- The CARES Act Paycheck Protection Program requires that small-business applicants for loans make a good-faith certification that the uncertainty of current economic conditions makes the loan request necessary to support ongoing operations.
- How do applicants determine “necessity,” and how do they ensure they make that determination in “good faith”?
- Where can applicants turn for guidance?
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). In section 1102 of the CARES Act, Congress established the Paycheck Protection Program (PPP), which provides for hundreds of billions of dollars’ worth of loans under section 7(a) of the Small Business Act (SBA) to borrowers that consist of, among others, eligible small businesses.
In applying for an SBA section 7(a) loan under the PPP (a PPP loan), eligible applicants must, among other requirements, be able to make a good-faith certification that the uncertainty of current economic conditions makes the PPP loan request “necessary” to support the ongoing operations of that eligible applicant (a “necessity” certification). However, further complicating the analysis, section 1102(I) of the CARES Act suspends the ordinary requirement that an applicant for a section 7(a) loan be unable to obtain “credit elsewhere”, which is defined in section 3(h) of the SBA to mean the ability to obtain credit from non-federal sources on reasonable terms and conditions, taking into consideration the prevailing rates and terms in the community in or near where the borrower transacts business, for similar purposes and periods of time. Unlike a borrower for a traditional section 7(a) loan, under the CARES Act, an applicant for a PPP loan is not required to certify that it is unable to obtain credit elsewhere. Instead, PPP loan applicants must consider alternate sources of liquidity in connection with their PPP loan application to assess whether the current economic uncertainty makes its PPP loan request necessary to support its ongoing operations.
On April 23, 2020, the SBA issued updated FAQs (SBA FAQs) addressing the “necessity” certification in the PPP loan application but failing to provide any specific standard or quantitative metrics for defining the applicant’s need for the PPP loan. The SBA FAQs did, however, make clear that:
- applicants must make a reasonable, good-faith determination of need
- applicants must assess 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
- applicants that receive a PPP loan should maintain records supporting their determination of need and be ready to demonstrate to a federal regulator the basis for having made their certification
Fortunately, for smaller borrowers—for these purposes, these are borrowers that, together with their affiliates, receive or have received PPP loans in an original, aggregate principal amount of less than $2 million (a Micro-Borrower)—the SBA, in consultation with the U.S. Department of the Treasury, just amended the SBA FAQs to include a safe harbor for Micro-Borrower’s making the “necessity” certification. Under the new safe harbor, Micro-Borrowers will be deemed to have made the “necessity” certification in good faith.
As a consequence of the new safe harbor, the focus on the “necessity” certification has shifted to borrowers that, together with their affiliates, receive or had received PPP loans in an original, aggregate principal amount of $2 million or more (Significant Borrowers); borrowers unable to rely on the safe harbor described above for Micro-Borrowers. Best exemplifying this risk, especially for the larger borrower, is the first official action taken by the Select Subcommittee on the Coronavirus Crisis (the Subcommittee), which is a special investigatory subcommittee established by the U.S. House of Representatives under the House Oversight Committee empowered to oversee that the funds for the PPP loans are used effectively and not subjected to fraud or waste.
On May 8, 2020, the Subcommittee delivered letters to five large, public corporations demanding that they immediately return the PPP loan proceeds that they had received, funds that Congress had intended for small businesses struggling to survive during the coronavirus crisis. These letters were sent to public companies with market capitalization of more than $25 million and 600 employees, PPP loan applicants that sought and received “small business” loans of $10 million or more. The Subcommittee instructed each of these companies to respond by May 11th as to whether they would return their PPP loan funds; otherwise, the Subcommittee gave them until May 15th to produce all documents and communications (1) between that borrower and the SBA and the Department of the Treasury relating to its PPP loan, and (2) between that borrower and any financial institution relating to its PPP loan, including all applications for a PPP loan. Thus, in its first official action, the Subcommittee sent a clear signal of the real risk that a borrower unable to rely on the Micro-Borrower safe harbor incurs in making the “necessity” certification. Where the Subcommittee will eventually draw the line on sending out similar demands to Significant Borrowers is anyone’s guess. Time, as always, will provide that answer.
