SBA Guidance on Economic Necessity for PPP Loans

The Small Business Administration (SBA) recently issued additional guidance clarifying how Paycheck Protection Program (PPP) loan applicants must assess their economic need for the loan. PPP loans were established under the CARES Act and offer employers with fewer than 500 employees, including 501(c)(3) nonprofit Community Action organizations, a fully forgivable loan to cover approximately 8 weeks of payroll costs and other eligible expenses. The SBA has continually updated its guidance for the PPP program, including through its informal guidance document, PPP Frequently Asked Questions.

New Standard for Economic Necessity

As part of the PPP application process, an authorized representative for each applicant is required to provide a certification that “[c]urrent economic conditions makes this loan necessary to support the ongoing operations of the Applicant.” The SBA added a new Question #31 to its PPP Frequently Asked Questions, that expanded this standard. In addition to making this certification in good faith and accounting for current business activity, borrowers must also 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. The SBA cites the example of public companies with substantial market value and access to capital markets as being unlikely to make the required certification in good faith.

As CAPLAW previously explained, for Community Action organizations, this means that PPP borrowers must consider their current financial condition, including the availability of existing federal funds and the impact of the COVID-19 outbreak on the organization’s operations and programs, to determine whether it actually needs the PPP loan to maintain its operations. For example, while some CAAs have enacted emergency closure policies to continue paying staff during the closure, paid leave benefits under these policies may expire before the outbreak ends, so an organization may determine, at that point in time, that a PPP loan is necessary to maintain payroll and full employment. State and regional Community Action associations may have suffered financial losses as a result of disruptions to planned conferences, meetings, and other events. Such losses may include cancellation fees, penalties for changing travel plans, as well as the loss of expected revenue. These organizations may determine that the PPP loan is necessary to maintain payroll and cover ongoing operational costs.

Further, a CAA may determine that it cannot pay a portion of its workforce as a result of COVID-19-related shutdowns (e.g., due to funding disruptions or limitations). This CAA might determine that it needs a PPP loan to cover payroll costs for part of its workforce, and work with its lender to apply for a loan amount that is less than what it is eligible to receive (i.e., up to 2.5 times its average monthly payroll costs) yet sufficient to meet those payroll needs. There are no stipulations in the PPP loan application or other indications in the SBA rules or guidance that require an organization to spend 100% of its PPP proceeds. Presumably, the organization could return any unused portion of the loan. However, it’s not clear whether the requirement to spend at least 75% on payroll costs for the loan to be fully forgiven would apply just to the portion of the loan the organization retains, or to the full loan amount disbursed (including any returned portion). Organizations should work with their lenders to determine how loan forgiveness will be calculated and whether there are any costs associated with returning a portion of the loan, including any accrued interest that would not be forgivable. Note that loan forgiveness is based on maintaining full employment and pay levels of the CAA’s entire workforce, even if the CAA only applied for and intended to use the PPP to cover payroll costs for part of its workforce.

If, on the other hand, a CAA has maintained its essential operations, continued to cover payroll and operational costs using federal funds, and not incurred economic losses or increased expenses as a result of COVID-19, it must carefully consider whether it has a justifiable basis for making the economic need certification. For example, Head Start grantees, which have been directed to continue to pay their staff during center closures due to COVID-19 using their current Head Start grants, will likely be unable to show that the PPP loan is necessary to cover payroll costs for their Head Start staff.

Documentation to Support Certification

FAQ Question 31 states that the SBA may request an applicant to demonstrate the basis for its economic necessity certification. The SBA also announced in FAQ Question 39 that, to ensure that PPP loans are limited to eligible borrowers in need, it would review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. The SBA plans to issue additional guidance implementing this procedure. At this point it is not clear what factors would trigger SBA review of a loan under $2 million, or what the SBA would consider and what documentation it would request as part of the audit process.

Thus, a Community Action applicant for a PPP loan should document that its board received and considered information about the impact of COVID-19 on the organization’s financial position and the organization’s economic need for the loan. Such information could include a projection of budget shortfalls, analysis of cancelled contracts, and/or explanation of how conditions specific to the organization are likely to affect its ability to continue employing staff. The applicant should maintain appropriate documentation to present to the SBA, if requested, such as board minutes reflecting the board’s discussion and/or a resolution certifying the organization’s economic need for the PPP loan based on information reviewed.

Reconsidering Economic Need and Repaying PPP

Finally, the SBA is providing a grace period for borrowers who received a PPP loan but have since concluded that they do not meet the economic necessity requirement to receive the loan. Any borrower that applied for a PPP loan prior to the issuance of Question #31 (published April 23, 2020) and repays the loan in full by May 7, 2020 will be deemed by the SBA to have made the required certification in good faith. An organization that applied for a PPP loan prior to FAQ Question 31 should consider its eligibility in light of the new SBA standard. If circumstances have changed such that the loan is no longer necessary, or if the new guidance leads the organization to question its eligibility, the organization should consider repaying the loan in full by May 7, 2020.

This News Flash is part of the Community Services Block Grant (CSBG) Legal Training and Technical Assistance (T/TA) Center. It was created by Community Action Program Legal Services, Inc. (CAPLAW) in the performance of the U.S. Department of Health and Human Services, Administration for Children and Families, Office of Community Services Cooperative Agreement – Grant Award Number 90ET0467-03. Any opinion, findings, conclusions, or recommendations expressed in this material are those of the author(s) and do not necessarily reflect the views of the U.S. Department of Health and Human Services, Administration for Children and Families.

The contents of this news flash are intended to convey general information only and do not constitute legal advice. Any communication through this publication or through CAPLAW’s website does not constitute or create an attorney-client relationship. If you need legal advice, please contact CAPLAW or another attorney directly.