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U.S. Treasury and SBA Guidance Regarding PPP Eligibility Triggers First-Of-Its-Kind Lawsuit

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Press Release
May 4, 2020

LOS ANGELES, CA – The considerable backlash directed at the Paycheck Protection Program has been amplified with the filing of a lawsuit against U.S. Treasury Secretary Steven Mnuchin and the Treasury Department, as well as the U.S. Small Business Administration and its administrator, Jovita Carranza.

The federal court case against Mnuchin and his fellow defendants, filed today (Monday, May 4, 2020) in the Central District of California on behalf of three privately held tech companies, seeks to nullify recent guidance issued by the SBA in tandem with Treasury that ostensibly reimposes a so-called “credit elsewhere test” as a criteria for PPP loans.

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 position themselves to reopen when safe to do so. Toward that end, the SBA has been issuing PPP loans up to $10M.

Commenting on the lure of the PPP, Mona Hanna of Michelman & Robinson, LLP—the law firm representing the plaintiffs—explains, “A key feature of these loans is that they’re forgivable given the intent to keep ‘America working.’ The net effect is that PPP loans, if spent properly, are akin to grants critical to the survival of small businesses. For this reason, any ‘guidance’ that unlawfully places an obstacle in the way of PPP loan eligibility is unacceptable, especially given the dire circumstances that prompted the passage of the CARES Act in the first place.”

The obstacle Hanna refers to is the “credit elsewhere test.” Ordinarily, to qualify for an SBA loan, a would-be borrower must demonstrate that it does not have the ability to obtain some or all of the requested loan funds from alternative sources without causing undue hardship. And where such credit can be obtained elsewhere, the SBA will not extend financial assistance. That being said, the CARES Act, which established the PPP, specifically waives the “credit elsewhere test,” and it is this waiver that is at the heart of the lawsuit filed by Michelman & Robinson on behalf of San Clemente-based Zumasys, Inc., which provides software programming services, and IT companies jBASE International and Total Computing Solutions, LLC.

Since the PPP’s rollout, negative commentary has been fast and furious. Most recently, Mnuchin, Treasury, and the SBA have been on the receiving end of extensive criticism stemming from PPP loans going to large, publicly traded companies. In response, the SBA updated its “Paycheck Protection Program Loans Frequently Asked Questions” on April 23, 2020.

According to Todd Stitt, another Michelman & Robinson partner, “The FAQs, which are housed on Treasury’s website, are specifically intended to provide guidance to borrowers and lenders concerning the implementation of the PPP. In their most current form, two of the FAQs—numbers 31 and 37—acknowledge the suspension of the ‘credit elsewhere test’ for purposes of the PPP, yet go on to require borrowers to certify in good faith that they are unable ‘to access other sources of liquidity sufficient to support their ongoing operations.’ The upshot is that by way of their guidance, Treasury and the SBA are, in fact, implementing a ‘credit elsewhere test’ in contradiction of the CARES Act. In legal parlance, they have enacted an ‘underground regulation.’”

Adds Hanna, “This guidance, which essentially imposes new requirements upon PPP borrowers, is not in accordance with the law and damages companies to the extent it jeopardizes their eligibility for PPP loans and calls into question the good faith behind their certifications. At the same time, FAQs 31 and 37, as written, have a chilling effect on small businesses that need PPP money to weather the COVID-19 storm.”

The plaintiffs suing Mnuchin, et al., are asking for an injunction to stop Treasury and the SBA from making determinations of PPP ineligibility based upon the guidance imposed by way of the FAQs, as well as a declaration from the federal court that FAQs 31 and 37 are contrary to law and must be withdrawn.