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Paul Zimmerman
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PPP Guidance Issued by the SBA and U.S. Treasury at Odds With the CARES Act—Michelman & Robinson Files First-of-Its-Kind Lawsuit Challenging FAQs

Click here to read the lawsuit.

There continues to be significant backlash about the Paycheck Protection Program and loans being taken by not-so-small businesses like Ruth’s Hospitality Group (operator of the Ruth’s Chris Steak House chain), Auto Nation, and even the Los Angeles Lakers, which has put U.S. Treasury Secretary Steven Mnuchin on the defensive. On the heels of his recent comment that PPP borrowers improperly certifying their needs for relief under the CARES Act will suffer “severe consequences,” comes Mnuchin’s statement last week that, “for any loan over $2M, the Small Business Administration will be doing a full review of that loan before there is loan forgiveness.”

At its core, the PPP is geared toward small businesses hit hard by the COVID-19 outbreak—those needing short-term money to stay afloat, retain their workforces, and pay for payroll, benefits, rent, and utilities. Clearly then, to the extent PPP loans are winding up in the wrong hands (read: big public companies with substantial liquidity and access to capital), there are problems with the program that must be ironed out.

That being said, Mnuchin’s threats and guidance issued by the SBA in consultation with Treasury regarding PPP certification (in the form of Frequently Asked Questions that Michelman & Robinson previously discussed here), have raised some glaring contradictions with the language of the CARES Act itself. They have also resulted in a lawsuit that M&R filed today (May 4, 2020) against Mnuchin and Treasury, as well as the SBA and its administrator, Jovita Carranza.

A description of the case is set forth below; but first, M&R answers some of the questions we are being asked about the so-called “credit elsewhere test” and the FAQs/guidance from Treasury and the SBA that are at the heart of our clients’ action against Mnuchin, et al.

Q. How does the SBA’s “credit elsewhere test” apply to PPP loans?

A. The short answer is it does not apply. Let us begin with a bit of background.

Ordinarily, to qualify for an SBA loan, a small business loan applicant must pass the “credit elsewhere test,” which analyzes whether the would-be borrower has the ability to obtain some (or all) of the requested loan funds from alternative sources without causing undue hardship. More specifically, the lender must determine that the applicant is unable to get a similar loan on reasonable terms without a federal government guaranty, and that some (or all) of the loan is not available from the resources of the applicant or the personal resources of the applicant’s principals. Toward that end, as part of the “credit elsewhere test,” SBA requires that the personal resources of any owner of 20% or more of the applicant be reviewed.

There is more to the “credit elsewhere test,” but the foregoing is sufficient for purposes of this discussion. That is because the CARES Act, which provides for the PPP, specifically waives the requirement that a PPP borrower demonstrate its inability to obtain credit elsewhere. As such, the SBA’s “credit elsewhere test” has no application to PPP loans, at least not if the express language of the CARES Act is taken into account.

Q. Can the FAQs/guidance from Treasury and the SBA about PPP certification and Secretary Mnuchin‘s related comments co-exist with the mandates of the CARES Act?

A. That remains to be seen, but pursuant to the lawsuit filed today, we believe the answer should be no. The FAQs/guidance regarding PPP certification specifically acknowledge that the CARES Act “suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act).” Yet they go on to say that borrowers must nevertheless certify in good faith that their PPP loan request is necessary, and that certification must take into account the “ability to access other sources of liquidity sufficient to support . . . ongoing operations in a manner that is not significantly detrimental to the business.”

There is obvious tension between these two competing ideas—that the “credit elsewhere test” is waived, on the one hand, and that borrowers must certify their inability to access other sources of liquidity (essentially, a “credit elsewhere test”), on the other. As set forth in our case against Mnuchin and his fellow defendants, as a rule, statutory language trumps departmental guidance, which means that Treasury and the SBA must be enjoined from making determinations of PPP ineligibility based upon new loan requirements imposed by way of the guidance/FAQs.

Q. Does a business owned by a large company with adequate sources of liquidity to support the subsidiary’s ongoing operations qualify for a PPP loan?

A. As we have previously reported, in addition to reviewing applicable affiliation rules to determine PPP eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. By way of its guidance, Treasury has essentially taken the position that businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations are not eligible for PPP funding. But again, a consideration of otherwise available credit is not supposed to factor into a borrower’s PPP loan eligibility. Thus arguably, a business may qualify for a PPP loan even if owned by a large company, but given the conflict between the language of the CARES Act and the guidance/FAQs issued by Treasury and the SBA, the jury is still out when it comes to this question. Hopefully, the litigation initiated today will settle the issue.

Q. Will the SBA actually be reviewing individual PPP loans in excess of $2M as Secretary Mnuchin has indicated?

A. Yes, as set forth in guidance issued by Treasury last week, the SBA has decided, in consultation with Treasury, that it will, in fact, review all PPP loans that are over $2M million, in addition to other loans as appropriate. Each review will follow a lender’s submission of its borrower’s loan forgiveness application.

As we understand it, additional guidance implementing this procedure will be forthcoming. In the meantime, the outcome of the SBA’s review of loan files will not affect its guarantee of any loan otherwise in compliance with PPP rules.

Q. What is alleged in the lawsuit filed against Mnuchin, Treasury and the SBA?

A. The lawsuit has been filed in the United States District Court, Central District of California, on behalf of three privately held tech companies. Big picture: our clients seeks to nullify the guidance/FAQs issued by the SBA in tandem with Treasury that ostensibly reimposes the “credit elsewhere test” as a criteria for PPP loans.

In the complaint, it is alleged that the guidance/FAQs (specifically, numbers 31 and 37) place new requirements upon PPP borrowers that are not in accordance with the CARES Act, and thus, the guidance/FAQs are contrary to law. By way of the litigation, our clients are asking for an injunction to stop Treasury and the SBA from making determinations of PPP ineligibility based upon the guidance imposed by the FAQs, as well as a declaration from the federal court that FAQs 31 and 37 are unlawful and must be withdrawn.

A description of the action can also be found in this press release.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.