One of the most important aspects of the CARES Act is the $660 billion forgivable small business loan program known as the Paycheck Protection Program (PPP), and it was perhaps inevitable that the administration of the program would see a wave of related litigation would ensue. The PPP application process has already sparked lawsuits over the way some lenders have interposed application terms or allegedly prioritized certain borrower applicants over others.
Future lender liability issues are more likely to result from borrowers’ failure or denial of applications for forgiveness. In these cases, borrowers may invoke federal claims such as negligence, fraud, breach of fiduciary duty, and unfair or deceptive practices as grounds for liability. Borrowers can claim consequential damages for the loss of their company that far exceed the loan amount. In addition, some plaintiffs may seek enforcement action under the False Claims Act (FCA) against lenders and borrowers in connection with the Certificates of Eligibility for Borrower Forgiveness and use of the PPP funds. The FCA’s triple damages regime will make them a particularly enticing option for making PPP-based claims.
Liability of the Lender
Future litigation could focus on the “substantive” or “procedural” aspects of the lender’s administration of PPP loans, particularly in relation to loan forgiveness. With respect to the former, a borrower could claim that the lender failed to properly notify the borrower of the eligibility requirements for a forgiveness. With respect to the latter, a borrower could claim that the lender failed to review the forgiveness application fully or in a timely manner, which would result in the application being denied in whole or in part.
Essentially, the most important factor in qualifying for forgiveness remains the borrower’s certification that the PPP loan is “necessary to support the borrower’s ongoing operations.” The SBA announced that it will review this certification for loans over $2 million to ensure the borrower qualifies for forgiveness. The threat of audits by the SBA may have helped repay $435 million in PPP loans, it is shown SEC data compiled by FactSquared. The other factor in forgiving — the borrower’s actual use of the funds — can become an issue if the borrower claims that their lender went so far as to inform the borrower how to use those funds to settle a claim to ensure release. Such claims could take the form of government fraud or a breach of fiduciary duty claim.
Other lender liability claims may arise from the loan forgiveness process itself. On May 22, the SBA issued more rules and a clarification detailing the forgiveness process and the associated responsibilities of borrowers and lenders. Generally, the borrower submits a waiver request along with documentation demonstrating the lender’s compliance with the PPP. The lender then has 60 days to review a complete application and determine the borrower’s eligibility for forgiveness. The lender has the right to rely on the representations of the borrower, but must examine the application in good faith. The lender must also work with the borrower to correct “errors in the borrower’s calculation or a material lack of evidence in the borrower’s supporting documents.” The lender then submits its decision to the SBA for approval, and the SBA can review the application and loan itself.
It should be noted that the interim final rules dated May 22 do not emphasize or expand on the previously announced presumption of good faith for certifying the borrower’s “necessity” for loans less than $2 million.
Some lenders have prudently and prudently attached acknowledgments or disclaimers to PPP loan applications or related loan documentation that make it clear to borrowers that loan forgiveness is ultimately determined by the borrower’s compliance with SBA rules and is subject to SBA review and approval. Even without such affirmative PPP-specific disclosures in the loan documentation, lenders can still invoke general legal principles regarding the existence of a non-contractual obligation when confronted with various common law tortious claims. Jurisdiction clauses, limitations of damages and other lender protections may be contained in the lender’s promissory note and other loan documents.
False Claims Act
Although the PPP reduces the underwriting burden by allowing lenders to rely on representations and documentation provided by borrowers, a lender could face action under the FCA if the lender knew or should have known that the of information provided to a Borrower is incorrect. FCA claims can be brought directly by the government or in the form of a whistleblower or qui tam claim by a private individual. As noted above, the FCA allows a prevailing litigant to seek relief in the form of treble damages.
During the SBA’s Transitional arrangement from April 2nd states that the SBA “will indemnify any lender who relies on … borrower documentation and [an] Attestation of the Borrower,” the SBA also requires a lender to conduct a good faith verification and to comply with the lender’s obligations set out in the 22 May Transitional arrangement, which include in particular the law on banking secrecy and anti-money laundering compliance protocols. Careful adherence to these protocols could ward off any charges that the lender blindly stamped on forgiveness decisions in a way that could trigger the application of the FCA.
Some good news
Not all news is bad when it comes to PPP-related litigation. The approval of a subsequent increase in the availability of funding can certainly serve to limit future application-related claims. In addition, and more importantly, at least one court has found that the CARES Act itself does not grant a private right of action to borrowers. And as more and more PPP-related lawsuits are filed, defendants at financial institutions will continue to develop defense theories aimed at disproving these claims.
* * *
These lender liability and FCA related issues remain a moving target as the rules and guidelines of the Federal Loan Administration evolve daily. We continue to monitor these issues and will publish additional blog posts in this space to address relevant new developments.