What are Significant Borrowers to do in the interim? Unfortunately, the good-faith certification as to the necessity for the PPP loan by the applicant still leaves unanswered questions such as: “How do you define good faith?” “How do you truly determine whether the PPP loan is necessary?” “What law or rule governs these definitions?”
Many commentators have spoken critically about these issues and the ambiguity of these terms. For example, in discussing the process of applying for a PPP loan, Don McGahn, former White House counsel from 2017–18 and now a partner at a large, private law firm, opined in the Wall Street Journal on April 27, 2020, that:
To get a loan, a business must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
A lax standard, to be sure. But is anyone really going to question that there is “current economic uncertainty”? And that such uncertainty makes a loan request “necessary” to support operations? There is no statutory requirement that a company would go under but for the loan, or that it must, with any degree of certainty, prove need in a detailed way. Hotels and restaurants were given additional statutory leeway: a per location size standard. Regardless of what the goal-post movers now claim they intended, the Cares Act says what it says, and its loose language was sold as a feature, not a bug.
Thus, Mr. McGahn makes the case that every qualified business applying for a PPP loan is capable of making this “necessity” certification in good faith.
However, in the Wall Street Journal the following day, Paul S. Atkins, a former Commissioner with the Securities and Exchange Commission and now CEO of Patomak Global Partners, stirred the pot further by cautioning businesses about taking federal money:
But borrower beware! Businesses with flexibility should seriously consider to what extent accepting the terms of federal loans or other support may be a Faustian bargain. The ultimate cost may dramatically outweigh the temporary gain.
Through the congressional oversight commission established under the Cares Act, the new Special Inspector General for Pandemic Recovery, and numerous other freshly funded inspectors general, the groundwork is already laid for aggressive investigation and review of which businesses received—and how they spent—federal emergency funds.
Thus, if a Delaware corporation is applying for a PPP loan, would Delaware General Corporation Law determine whether that entity (and its board of directors) had acted in “good faith” in making its “necessity” certification for a PPP loan? Is not every decision of the board of directors of a Delaware corporation required to be taken in good faith? Remember, section 102(b)(7) of the Delaware General Corporation Law expressly provides that directors cannot be shielded from liability for actions not taken in good faith or breaches of the duty of loyalty.
Moreover, the duty of good faith under Delaware law falls under the protection of the business judgment rule. In Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360–61 (1993) (citations omitted), the Delaware Supreme Court stated that:
The [business judgment] rule operates as both a procedural guide for litigants and a substantive rule of law. As a rule of evidence, it creates a ‘presumption that in making a business decision, the directors of a corporation acted on an informed basis [i.e., with due care], in good faith and in the honest belief that the action taken was in the best interest of the company.’ The presumption initially attaches to a director-approved transaction within a board’s conferred or apparent authority in the absence of any evidence of ‘fraud, bad faith, or self-dealing in the usual sense of personal profit or betterment.
. . . To rebut the [business judgment] rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty—good faith, loyalty or due care.
If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.
Thus, an applicant for a PPP loan could argue that its good-faith determination was subject to the business judgment rule, which protects directors from second guessing if they can demonstrate that they have fulfilled their fiduciary duties: the duty of loyalty and duty of care. If the board of directors can demonstrate that its members made a good faith determination, then the directors should be protected by the business judgment rule. After all, the business judgment rule dictates that courts defer to decisions taken by the board of directors if the directors acted in good faith and in what they reasonably believed to be in the best interest of the corporation after the exercise of due care. The duty of loyalty, which means that a director must act in good faith and free from any conflict of interest, should not be an issue with respect to a PPP loan. The second component of the director's fiduciary duty is the duty of care, which requires, first, that directors inform themselves of all material information reasonably available to them prior to making a business decision on behalf of the corporation; and then, after becoming appropriately informed, the directors must act with requisite care in the discharge of their duties. Although the duty of care can be in play with respect to a PPP loan, it is not relevant for determining whether a PPP loan applicant’s “necessity” certification was done in good faith. If that were the case, then the new federal-level Special Inspector General for Pandemic Recovery would, for example, be obliged to look at how each of the states have interpreted the term “good faith,” applying principles of state law (corporation, limited liability company, or limited partnership law, as applicable), in order to determine whether an applicant from that state which applied for a PPP loan satisfied its obligation to make a “necessity” certification in good faith. You know that will not be the case.
