Photo of a business owner determining if they applied for the PPP loan in good faith.

'Good faith' risk and PPP: 2 questions to ask about your loan

Getting—and using—help from the Paycheck Protection Program (PPP) became even more complicated when the Small Business Administration (SBA) magnified a single phrase in its loan application. Businesses seeking the federal stimulus must attest “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations ...”

Figuring out what qualifies as “necessary” isn’t simple. With limited guidance to go on, ask yourself one or two questions to feel more comfortable assuming your loan application meets the requirement.

1. Is my original loan less than $2 million?

This may be the only question you need to ask yourself.

SBA guidance issued May 13, 2020, should give some borrowers peace of mind: PPP loans with an original principal amount less than $2 million will meet the good faith requirement. This is consistent with the intent of PPP—to help smaller borrowers retain and rehire employees.

But Schedule C filers following new guidance issued March 3, 2021 must keep in mind whether you based your PPP loan on gross (rather than net) income. If that gross income is above $150,000, you won’t be able to rely on the $2 million “safe harbor.” The SBA may review your certification that “current economic uncertainty makes this loan request necessary to support ongoing operations of the applicant.”

This restriction applies only to first-draw PPP loans. (To be eligible to apply for the second draw, you must certify that you had a reduction in gross receipts of more than 25% in the selected comparable period.)

2. If my original loan is not subject to the $2 million safe harbor, does my application qualify as ‘necessary’?

It depends on a couple factors.

  • The COVID-19 crisis has already impacted your business financially: When the PPP rolled out, being impacted by COVID-19 seemed to be the main qualification—even for relatively large businesses, such as publicly traded companies or hedge funds. But what qualifies as a COVID-19 “impact” remains vague. There’s room for interpretation, but if your business shut down during the pandemic, you should have no problem demonstrating impact.
  • A PPP loan is “necessary to support the ongoing operations” of your business: For the sake of speed, when assembling the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress removed a typical SBA requirement that screens out most large businesses: a lack of other credit options. A number of big loans taken by big companies in the first funding round made the federal government reexamine how to set limits, emphasizing the good faith certification.

These borrowers should be “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.”

This updated nuance probably changes the calculation for a public company with substantial market value, which the SBA says is “unlikely” to qualify. The same goes for private companies that haven’t yet exhausted, as the SBA puts it, other “adequate sources of liquidity.”

“The SBA seized on the original language in the CARES Act to enforce the intent of the PPP program,” says April Caudill, advanced solutions director for Principal®. “The thinking is: If you have all these other resources—if you’re publicly traded with access to the capital markets and so on—you cannot say in good faith that you need PPP.”

What if the SBA finds that a business didn’t borrow in good faith?

The SBA will seek repayment of the outstanding balance and inform your lender that you’re ineligible for loan forgiveness. If you repay the loan, the SBA won’t penalize you. If you don’t repay, your risk could range from civil to criminal liability, probably depending on the degree to which it appears you exercised bad faith or misled the SBA.

If you already have enough cash reserves or other liquidity that won’t hurt your business if you use it, and you can retain employees without the loan, the risk of taking a PPP loan may not be worth it.

However, if you’ve lost customers or suppliers, or you had to close your business due to COVID-19, and you can document all these circumstances (Excel) to show the necessity of your PPP loan, your risk may be relatively minimal.

Bottom line: If your need for a PPP loan is clear and was caused by COVID-19, don’t be deterred from applying. Track your expenses (Excel) and document your need. But if you borrowed more as a defensive move, you may want to be prepared to repay the loan quickly. Future guidance may provide further detail, such as how and when payment would be required.

Next steps

The subject matter in this communication is educational only and provided with the understanding that Principal® and its employees are  not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

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