By Derek Adams, Ellen London and Steven Deolus

Law360 (January 11, 2021, 3:58 PM EST )

Derek Adams

Ellen London

Steven Deolus

The Coronavirus Aid, Relief and Economic Security, or CARES, Act was passed in the early days of the pandemic, on March 27, 2020, to stimulate the economy amid the unfolding crisis. It was unprecedented in terms of its size and scope and, not surprisingly, there has been a great deal of concern about fraud.

The CARES Act's largest program is the Paycheck Protection Program, which made available $659 billion in potentially forgivable loans to small businesses and nonprofits for use on certain payroll and nonpayroll expenses. Between March 27 and Aug. 8, 2020, financial institutions approved more than 5.2 million PPP loans and disbursed more than $5.25 billion.[1]

On Dec. 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act, or Economic Aid Act, was signed into law as part of the Consolidated Appropriations Act of 2021.

The Economic Aid Act modifies certain rules for PPP loans already issued in 2020, and provides nearly $2.85 billion in new PPP loan funding, under new qualification rules, available through March 31.

Some of the most significant changes for the second-draw loans, i.e., loans to borrowers that already received a PPP loan, include (1) the fact that only borrowers that can show a 25% drop in gross receipts in at least one quarter of 2020 as compared to the same quarter in 2019 are eligible; (2) most borrowers must now employ not more than 300 employees to qualify — down from 500; (3) loans are capped at $2 million instead of the previous cap of $10 million; and (4) certain organizations are expressly shut out, such as publicly traded companies.

Core PPP Rules

The PPP is an experiment of sorts. In a rush to flood the economy with economic relief, the PPP was designed to allow lenders to rely on borrower representations with little to no due diligence performed. This was arguably necessary because of the delay that traditional loan underwriting would have caused.

Lenders were required to: (1) confirm receipt of borrower certifications; (2) confirm receipt of information demonstrating that a borrower had employees for whom the borrower paid salaries and payroll taxes on or around Feb. 15, 2020; (3) confirm the dollar amount of average monthly payroll costs; and (4) follow applicable Bank Secrecy Act requirements.[2]

Lenders were permitted to "rely on certifications of the borrower in order to determine eligibility of the borrower and use of loan proceeds and to rely on specified documents provided by the borrower to determine the qualifying loan amount and eligibility for loan forgiveness."[3] Moreover, lenders would "be held harmless for borrowers' failure to comply with program criteria."[4]

Borrowers, on the other hand, made a host of certifications at the time of their loan applications, including an overarching certification that the borrower was eligible to receive a loan under the PPP rules issued by the agency administering the program, the U.S. Small Business Administration.

Borrowers also certified to compliance with many specific PPP rules, such as their size eligibility, operation as of Feb. 15, 2020, loan necessity — as discussed further below, use of the funds, prior federal loan history, prior criminal history, absence of other PPP loans, and the accuracy of all information provided in all supporting documents.[5]

At the time of loan forgiveness submissions, borrowers must make additional certifications — for example, attesting to the accuracy of all information provided in support of their loan forgiveness request and certifying to information regarding either their maintenance of employee levels and salaries or their qualification for certain safe harbors and exceptions to these rules.

PPP Rollercoaster in 2020

The only thing consistent about the PPP during 2020 was change. The SBA and/or Treasury issued twenty-four interim final rules between April 15 and Oct. 19 — in other words, approximately one interim final rule per week. It also issued 80 frequently asked questions, three different loan forgiveness applications and a host of lender notices and forms. Staying abreast of PPP developments was a full-time job in 2020.

The changes to the PPP throughout 2020 were not minor. Many of the changes have and will make the difference between eligibility versus noneligibility, between loan forgiveness versus having to repay the loan and between a previously compliant company and an allegedly fraudulent borrower.

One of the more notable changes was the seemingly shifting landscape concerning what it meant for a borrower to certify that "the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient."[6] This certification received little attention until the program — originally funded with $349 billion — depleted all funds within 13 days of opening.

Then followed a dizzying array of guidance by the SBA between April 23, 2020  and May 13, 2020, which informed all borrowers to assess "their ability to access other sources of liquidity sufficient to support their ongoing operations," provided a safe harbor for borrowers to refund their PPP loans without facing penalty, and then reversed course again by effectively exempting borrowers with loans of less than $2 million from this requirement.

