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PPP Loan Necessity Certifications and Fraud Investigations

A recent article in the Wall Street Journal highlights renewed talk in some circles about allegedly “growing evidence” of fraud among PPP participants.  We think the observation of the former federal prosecutor who is quoted in the story is salient.  While we wouldn’t phrase it the way the ex-prosecutor does (the “scandal is what’s legal, not what’s illegal”) and we disagree with his disdain for the program, the larger point is important: Congress has spoken—twice—and may speak a third time. In adopting the CARES Act, Congress established a program with small businesses’ self-assessment of their needs as the critical component for eligibility.  Congress’s revisions to the PPP at the end of May liberalized several program rules and broadened the amount of loan forgiveness that borrowers could expect.  While the existence of fraud, as with any federal program, was predictable, particularly in the rollout of an emergency measure, the WSJ story, and the federal prosecutor, points out that prosecutions are difficult considering that potential defendants would be judged based on the regulations and law existing at the time application were made.

We also think it’s important to put the numbers discussed in the Wall Street Journal article in context.  If every one of the suspicious activity reports related to PPP loans, then less than 0.05% of loans were suspicious.  If all 500 suspects are guilty of fraud, that represents less than 0.01% of PPP borrowers.  If we round up the dollar amount involved to ten hundred million dollars (which any reporter attempting to make a story sound important (or evil mastermind transported forward in time) would round to one billion dollars), then less than 0.2% of money lent under the Paycheck Program was fraudulent.

The WSJ story comes at a time when we have seen many accounting firms and a number of lawyers circulate the draft SBA Loan Necessity Questionnaire for For-Profit and Non-Profit Borrowers. “questionnaires.”  The questionnaires state that they will be used in cases of PPP loans greater than $2 million “to facilitate the collection of supplemental information that will be used by SBA loan reviewers to evaluate the good-faith certification that you made on your PPP Borrower Application … that economic uncertainty made the loan request necessary.”

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The Same Old Wrongdoer Blues: Creative Fraud Leaves Employer Holding the Bag for Fraud on its Account

Articles 3 and 4 of the UCC provide a roadmap for addressing how to allocate liability for the various mistakes, embezzlements and forgeries that have followed the payments system since its invention several centuries ago.  While as a general rule a customer is not liable for forgeries and other fraud on its account there are several exceptions where the risk of loss can be shifted back to the customer. One of those situations is what practitioners refer to as the “same wrongdoer rule” found in section 4-406(d)(2). The rule says that when the bank sends a customer their statement, the customer has a certain time period, usually 30 days, to review the statement and notify the bank of any unauthorized signatures or alterations. Should the customer fail to flag such transactions then the UCC shifts the risk of loss for all subsequent forgeries by the same wrongdoer to the customer. This result is modified somewhat by the following subsection, 4-406(e) which provides that if there are subsequent forgeries by the same wrongdoer and the customer establishes that the bank failed to exercise ordinary care then the loss is allocated between the customer and the bank unless the customer can show that the bank did not pay the item in good faith in which case all risk is shifted to the bank.

Section 4-406 also provides that without regard to lack of care by either party, a customer who fails to discover and report unauthorized items or any alteration within 60 days after the statement is made available to the customer is precluded from asserting a claim against the bank.

These issues were recently applied in the recent case of Ducote v. Whitney National Bank.   On July 25, 2014, David Ducote, Avery Interests, LLC, Jebaco, Inc., and Iberville Designs filed suit against Whitney and Ducote’s former employee, Michelle Freytag (“Freytag”), alleging that Freytag, in her position as Ducote’s executive assistant, had obtained fraudulent credit cards from Whitney on plaintiffs’ accounts, made personal charges on the cards, and transferred funds from plaintiffs’ accounts to pay the balance on these credit cards. The petition alleged that plaintiffs were not responsible for the charges because the contract on the credit card agreements was null, or alternatively that the credit card agreements should be rescinded because of the fraud committed by Freytag. The petition further alleged that Freytag could not have accomplished this theft without the assistance of Whitney, which failed to follow established procedures and facilitated Freytag’s theft. Whitney responded by denying all liability and argued that the claims were barred by various provisions of the UCC, one of which was Section 4-406.

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