To supplement its Payroll Protection Program (PPP) Rules, the Small Business Administration (SBA) regularly issues PPP frequently asked questions (FAQ) in numerical order, easily found from the “red line” across the Treasury Department homepage. On April 23, the SBA issued FAQ 31 (https://bit.ly/2SjiC01), stating that PPP loan recipients who have not faced COVID-19 crisis liquidity problems and economic harm were not PPP-eligible borrowers. Anyone who received PPP funds has until May 7 to return unneeded funds without violating the “good faith” certification made about suffering economic harm.
FAQ 31 likely was a response to the negative publicity about public companies and private banking clients receiving both PPP loans and preferential “front-of-the-line” treatment. Unfortunately, the guidance in the FAQ will have unintended consequences for many borrowers. Unless the SBA clarifies this quickly, pre-FAQ 31 advice that CPAs gave to small and medium-sized businesses, IRC section 501(c)(3) organizations, independent contractors, and others to apply for PPP loans may have to be revisited.
The statutory certification to which the FAQ refers—and the only PPP needs-based test, which all PPP loan applicants must sign—states, ”Current economic uncertainty makes this loan request necessary to support the ongoing operation of the Applicant.” Until now, this has generally been interpreted as COVID-19 causing significant current or prospective economic harm due to materially reduced revenue and operations that would likely lead to layoffs or a similar interpretation. FAQ 31 has changed this with two highly subjective tests, nowhere to be found in the statute, involving a borrower’s undefined level of “current business activity” and “ability to access other sources of liquidity.” The lack of definition will be problematic for many current and prospective PPP borrowers.
While FAQ 31’s “Question” concerns large companies, its “Answer” applies to all borrowers with this highly subjective phrase:
Borrowers must make this certification in good faith, taking into account their current business activity and 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.
Larger businesses and public companies with resources will receive more attention from the SBA, especially those of the type that had recent negative publicity. Treasury Secretary Stephen Mnuchin has stated that all borrowers with PPP funds exceeding $2 million will have their certifications audited, but for everyone else, SBA does not state the degree to which average small businesses or 501(c)(3)s with material pandemic-related revenue declines coming out of “current economic uncertainty” have a decreased level of “current business activity” sufficient to qualify for the PPP.
Implications and Questions
Before this FAQ, if a local wine store was weathering the COVID-19 pandemic with no trouble, it is fairly clear that it could not make the economic harm certification, while the dry cleaner next door whose revenue had seriously declined could. But has it declined enough to now meet this vague new “current business activity” standard? In addition, do the dry cleaner’s owners have to put their personal savings into the business as an available “source of liquidity” before taking a PPP loan? Does a 501(c)(3) whose revenue programs and fundraising gala were cancelled due to COVID-19 have to return PPP funds because it didn’t spend down “other sources of liquidity” reserves it may or may not need for the recovery? Does an independent contractor whose revenue has evaporated due to COVID-19 become PPP-ineligible because he prudently has liquid resources saved for retirement?
Furthermore, what is the bright-line test to determine if spending a liquidity source is or is not “significantly detrimental to the business?” What level of “current business activity” is required for a PPP loan? Who will evaluate or adjudicate the facts and circumstances around these tests, which will be unique for each entity?
For both small businesses and 501(c)(3)s, existing sources of liquidity will likely be vital after the PPP ends and the economy slowly opens again. The new SBA guidance is creating concern that such resources may have to be spent down before seeking a PPP loan. The SBA needs to objectively clarify the extent to which medium-size entities, whose revenues have sharply declined due to COVID-19, meet these standards.
The wording of the “current economic uncertainty” certification could have been clearer, but those who have become familiar with PPP’s rules generally understand it to mean that a borrower is suffering or will likely suffer meaningful economic harm as a result of the crisis. FAQ 31 does respond to the publicized broad concern of preventing “a public company with substantial market value and access to capital markets” from accessing PPP loans, but for legitimately hurting entities, the FAQ’s “level of current business activity” and “sources of liquidity” tests are not only worrying but seem contrary to congressional intent.
