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Analyzing Borrower Certification Risks under the Paycheck Protection Program

As the editor of BankBCLP.com, I tend not to write a lot of posts for other blogs hosted by Bryan Cave Leighton Paisner LLP. However, the Paycheck Protection Program(PPP) has affected small business clients throughout the firm.

The shifting narratives around the government’s interpretations regarding eligibility for participation in the PPP has caused many borrowers to reconsider their own applications and to consider exiting the program by returning PPP funds by the government’s current safe harbor return deadline of May 14th.

In this post on the BCLP US Securities and Corporate Governance Blog, I describe the history and background of the PPP certification process, and suggest a three bucket risk framework for analyzing one’s certification. In discussions with corporate clients, we have found this framework to be useful for public and private companies.

As recognized in FAQ 31, this remains primarily a risk for PPP borrowers, and not PPP lenders, as “lenders may rely on a borrower’s certification regarding the necessity of the loan request.” In our experience, this has also made many lenders reasonably constrained from providing any further advice to borrowers regarding analysis of the borrower’s certification.

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The Paycheck Protection Program: Managing Fair Lending Risks

The past few weeks have seen increasing scrutiny of the lenders and borrowers participating in the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”), including by the Treasury Department, SBA Inspector General, U.S. Department of Justice, and Congress with the Special Inspector General for Pandemic Recovery surely soon to follow.

Against this backdrop, the Consumer Financial Protection Bureau (“CFPB”) has recently raised concerns related to fair lending for lenders participating in the PPP. On May 6, 2020, the CFPB issued guidance related to the timing for Equal Credit Opportunity Act (“ECOA”)-mandated adverse action notices under the PPP. On April 27, 2020, the CFPB published a statement in which the Bureau emphasized that lenders must comply with ECOA when extending small business credit, outlining key bases for discrimination claims under ECOA and encouraging women and minority-owned businesses who feel they have suffered lending discrimination to submit complaints to the CFPB through its complaint portal.

The CFPB’s recent focus on institutional fair lending compliance accords with that of federal banking regulators. For example, on April 27, 2020, the Office of the Comptroller of the Currency released “OCC Bulletin 2020-45,” which, among other things, encourages institutions to “prudently document their implementation and lending decisions” under the SBA’s PPP.

Given recent regulatory focus on fair lending compliance in connection with PPP lending, banks and other lenders should consider the following proactive risk mitigation steps.

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Guidance for Public Company PPP Recipients

On April 23, 2020, the U.S. Treasury published FAQ #31 for the Paycheck Protection Program, providing a safe harbor for return of funds by May 7, 2020 in cases of insufficient need by recipients of PPP funds by public companies with liquidity alternatives.

With this background, I joined several of my securities law and litigation colleagues to publish guidance for public company Paycheck Protection Program loan recipients.

PPP applications require certification that “[c]urrent economic uncertainty makes this loan request necessary to support ongoing operations.”  To the extent that public companies may have had other reliable, accessible sources of capital markets funding, the borrower’s certification of economic need could be called into question. Public companies are clearly not all in the same sitaution with regard to their ability to obtain other sources of funding, and face a number of difficult decisions.

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PPP Litigation and Regulatory Risks

With assistance from some of my litigation colleagues, Bryan Cave Leighton Paisner has just published guidance on re-evaluating practices and considering some of the litigation risks that could arise with the Paycheck Protection Program.

Prior to the PPP going live on April 3, banks scrambled to assemble teams and online application in-take and processing protocols to handle the onslaught of applications.  Over 1.6 million small businesses were approved for relief, a small fraction of the total number of small businesses in the U.S. 

For many, the Program ground to a halt on April 16, 2020, a mere 13 days after it opened, when all of the $349 billion in funding was exhausted.  The abrupt and swift depletion of the Program left many small business owners in dismay and frustrated with their banks, and pondering what recourse they might have.  A few quickly filed lawsuits.  More lawsuits no doubt are coming.  

As Congress gets set to appropriate more than $300 billion in additional funding for the Program, and lenders prepare for ramping up their PPP operations for the second round of applications, it is smart to re-evaluate practices and consider some of the litigation risks that could arise. 

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PPP Refresh – $310 Billion More

Based on news reporting, we understand that Congress and President have collectively agreed on $300 billion in additional funding for the Paycheck Protection Program. The circulated draft of the “Paycheck Protection Program and Health Care Enhance Act” makes no changes to the eligibility or terms of the PPP, but does authorize an additional $310 billion in funds, raising the total funding level for PPP loans to $659 billion.

The Paycheck Protection Program and Health Care Enhance Act would also increase the amount authorized for the SBA to ultimately forgive to $670 billion, presumably recognizing an intent to also be in position to forgive interest in additional to principal.

While the Paycheck Protection Program and Health Care Enhance Act does not alter the eligibility or terms for either borrowers or lenders, it does provide some protected classes of lenders who are ensured a set aside of a portion of the expanded PPP authorization. Specifically, depository institutions and credit unions with between $50 billion and $10 billion in consolidated assets will be ensured the ability to issue, in the aggregate, at least $30 billion in loans guaranteed by the SBA under the PPP. Depository institutions and credit unions with less than $10 billion in consolidated assets, as well as community development financial institutions (CDFIs), minority depository institutions (MDIs), and certain state development companies certified under Title V of the Small business Investment Act will be ensured the ability to issue, in the aggregate, at least $30 billion in loans guaranteed by the SBA under the PPP.

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The Bank Account’s Introduction to the Paycheck Protection Program

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Joining all the (far more) popular podcasts, The Bank Account is now recording from the host’s home. This episode features Partners Karen Fries and Mike Royle joining me in a presentation about the basic terms of the SBA’s small business forgivable loan program, the Paycheck Protection Program.