Finally, in October 2020, the SBA issued loan-necessity questionnaires for borrowers with loans of $2 million and greater that foretell potentially extensive scrutiny by the SBA at the time of loan forgiveness.[7]

PPP Enforcement Actions in 2020

The PPP enforcement actions announced in 2020 were all criminal in nature. As of Sept. 10, 2020, the U.S. Department of Justice Criminal Division had brought PPP-related charges against 57 defendants.[8] That number continued to grow in the fall, exceeding 90 individuals charged by December, representing $250 million in alleged losses.[9]

Early in the pandemic, the DOJ Criminal Division's Fraud Section established a team dedicated to PPP fraud, and it has led efforts nationwide to criminally prosecute PPP fraud.

The Criminal Division's Fraud Section works with U.S. attorneys' offices around the country to bring these cases. Most criminal cases to date have involved allegedly falsified borrower information — for example, receiving PPP loans for fake businesses, using fake employee or payroll information to inflate loan amounts, falsifying IRS records or other documentation submitted to the lender, and obtaining multiple loans.

Many criminal actions have also been accompanied by allegations that, instead of using the PPP loan funds for business expenses, borrowers purchased expensive vehicles or otherwise funded their lavish lifestyles.

What to Expect in 2021

While there are many unknowns given the unprecedented nature of the program, it is certain that the fallout from the PPP, whether in the form of litigation or not, will continue for years if not decades. Below are a few areas in which there is likely to be concentrated activity in the near term, some of which may be more pronounced considering the new administration.

Appeals to the SBA

As of Nov. 22, 2020, a little more than $83 billion of PPP funds had been forgiven.[10] This means that most loan forgiveness requests will occur, or at least carry into, 2021. The SBA has established a review and appeal process that we anticipate being flooded with action in 2021.

Once a borrower's covered period ends, it has 10 months to submit its loan forgiveness request or else it will begin receiving charges from its lender for principal and interest payments that are due. After a borrower submits its loan forgiveness request, the lender must issue a decision to the SBA within 60 days.[11] The SBA has up to 90 days to conduct its review. At the conclusion of its review, the SBA will issue its decision to the lender and the lender will notify the borrower.

On Aug. 11, 2020, the SBA issued an interim final rule which established a new subpart L for Title 13 of the Code of Federal Regulations, Part 134, and which contains the procedure governing appeals before the SBA's Office of Hearings and Appeals, or OHA.[12] A borrower seeking to appeal the SBA's decision must file an appeal within 30 calendar days after receiving notice of the SBA's decision.

OHA decisions will be published on OHA's website and create precedent for appeals involving the PPP. Some issues to watch closely in 2021 include: (1) decisions on ineligibility based on preexisting SBA regulations; (2) decisions on size-based qualification, including the application of affiliation rules; (3) decisions involving PPP safe harbors and exceptions, such as the business activity-level safe harbor; and (4) decisions regarding the need-based certification.

Taking these issues in turn, first, much of the litigation against the SBA during 2020 centered around its application of traditional 7(a) ineligibility rules to PPP borrowers.[13] Contained at Title 13 of the Code of Federal Regulations Section 120.110, these rules, which few lawyers — let alone PPP borrowers without legal training — understand, may serve as a rude awakening for many borrowers at the time of loan forgiveness.

The SBA's 7(a) ineligibility rules prohibit a host of business types from obtaining SBA loans, such as financial businesses, passive businesses, life insurance companies, pyramid sale distribution plans, businesses of a prurient sexual nature, marijuana-related businesses, legal gambling businesses, businesses with an associate of poor character, businesses engaged primarily in lobbying activities and speculative businesses.

While Congress did not reference Section 120.110 of the regulations in the PPP, the SBA has taken the position that it nonetheless applies and renders such businesses ineligible for PPP loans, unless explicitly permitted by statute — i.e., certain nonprofit organizations — or by SBA interim final rule, e.g., legal gambling businesses and religious organizations.[14]

PPP borrowers certified eligibility for a PPP loan which, in the SBA's view, includes the eligibility requirements contained in Section 120.110. Lenders were permitted to rely on a borrower's certification and, thus, most would not have independently verified compliance with these business-type restrictions.[15]

Now, long after loan approval and long after the PPP funds have been used, the SBA may inform borrowers that they were ineligible to receive loans and must immediately pay back their already expended loans, in full. This will be a ripe area for dispute, as borrowers will argue that the SBA's application of these restrictions is inconsistent with the PPP and should not be permitted.