While Congress made PPP loans an add-on to the standard SBA 7(a) loan, the PPP statutory provisions expressly set aside virtually every typical 7(a) loan underwriting standard, including credit scores, collateral and personal guarantees, and demonstration that the borrower cannot obtain credit elsewhere. To this end, the SBA’s March 31, 2020, “For Borrowers—More Information” PDF (https://bit.ly/2WgPUOB) contains the following Q&A:
Do I need to first look for other funds before applying to this program? No. We are waiving the usual SBA requirement that you try to obtain some or all of the loan funds from other sources (i.e., we are waiving the Credit Elsewhere requirement).
This Q&A does not state that an entity must assess its (per FAQ 31) “ability to access other “sources of liquidity” that are not “credit elsewhere sources” before being PPP-eligible. In fact, the FAQ 31 requirement seems like a close cousin to the “credit elsewhere” requirement that the PPP statutory provisions expressly set aside for PPP loans.
The SBA did not say what the consequences of not returning funds would be, nor did it say how it will enforce the new interpretation, or against whom. It is one thing to enforce against major companies and institutions that have clearly abused the certification and another to enforce against average small businesses, nonprofits, and independent contractors that have truly suffered economic loss. Anyone who has seen the SBA pursue action against individuals who personally guaranteed defaulted loans knows the agency can be serious. Enforcement may be more than turning the proceeds into a two-year loan at 1% interest, and in the most egregious cases can result in criminal prosecution.
Entities that have received or applied for PPP funds would be wise to conduct a FAQ 31 evaluation. Those that are not facing a COVID-19 related revenue downturn should probably return or decline PPP funds. Entities that do have a material revenue decline and no alternative liquidity sources to meet payroll costs over the program’s eight-week period should be fine accepting the funds. Everyone else must make subjective, risk-based judgments; the more difficult it is for an entity to afford eight weeks of payroll costs without sacrificing future operations, the more likely the entity can meet the FAQ’s standards for accepting PPP funds. To the extent there are other available resources both to meet payroll costs over the eight weeks and to fund operations over a gradual recovery period, PPP money should possibly be returned.
The one bit of solace for 501(c)(3)s is that nonprofit endowment fund spending is governed by each state’s version of the Uniform Prudent Management of Institutional Funds Act, and thus, it would be difficult for SBA to consider fund principal as a “liquidity source.” In New York, spending more than 7% of a fund’s fair market value in a single year is presumed imprudent without sound reason, and lesser spending may be imprudent as well.
One unanswered question is the extent to which business owners’ assets outside the business are an “other source of liquidity” under FAQ 31. Entities accepting PPP funds would be wise to prepare at least a brief written analysis, possibly including Excel projections, covering their reasons for meeting the FAQ 31 tests, as subjective as such an analysis might need to be. One approach is to prepare three scenarios—one best-case, one worst-case, and one in-between—for the economic recovery and project how using an entity’s other sources of liquidity would or would not be “detrimental to the business.”
Many Unanswered Questions
SBA FAQ 31 has created new PPP loan qualification standards that were not envisioned until its issuance, leaving many open questions that require answers for entities that seemed clearly entitled to PPP funding. If the SBA does not quickly provide clarification, many entities with significant COVID-19 revenue losses that received PPP loans but also have internal or external “sources of liquidity” may believe they now have to return the funds. Some will send employees about to be paid with PPP funds to states’ unemployment insurance websites instead, an outcome diametrically opposed to the PPP’s original intent.
Walter Primoff, CPA/PFS, CGMA, is a tax and financial advisor with The Dowling Group in Greenwich Conn, and a consultant for CPA and other professional firms and 501(c3) organizations. He is a past deputy executive director of the NYSSCPA and a former contributing editor of The CPA Journal.