The CARES Act is not governed by notions of corporate law because section 7(a) loans involve a federal statutory duty or obligation, which is outside the purview of the Delaware General Corporation Law. The CARES Act is federal law and unfortunately does not include definitions of “necessary,” “necessity,” or “good faith.” So, what are applicants for PPP loans of $2 million or more to do? A good first step is to determine whether there are any SBA rules and interpretations regarding section 7(a) loans that offer guidance in construing these terms.
One SBA publication does in fact shed light on the definition of “good faith”—publication SBA SOP 50 57 from the Office of Capital Access, Small Business Administration, dated March 1, 2013, titled “7(a) Loan Servicing and Liquidation.” Item 16 on page 12 of publication SBA SOP 50 57 provides the following definition of “good faith”:
Good Faith, whether capitalized or not, means the absence of any intention to seek an unfair advantage or to defraud another party; i.e., an honest and sincere intention to fulfill one's obligations in the conduct or transaction concerned.
Thus, the SBA itself defines “good faith” to include “an honest and sincere intention” and an “absence of any intention to defraud . . . [or to] seek an unfair advantage.” These are helpful standards that businesses can utilize to reduce risks associated with any lack of good faith in applying for a PPP loan.
Also helpful to PPP loan applicants are a question and a comment buried inside a PPP loan guide prepared by the U.S. Senate Committee on Small Business and Entrepreneurship titled, “The Small Business Owner’s Guide to the CARES Act” (the SBA Guide. Taken together, they illustrate the purpose and intent of the CARES Act (italics added):
[Do you need c]apital to cover the cost of retaining employees?
The program would provide cash-flow assistance through 100 percent federally guaranteed loans to employers who maintain their payroll during this emergency.
The SBA Guide therefore makes clear that the primary aim of the PPP is to protect workers and help maintain their jobs; thus, applicants interested in protecting their workers and maintaining their payrolls should apply for a PPP loan, in good faith, especially during this unprecedented time.
Facts and circumstances are paramount. Each business applying for a PPP loan should carefully consider and reasonably document its determinations and considerations of issues such as:
- whether it is subject to any risk of losing employees because of the economic uncertainty caused by the COVID-19 pandemic
- whether the PPP loan may help the applicant maintain its payroll during this emergency
- whether alternative sources of liquidity are available
- the terms of any alternative source of liquidity, including repayment terms, if any
- the likelihood and timing of closing on those alternative sources of liquidity
- whether any additional preference overhang might be created by such alternative sources of liquidity
- the dilutive effect upon existing owners of pursuing alternative sources of liquidity
So, rather than “borrower beware,” we say, “Significant Borrowers, don’t worry, just act in good faith and be sure to document your determinations!”
 The full text of the CARES Act can be found at this link: https://www.govinfo.gov/content/pkg/BILLS-116hr748enr/pdf/BILLS-116hr748enr.pdf.
 Section 7(a) of the Small Business Act can be found at this link: https://www.sba.gov/sites/default/files/Small%20Business%20Act_0.pdf
 full text of the updated the Paycheck Protection Program Loans – Frequently Asked Questions (FAQ) can be found at this link: https://www.sba.gov/sites/default/files/2020-05/Paycheck-Protection-Program-Frequently-Asked-Questions_05%2013%2020.pdf.
 Opinion piece in the Wall Street Journal, dated April 27, 2020, by Don McGahn, titled “The Cares Act Game Begins”, posted at this link: https://www.wsj.com/articles/the-cares-act-blame-game-begins-11588026158.
 Opinion piece in the Wall Street Journal, dated April 28, 2020, by Paul S. Atkins, titled “Borrower Beware: Cares Loans Carry a Steep Cost”, posted at this link: https://www.wsj.com/articles/borrower-beware-cares-loans-carry-a-steep-cost-11588113575.