Second, borrowers likewise certified to compliance with the PPP's size-based qualification requirements, an equally complex undertaking. In addition to the proper method of counting employees — for example, counting part-time and "other basis" employees, but excluding independent contractors — the borrower's affiliates, as determined by SBA regulation and specific PPP rules, must be taken into consideration when counting a borrower's total employees.

Thus, a well-intentioned borrower believing that it met the PPP's size-based qualification requirements could still run afoul of those requirements upon scrutiny by the SBA. In addition, borrowers with more than 500 employees that certified to compliance based on the SBA's revenue-based criteria or its alternative size standard will be required to show their work to the SBA during its loan forgiveness review.

Third, as a general proposition, if a borrower's full-time equivalent employee count drops during its covered period as compared to a prior reference period, then it may be required to repay part of its loan. Certain exceptions and safe harbors apply, however, and may rescue a borrower from this unwanted result. One such safe harbor is known as the business activity level safe harbor.

It was passed on June 5, 2020, as part of the Paycheck Protection Program Flexibility Act of 2020, and provides a safe harbor to the full-time equivalent reduction impact if a borrower can "document an inability to return to the same level of business activity as such business was operating at before February 15, 2020," due to compliance with various restrictions relating to social distancing and other COVID-related safety measures.

While the SBA has provided some guidance on this safe harbor — for example, expanding it to cover local and state ordinances, the bounds of the safe harbor are unclear and untested. For many borrowers, the business activity level safe harbor would be the difference between full loan forgiveness or substantial required repayment. Thus, we expect to hear much more about this safe harbor during 2021.

Fourth, as discussed above, the need-based certification has been a moving target and its meaning is still unclear to most. If the SBA seeks to invalidate loans during the loan forgiveness process based on this certification, we expect hotly contested appeals and litigation to follow.

Administrative and Civil Enforcement

As part of the CARES Act, the SBA Office of Inspector General received an additional $25 million for activities through Sept. 30, 2024. In addition, new authorities were created to help investigate fraud in the PPP, among other programs, including the Pandemic Response Accountability Committee and the Special Inspector General for Pandemic Recovery. We will see increased investigatory activity by these various enforcement bodies in 2021, and perhaps other increases either to their funding or available tools with the Biden administration.

We also anticipate increased actions to be filed by relators alleging fraud in connection with the PPP under the False Claims Act. These actions are filed under seal and then investigated by the DOJ, often for an extended period. Thus, it is unknown how many FCA actions already have been filed; it would be surprising, though, if the number was not high.

The loss of federal funds, however, which is required for FCA liability, will arguably occur after a borrower receives approval for its loan forgiveness request and the funds are transmitted by the SBA to the lender, thereby extinguishing the borrower's repayment obligation. As a result, we anticipate more FCA actions to be filed following loan forgiveness, much of which will occur during 2021.

Additional Criminal Enforcement

While nearly 100 criminal actions during 2020 may sound impressive, that represents only about 0.002% of the 5 million PPP loans issued during 2020. While the vast majority of PPP borrowers are likely honest and eligible borrowers, we anticipate additional criminal actions during 2021 as new schemes are uncovered. We may also see more sophisticated frauds charged in 2021 that are detected by SBA auditors during their loan forgiveness reviews.

The SBA has stated that all loans greater than $2 million — of which there are approximately 28,982 according to SBA data — will be reviewed by the SBA during the loan forgiveness process. These reviews will undoubtedly lead to some, and probably many, referrals to the SBA OIG and/or to the DOJ for enforcement action.

Litigation Against the SBA

While 2020 saw some litigation against the SBA, this was mainly from prospective borrowers who were shut out of PPP loans due to SBA restrictions imposed on the program. 2021 will see a much larger number of borrowers with disputes arising from loan forgiveness denials, or partial denials. While this process will likely begin with appeals to OHA, unsuccessful appellants may then seek refuge in federal district court.

