days after receipt and then return it to the lender, which will then be responsible for sending it to the SBA. If the borrower does not submit the form, the SBA may retract eligibility, seek repayment of the PPP loan or “pursue other available remedies.” Therefore, as currently structured, the filing of this form by a borrower is essentially mandatory.
Form 3059 is divided into two categories of information requests: a “Business Activity Assessment” and a “Liquidity Assessment.” In some instances, detailed disclosure is required. Under the “Business Activity Assessment” section, the form requires information regarding the following items in the form of a series of questions for each such item:
- A financial revenue comparison from the second quarter of 2020 to the second quarter of 2019 (with special rules for seasonal employees), or if the company was not in business in the second quarter of 2019, to the first quarter of 2020.
- Information on changes in the business operations after March 13, 2020 (the date of the issuance of the National Emergency Declaration issued by President Trump) due to the pandemic, including the impact of state and local emergency orders and any cash outlays caused by the changes in business operations.
- Information on voluntary measures taken after March 13, 2020 due to the pandemic, including cash outlays caused by changes in the business operations.
- Capital expenditure projects after March 13, 2020 due to the pandemic, and the approximate cash outlay for these projects.
The Liquidity Assessment section of the form requires information regarding the following items in the form of a series of questions for each such item:
- The borrower’s cash position and any payment of dividends during the period commencing March 13, 2020 through the end of the loan forgiveness covered period for the PPP loan (the “Liquidity Assessment Period”).
- The payment of any dividends during the Liquidity Assessment Period, excluding dividends for any pass-through estimated tax payments.
- Any prepayments of any outstanding debt during the Liquidity Assessment Period.
- Compensation payments in excess of $250,000 to any employee or to any owner employed by the borrower.
- The market capitalization on the date of the PPP loan application for a borrower that is a public company and for any 20% publicly owned parent of a borrower.
- If the borrower is a private company, the book value of the borrower in the last calendar quarter prior to the loan application.
- For borrowers that have 50% foreign ownership by a parent company, the market cap of the parent company if it is a public company listed on a U.S. or non-U.S. securities exchange.
- For borrowers that are 20% owned by a private equity fund, a venture capital fund or a hedge fund, either directly or indirectly, disclosure of that relationship.
- Disclosure of any foreign state enterprise that owns 50% or more of, or is affiliated with, the borrower.
- Information on other funding under the CARES Act.
The borrower has the option to write additional comments to any question under both the Business Activity Assessment and the Liquidity Assessment. The purpose of that option is unclear.
The borrower is also required to provide supporting documentation in the form of financial data with respect to the quarterly comparison disclosed under the Business Activity Assessment section and the cash position, payment of dividends, prepayment of outstanding debt and excessive compensation payments disclosed under the Liquidity Assessment section.
Finally, the borrower must certify that it has made “reasonable inquiry of people, systems, and other information available to Borrower.” No clarification is given as to the meaning of “reasonable inquiry,” but the borrower should be diligent in completing the questionnaire to avoid any liability to the SBA due to any misrepresentation or inaccuracy.
Questions and Concerns
It is anticipated this form will not be well received by borrowers or lenders. First, it contemplates a “rearview mirror” analysis. For example, requesting a revenue comparison at the end of the second quarter of 2020, which for many borrowers occurs after the date of making the loan, is not contemplated under the CARES Act. The certification for the PPP loan was made as of the date of the loan application, and there were no accountability standards for the future financial condition of the company after the date of the loan. In fact, the genesis of the PPP Loan Program was to keep companies in business and assist them financially in the hope of minimizing a company’s loss of revenue. Likewise, some of the information addresses business activities occurring after the date of the loan application.
The form also introduces criteria to the PPP Loan Program that did not exist at the time of application. It inquires about compensation to employees and to owner-employees who earned in excess of $250,000. One has to question why that should be a factor in the audit. There are no compensation limitations under the PPP Loan Program except with respect to the determination of the proposed amount of the loan. One also has to question the purpose of estimating the market capitalization or value of a company. Is this a new separate consideration under the PPP Loan Program? In addition to the difficulty many borrowers will have in determining their value as of the specified date, it is unclear why this is relevant. Does this indicate that the SBA is reviewing a borrower’s compliance with eligibility requirements? If so, the value of a company generally was not one of the criteria for determining eligibility.
Similarly, why are there questions on foreign ownership and investment fund ownership? Perhaps that is designed to provide information to the auditor in conducting an eligibility review or in determining the borrower’s access to capital at the time of the PPP loan application.
Complete With Caution
Most importantly, this form will most likely be used by auditors to prepare for audits of PPP loan borrowers. The audit has legal implications, such as disqualification of a borrower and potential civil and criminal liability. A borrower must be careful in answering these questions and should seek legal advice before submitting the application. A borrower may be inclined to respond to the open-end solicitation for additional information, but we recommend against completing any of these sections without the advice of counsel. If not stated correctly, the response to such an open-ended question could inadvertently be turned against a borrower by an auditor. A borrower will be certifying to the truthfulness of this form, and there is potential legal liability if it incorrectly presents the information. Moreover, any statement made in this application would constitute an admission in any civil or criminal action brought by the SBA based upon the audit.
As mentioned at the outset of this article, this form has not yet been published by the SBA. The above discussion is subject to any changes in the form or its procedures in its final promulgation by the SBA. It is subject to a 30-day comment period. Hopefully, the form will be pared back in its final iteration or safeguards for borrowers will be added.