As the Paycheck Protection Program is changing rapidly, it’s important to note that guts of this presentation were recorded on April 9, 2020. While the funds have currently been exhausted for new PPP loans (pending Congress deciding when and how to allocate additional funds), the key terms of the loans and the forgiveness functions discussed in this podcast episode remain accurate, at the least as of the time of posting.

While our initial approach was going to be to engage in a debate on the merits of this practice, none of us ultimately wanted to take the side of justifying the practice; for different reasons, many of which are expressed on the podcast, we all believe that it is a bad idea for bank directors to personally approve loans.

For those interested in hearing more information about the Paycheck Protection Program in audio form, I highly recommend the Big Small Business Rescue from Planet Money. And if you’re craving more content, and prefer the last financial crisis, I’d also suggest the FDIC “podcast” on the 2008 financial crisis.

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SBA PPP Loan Approval Statistics

From launch of the Paycheck Protection Program on April 3, 2020 through the exhaustion of the originally committed funds on April 16, 2020, 4,975 lenders approved loans to over 1.6 million small businesses for over $342 billion. On April 17, the SBA published a Paycheck Protection Program Report with additional statistics on the approved PPP loans.

Excluding weekends (which probably isn’t fair, as I know a lot of bankers that worked non-stop the last two weekends), this amounts to over 160,000 applications approved each day, or more than $34 billion in loan proceeds each day.

The Report indicates the overall average loan size approved was $206,000. Assuming each applicant applied for the maximum PPP loan it was entitled to, this indicates that the average applicant’s monthly payroll costs were approximately $82,400.

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SBA PPP Eligibility Requirements

The SBA has made clear that businesses with 500 or fewer employees can apply for PPP funds, with certain exceptions. The number of employees for a business is generally determined by the average number of people employed for each pay period over the business’s latest 12 calendar months. For this determination, any person on the payroll must be included as one employee regardless of hours worked or temporary status.

However, for businesses with greater than 500 employees, there are still three possible ways qualify for PPP funds. This post analyzes the three additional methods for a business to qualify for PPP funds, based on the latest guidance from the SBA as of April 15, 2020.

Method 1: SBA Employee-Based Size Standards

Under the CARES Act, the SBA requires borrowers to have 500 or fewer employees or the number of employees specified per the SBA’s Size Standards table. Thus, a business with greater than 500 employees may still be eligible if it meets applicable SBA employee-based size standards for its primary industry. A business’s primary industry is denoted by its North American Industry Classification System (NAICS) Code. A list of all NAICS codes is available here.

For example, a business in the in the primary industry of natural gas extraction (NAICS Code 211130) with 1,000 employees would still be eligible for PPP funds because the applicable SBA employee-based size standard is 1,250.

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SBA PPP April 14 Interim Final Rule Guidance

On April 14, 2020, the SBA published an interim final rule that provides additional guidance regarding topics of confusion among both Payroll Protection Program (“PPP”) lenders and borrowers. This new rule supplements the first interim final rule, which was issued by the SBA on April 2, 2020, and specifically addresses the eligibility of self-employed individuals, partnerships, director-owned businesses, and legal gambling businesses. This post covers the updates detailed in the new interim final rule, based on the latest guidance from the SBA as of April 16, 2020.

Self-Employed Individuals

Eligibility

The new interim final rule makes clear that an individual may be eligible for a PPP loan if the individual:

  1. was in operation as a business on February 15, 2020;
  2. is an individual with self-employment income (such as an independent contractor or a sole proprietor);
  3. has a principal place of residence in the United States; and
  4. filed or will file a Form 1040 Schedule C for 2019.

The SBA has communicated that it will issue additional guidance for those individuals with self-employment income who: (i) were not in operation in 2019 but who were in operation on February 15, 2020, and (ii) will file a Form 1040 Schedule C for 2020.

We note that individuals should be aware that participation in the PPP may affect eligibility for state-administered unemployment compensation or unemployment assistance programs.

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TARP Exit Ramp for Community Banks: The SBLF

Only about 1 % of principal repayment to Treasury through 2011 under the TARP Capital Purchase Program (CPP) was the result of SBLF refinancing, according to latest Quarterly Report to Congress issued by the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP).  Though the lion’s share of Treasury’s $4 billion investment under the Small Business Lending Fund was used for this purpose, the figure constitutes only a fraction of the $186 billion in CPP principal repaid thus far.  About $20 billion in CPP securities remains outstanding.

The rest of the story is that the smaller CPP participants have been much slower to repay CPP obligations, and the SBLF was a major boost for those institutions.  In all, 137 institutions exited TARP by refinancing their outstanding CPP investment using SBLF funds.  Through December 31, 2011, 279 banks in all had exited the CPP program either by fully repaying CPP or by virtue of Treasury’s having sold the institution’s stock.  So roughly half of all exits from the CPP – the first investments under which took place in 2008 – occurred during the three months of SBLF infusion in 2011.  In contrast, by the middle of 2009, ten of the largest CPP participants had already repaid $68 billion worth of Treasury investment.

The average SBLF participant exiting the CPP program used $16 million in SBLF funds to refinance CPP obligations.  Compare that to the median CPP investment among the 707 recipients under that program – $10.3 million – and you can see how the SBLF closed out very little of Treasury’s overall CPP investment but was the single most successful community bank TARP exit strategy to date.

Meanwhile, Treasury continues to make its case that the SBLF has also increased small business lending among participants – $3.5 billion (September 30, 2011) over a $35.9 billion baseline (the average for the four quarters ending June 30, 2010) – or about $10 million per bank.  The average SBLF recipient (332 recipients in all) received $12 million.

 

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