These challenges will likely be spurred on by the inevitable unequal treatment of different borrowers and groups of borrowers, whether intentional or not. The case law will further develop in 2021 as this process continues.

PPP Second Draw Loans

The above considerations will of course be occurring alongside the SBA's efforts to promulgate new guidance and rules for the $284 billion in PPP funds administered in the first quarter of 2021 under the Economic Aid Act. This round of second-draw funding has new qualification requirements — for example, new requirements for revenue declines, lowered employee counts, new prohibitions and other changes. We are likely to see new issues arise during 2021 based on the new rules.

The 30,000 Foot View

Given the various ways that the government will be seeking to recover funds that were obtained fraudulently, a big question is how coordinated the federal response can or will be, especially with the transition to the Biden administration and the overall changes to law enforcement that are inevitable.

As the various law enforcement entities move forward, we will be watching for whether the government focuses on certain issues — either through specific guidance or as a practical matter as the cases move forward — as opposed to simply following whatever leads come in, either through audits, whistleblowers or other sources. At least in the FCA space, the government will have to spend some of its resources based on the qui tam actions that are filed.

While there is no guarantee of consistency, keeping abreast of the various developments and how others are being treated will give borrowers a leg up in determining the best approach for any given dispute. Thus, it appears that the full-time work of staying informed about the PPP and related matters will continue into 2021.

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Derek Adams is a partner at Potomac Law Group PLLC and former trial attorney with the DOJ's Civil Fraud Section.  

Ellen London is a partner at Alto Litigation PC and formerly served as an assistant U.S. attorney for the Southern District of New York and the Northern District of California. 

Steven Deolus is a junior associate at Alto Litigation.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program.

[2] https://www.federalregister.gov/documents/2020/04/15/2020-07672/business-loan-program-temporary-changes-paycheck-protection-program.

[3] Id. at page 20812.

[4] Id.

[5] https://www.sba.gov/sites/default/files/2020-12/2483-PPP-Borrower-Application-Form%20%28Revised%2012.29.2020%29-%20508.pdf.

[6] CARES Act, Section 1102(a)(36)(G)(i)(I). Read more at: https://www.law360.com/articles/1326356/sba-survey-signals-enhanced-covid-19-loan-scrutiny.

[7] See https://www.law360.com/articles/1326356/sba-survey-signals-enhanced-covid-19-loan-scrutiny.

[8] https://www.justice.gov/opa/speech/acting-assistant-attorney-general-brian-rabbitt-delivers-remarks-ppp-criminal-fraud.

[9] https://www.justice.gov/opa/speech/acting-deputy-assistant-attorney-general-robert-zink-delivers-remarks-virtual-gir-live.

[10] https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program.

[11] https://www.govinfo.gov/content/pkg/FR-2020-06-01/pdf/2020-11533.pdf.

[12] Id.

[13] See e.g., Camelot Banquet Rooms Inc. v. U.S. Small Business Administration , 2020 WL 2088637 (E.D.WI., May 1, 2020); DV Diamond Club of Flint LLC v. U.S. Small Business Administration , 2020 WL 2315880 (E.D.MI., May 11, 2020); Pharaohs GC Inc. v. U.S. Small Business Administration , 2020 WL 3489404 (W.D.N.Y, June 26, 2020); American Association of Political Consultants v. U.S. Small Business Association , 810 Fed. Appx. 8 (D.C. Cir., May 26, 2020).

[14] Notably, the Economic Aid Act does mention 13 C.F.R. § 120.110 and states that entities, other than those captured by 120.110(a) or (k), are not eligible for second draw PPP loans under 15 U.S.C. § 636(a)(37). The act also codifies SBA's interim final rule which permitted loans to religious organizations under 120.110(k) and applies that change retroactively to section 636(a)(36). And finally, while it prohibited businesses otherwise ineligible under section 120.110 from receiving a second draw loan, the act does not speak to whether these entities were eligible under round one funding.

[15] See e.g., Docket No. SBA-2021-0001, at 26; https://www.sba.gov/sites/default/files/2021-01/PPP%20--%20IFR%20--%20Paycheck%20Protection%20Program%20as%20Amended%20by%20Economic%20Aid%20Act%20%281.6.2021%29-508.pdf.

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