The Good Faith Necessity Certification Requirement under the CARES Act and Paycheck Protection Program: A Borrower's Update


By: Zack R. Gardner, Esq. and Law Clerk Zach Kiffmeyer

For the past few weeks, many small businesses that received loans under the Paycheck Protection Program (“PPP”) have wrestled with the decision of whether to keep the money or give it back after confusing guidance from the Treasury Department and the Small Business Association (“SBA”) raised questions about the good faith necessity certification.  Much to their relief, new guidance released May 13, 2020 provides a certification safe harbor for businesses receiving loans under $2 million.

The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which governs the PPP, requires borrowers to certify that “the uncertainty of economic conditions makes necessary the loan request to support the ongoing operations of the [borrower].” CARES Act § 1102 (emphasis added).  In response to public companies requesting and receiving larger loans from the PPP, causing many smaller, local businesses to be left out, the SBA and the Treasury Department provided guidance on the “necessity” of a PPP loan as part of their FAQs.  The guidance, however, raised more questions than answers for smaller companies.

In FAQ #31, published April 23, 2020, the SBA presented the following question: “Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” In response, the SBA stated:

“In addition to reviewing applicable affiliation rules to determine 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. Although 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), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” 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. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.

Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 [extended to May 14, 2020] will be deemed by SBA to have made the required certification in good faith. (Emphasis added).” 

In FAQ #37, the SBA asked, “Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?”, but the answer merely referenced the question and answer to FAQ #31.

On April 28, 2020, Treasury Secretary Steve Mnuchin declared that any business that receives more than $2 million in PPP loan proceeds will be audited. On April 29, in response to Mnuchin’s declaration, the SBA added FAQ #39, stating:

“To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will 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. Additional guidance implementing this procedure will be forthcoming.”

This guidance left borrowers receiving loans of less than $2 million and some access to other forms of liquidity worried about whether the SBA would conclude retroactively that their loans were not “necessary” to support ongoing operations and subject them to penalties. 

The day before the deadline to repay the PPP loans without consequences, the SBA released FAQ #46, which asked, “How will SBA review borrowers’ required good faith certification concerning the necessity of their loan request?” In its response, the SBA created a certification safe harbor, stating, “Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.”

In justifying the safe harbor, the SBA noted that businesses receiving loans for less than $2 million likely did not have other sources of liquidity; the safe harbor comports with the overarching goal of the PPP, which is to keep people employed in small businesses; and finally, the SBA, by only auditing businesses who took out loans in excess of $2 million, will be able to conserve its finite audit resources and focus on those businesses which might yield the highest number of compliance issues.

The SBA also gave further guidance to borrowers receiving loans in excess of $2 million, as follows:

“Importantly, borrowers with loans greater than $2 million that do not satisfy this safe harbor may still have an adequate basis for making the required good-faith certification, based on their individual circumstances in light of the language of the certification and SBA guidance. SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form. If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request. SBA’s determination concerning the certification regarding the necessity of the loan request will not affect SBA’s loan guarantee.”

In light of this guidance, businesses receiving loans of less than $2 million can breathe easier and concentrate on using their loan proceeds for the purposes outlined in the CARES Act.  Businesses receiving loans in excess of $2 million should be preparing to document support for the necessity certification.  Until additional guidance is released on the audit review process, we would suggest gathering documentation of the following items to help smooth the audit experience with the SBA:

1) Uncertainties in your business operations due to COVID-19 such as:

  • uncertainties in supply chain of products;
  • uncertainties about when your business may reopen due to constantly evolving state government executive orders regarding COVID-19;
  • uncertainties about whether your usual customers or others in the market will purchase goods/services from you if your business were to reopen;
  • uncertainties about what will happen to your business if a new wave of the virus should occur based off medical expert opinions and data; and/or
  • uncertainties about whether your customer or target markets will be able to afford your products/services given the overall economic impact of COVID-19.

2) Inability to access liquidity elsewhere. Public companies may have a harder time showing this given their access to larger capital markets and sources of liquidity outside the PPP.

3) Risks involved with maintaining your current workforce, such as:

  • employees that may choose to leave your business should they find a more cash-healthy business to work for;
  • employees that would prefer to collect unemployment payments instead of receiving pay from your business; and
  • employees that are fearful of working during the pandemic.

4) Impacts to competitors that you feel would soon affect your business as well.

5) Overhead cuts and other reduction in working capital made by similar businesses within your industry.

6) Cash flow, revenue, and balance statements since the national emergency and quarantine orders were declared demonstrating how the COVID-19 pandemic is currently impacting your business.

Kennerly Montgomery is here to assist you during these unusual and unprecedented times.  If you have any questions, please reach out to one of our attorneys at (865) 546-7311.

Please Note:  The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information and content is for general informational purposes only. 

Other COVID-19 Coverage:

How To Get Your Paycheck Protection Program Loan Forgiven: An FAQ Guide for Small Businesses and Self-Employed Individuals
Are COVID-19 Business Losses Covered By Insurance?
CARES Act: Small Business Loans
We've Got Your Six (Reasons for Paid Sick Leave Under the FFCRA) Covered.
CARES Act Provides Early Access to Retirement Funds and Other Retirement Plan Relief
DOL Provides Limited Guidance on New Families First Coronavirus Response Act
A Summary of the Family First Coronavirus Response Act for Employers and Employees
Leave Policy Review: Coronavirus (COVID-19)

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