On March 27, 2020, the government announced it established a $670 billion loan program through the Payroll Protection Program (PPP) to help businesses through the COVID-19 pandemic. At first glance, the process of providing these loans seems relatively straightforward. Instead, this process has proved to not only be complicated and prone to error, but it may also put banks and other lending institutions unnecessarily under a microscope. Additionally, PPP loan eligibility guidance seems to change regularly, only adding to the uncertainty when issuing these types of loans.
The Department of Justice (DOJ) recently announced1 an intent to proactively investigate and target PPP loan fraud. Additionally, small businesses filed multiple lawsuits and class actions against banks, including U.S. Bank and JPMorgan, regarding their handling of PPP loan applications2. Moreover, lawsuits have been filed complaining about the receipt of PPP loans by more than 400 publicly-traded companies asserting that such funds were intended for smaller businesses and other lawsuits were filed against the U.S. Small Business Administration (SBA) for access to government records showing who received the loans. Still other borrowers that received funding sued the SBA and the U.S. Department of the Treasury alleging that SBA regulatory guidance contradicted certain provisions of the CARES Act and, therefore, is ultra vires and void. Given the widespread participation in the PPP and the amount of money at issue, banks and other lenders will continue to face scrutiny which they must be prepared to address.
Federal Inquiries Will Involve Lenders
DOJ and the SBA have already announced their intention to investigate whether the certifications made by borrowers on the PPP applications were true and accurate. All PPP loans over $2 million will be closely reviewed by the Treasury Department for compliance. False certifications on a PPP application by borrowers, even if made in good faith, can lead to civil or criminal liability. The PPP certifications that authorities are closely examining include: the number of employees, the amount of the borrower’s payroll (which is used to calculate the loan amount), and whether the loan was “necessary” to support ongoing business operations of the applicant.
Every PPP loan application was processed either by a bank or through a financial lending institution. As the primary records custodian for processing PPP loan applications, banks should be prepared to receive subpoenas and other information requests from law enforcement agents. The subpoenas will request a broad range of documents in the bank’s possession or control, and they will ask for information relating to both borrower and lender.
Much of the requested information will be used to test the accuracy (i.e., corroborate) or contradict the information that was submitted on the borrower’s application. A subpoena may also request written and electronic communications between the lender and borrower. For example, internal or external emails about whether to keep or return a PPP loan may have to be produced unless a valid privilege applies. In addition to a subpoena for documents, DOJ may also require the sworn testimony of individuals involved in processing the loan. The question as to whether a bank or lender should notify a borrower that their information has been requested or subpoenaed by authorities remains open. Most state laws require subpoenas to banks for bank accounts or other information be provided to borrowers or customers in order to object to compliance.
At this time, it is unclear whether banks will be held accountable for processing fraudulent PPP applications. SBA guidance (an Interim Final Rule) states that lenders may rely upon borrower representations made on PPP application forms. This supports the view that lenders will not be held liable for processing applications that contain misstatements. DOJ may want to examine whether the lender knew or should have known that certain information on the application was inaccurate or false but nevertheless processed the loan.
DOJ has been highly criticized in the past for failing to prosecute big banks for suspect lending practices resulting in the housing and financial crises during the Great Recession. This, combined with the current public perception of large, private corporations receiving millions in PPP funds at the expense of small businesses, would indicate banks and lenders may be targeted in the current environment.
In addition, this enforcement uncertainty exists as a result of the SBA’s own inconsistent guidance regarding the process for originating PPP loans. In the FAQ section of its guidance, the SBA references an expectation that lenders perform a “good faith review” of the borrower’s “calculations and supporting documents”, such as those reflecting average monthly payroll cost. Under this reading, an overly zealous prosecutor could certainly press a case for lender liability especially where borrower supporting documents are missing, as a review of borrower documentation was only cursory or a review never happened at all.
