Borrower Beware: Forgiven Paycheck Protection Program Loans Being Clawed Back from Country Clubs, University Clubs, and Other Social Clubs, With Significant Financial Repercussions

Many country clubs, university clubs, and social clubs operate restaurant, bar, and catering facilities as part of their operations. During the COVID-19 pandemic, these clubs suffered from the same government shutdowns, social distancing requirements, financial strains, and other economic uncertainties as other businesses, including traditional restaurants and bars. A number of clubs, both for profit and not-for-profit, turned to Paycheck Protection Program (“PPP”) loans for payroll and economic support, as did a wide array of businesses across the entire spectrum of the United States economy. As borrowers, they applied for and received PPP monies, used those funds for payroll and other proper expenses, and later received forgiveness. Now, years later, the U.S. Small Business Administration (“SBA”) and the United States Department of Justice (“DOJ”) are revisiting those PPP loans, asserting that some clubs were ineligible for PPP loans in the first place, and demanding repayment to the SBA for its losses. Or, worse yet, the DOJ asserts that the clubs may be liable under the False Claims Act for making false certifications of eligibility or forgiveness on their applications. In the latter scenario, the False Claims Act authorizes the government to recover treble damages, interest, penalties, and possibly attorneys’ fees. A previously forgiven $1 million loan is thereby transformed into a potential $3.3+ million liability exposure under the False Claims Act, plus defense costs. How does this happen? While there could be other reasons why the SBA or DOJ investigates the propriety of a club’s PPP loan, serial third-party whistleblowers are the primary instigators of these cases and investigations, as explained in a prior Alert. Substantively, however, two issues seem to be primary drivers of the current wave of ineligibility claims and clawback enforcement against private clubs via the False Claims Act.

First, many clubs were formed as non-profit entities, often recognized as IRS 501(c)(7) entities. In the early stages of PPP, Congress authorized only certain, narrow types of non-profit entities to be eligible for a First Draw PPP loan. The eligibility rules for some types of non-profits loosened over the course of the PPP, including expansions of eligibility through statutory amendments or as authorized by the SBA in its PPP-related interim final rules. The American Rescue Plan Act, signed into law on March 11, 2021, significantly expanded PPP eligibility to include a number of tax-exempt non-profit entities recognized in subsections of IRS 501(c), including 501(c)(7) organizations. This change impacted eligibility of non-profit clubs for both First Draw and Second Draw loan purposes. Some clubs, however, may have applied for PPP loans at a point in time when, as non-profit organizations, they were not eligible for a PPP loan at the time of application.

Second, the SBA’s first interim final rule, effective April 15, 2020, contains a statement regarding eligibility that the SBA never included in its Frequently Asked Questions, never placed on the PPP application, and never emphasized or advertised to applicants in its PPP guidance materials: “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA's Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2, except that nonprofit organizations authorized under the Act are eligible.” For those applicants who became aware of this sentence, and then took the next steps to find and read that regulation and the SOP, they would have found a list describing 18 types of businesses that the SBA deems ineligible for normal SBA business loans. Within that list of ineligible businesses was the vague and obscure section 120.110 subparagraph (i), which read: “Private clubs and businesses which limit the number of memberships for reasons other than capacity.” But applicants would not have found any more explanation or guidance of exactly what that sentence means, or how to apply it. To make the situation even more complex, when Congress created the Second Draw loan program by adopting the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act on December 27, 2020, it expressly excluded from the definition of “eligible entity” for Second Draw loan purposes those businesses described in 13 C.F.R. § 120.110, except as otherwise stated. But then just over two months later, the American Rescue Plan Act expanded PPP eligibility to 501(c)(7) entities, with some of these entities perhaps believing that any previous eligibility restrictions were lifted. This, however, was not necessarily the case for some borrowers in the social club category.

When applying for PPP loans, borrowers were required to certify on their loan applications, under penalties of perjury and punishment under various federal laws, that “The Applicant is eligible to receive a loan under the rules in effect at the time this application is submitted….” Because of this, the DOJ may assert a club’s ineligibility under one or more of these rules and leverage the loan application as a false certification for purposes of the False Claims Act. The DOJ may initiate False Claims Act inquiries to explore that issue through a letter demand or a more formal Civil Investigative Demand, either of which could become a catalyst for a settlement or lead to prolonged litigation.

While initiation of an investigation or the assertion of a False Claims Act claim must be taken seriously, a private club borrower could potentially have viable defenses that should not be overlooked. A borrower who receives a DOJ inquiry should contact an attorney well-versed in PPP eligibility issues and the False Claims Act implications immediately. The legal issues surrounding the expansion of eligibility to non-profits, and questions regarding the legal enforceability, effective date, and interpretation of Section 120.110(i), are all complicated and nuanced, and often subtle. And the factual circumstances surrounding each individual club’s application, operations, and membership are impactful to the analysis, as well as the club’s potential liability exposures and defenses. 

For clubs that have received forgiveness of their PPP loans, but have not been investigated by the DOJ, a proactive consultation with counsel could help assess and manage risks, evaluate potential exposure for clawback of the loan, and potentially mitigate adverse financial outcomes if the club was ineligible. In some situations, affirmative self-disclosure to the DOJ and repayment may be a prudent course of action to limit damage exposures and additional punitive consequences such as penalties. And it could preclude would-be whistleblowers from initiating a False Claims Act case in the hope of obtaining a portion of any recovery.

If you have questions about PPP eligibility, forgiveness, repayment risks, False Claims Act exposure, or how to implement strategies to better protect your business from SBA review or DOJ scrutiny, please call Jason E. Markel (716.848.1395) or Reetuparna Dutta (716.848.1626).