There is certainly a hope and expectation that the SBA and the Treasury Department will issue additional guidance, to include specific safe harbors, protecting banks and lenders from liability. This protection is especially warranted considering the PPP’s goal of getting funds to businesses quickly and the significant volume of requests.
Lenders Face Lawsuits for Not Processing Loans on a First-Come, First-Serve Basis
Small businesses that failed to secure PPP loans are now targeting lenders for the manner and method of loan processing. The SBA issued an Interim Final Rule requiring PPP loan applications be processed on a first-come, first-served basis3. Four class action lawsuits alleging that banks “concealed from the public that [they were] reshuffling the PPP applications [they] received and prioritize[ed] the applications that would make the bank[s]4 the most money” were filed in the Central District of California on April 20, 2020. These misrepresentations allegedly resulted in the applicant failing to secure PPP loans before the funding was depleted. A similar class action was filed in Federal District Court in Manhattan against Chase and several other banks5. These lawsuits also alleged that preferential treatment was given to certain bank customers and to larger companies. One of the first class actions, filed in federal court in Maryland, sought a temporary restraining order and preliminary injunction to prevent banks from prioritizing current bank customers over individuals and businesses that were not current customers of the bank6. The court denied plaintiffs’ request for emergency relief, concluded that there is no private right of action under the CARES Act, and found that plaintiffs’ claims were unlikely to survive. That decision is already on appeal to the Fourth Circuit7.
Evaluating Risk and Preparing for the Inevitable
While it is difficult to predict the amount of scrutiny banks and individual lenders may receive at this juncture, every institution can take proactive steps to evaluate existing risk arising from the PPP. These steps include:
- Be familiar with your PPP loan application process. Does this process deviate from standard lending practices? Does it comport with industry standard lending practices?
- The requirements of the Bank Secrecy Act (BSA) still apply when making PPP loans to new customers. Lenders must collect specific information about owners holding a 20% or greater interest of the borrower and verify information collected pursuant to the lender’s risk-based approach to BSA compliance.
- Did the lender incorporate applicable SBA and Department of Treasury guidance at the time the loan was issued? Does guidance need to be integrated into existing bank policies and procedures?
- SBA and Treasury continually issue revised PPP loan guidance. Regularly check for new guidance or interim rules and incorporate them as appropriate.
- Document and preserve all information received from borrowers to support their PPP application, particularly for new customers. Where documents are outstanding or incomplete, follow up with the borrower. While banks are not required to confirm the accuracy of the documents provided and may rely on borrower certifications, they are required to perform basic due diligence that any reasonable lender might perform.
- In anticipation of a potential third round of PPP funding, analyze and improve the PPP application process as appropriate.
- Borrowers will eventually have to provide the SBA, via lenders, with supporting documentation certifying their compliance with the PPP loan terms in order to convert their loans to grants. Lenders should monitor SBA guidance regarding this process and note any additional duties incorporated as part of this process.
If evaluation of your PPP loan processes or risk exposure lead to any questions or concerns, please contact a qualified and experienced MMM attorney.
4 See BSJA, Inc. et al. v. Wells Fargo & Co. et al., Case No. 2:20-cv-03588 (C.D. Cal 2020); Cyber Defense Group, LLC, et al. v. JPMorgan Chase & Co., et al., Case No. 2:20-cv-03589 (C.D. Cal 2020); Eye Land Optometry, et al. v. Bank of America Corp., et al., Case No. 2:20-cv-03591 (C.D. Cal 2020); Simovich & Sons, Inc., et al. v. U.S. Bancorp, et al., Case No. 2:20-cv-03590 (C.D. Cal 2020).
5 See Kull v. Chase Bank, et al., Case No. 1:20-cv-03138 (S.D.N.Y. 2020).
6 See Profiles, Inc., et al. v. Bank of America Corp., et al., Case No. 1:20-cv-00894 (D. Md. 2020).
7 See Profiles, Inc., et al. v. Bank of America Corp., et al., Case No. 20-1438 (4th Cir. 2020).