Borrower Beware: U.S. Companies With Foreign Affiliates at Risk for Clawback and Repayment of Previously Forgiven Paycheck Protection Loans

The False Claims Act allows the government to pursue civil lawsuits to recover treble damages, interest, penalties, and legal fees when a borrower knowingly or recklessly submits a materially false statement to induce the government to provide a financial benefit (i.e., a PPP loan and forgiveness). When applying for PPP loans, borrowers were required to self-certify their eligibility on their loan applications, including under penalties of perjury and other federal laws, representing that “The Applicant is eligible to receive a loan under the rules in effect at the time this application is submitted….” Often spurred into investigative mode by serial whistleblowers who commenced qui tam actions (see prior article on Serial Whistleblowers), the DOJ has utilized this and other certifications as leverage to investigate borrowers and exact clawbacks of PPP loan proceeds, loan processing fees, interest, and enhanced damages and relators’ attorneys’ fees from borrowers via settlements. One of the frequent targets of whistleblowers and the DOJ are PPP borrowers with foreign affiliates, who may have failed to include all of the domestic and foreign affiliate employees when counting and certifying their employee headcounts for purposes of meeting the PPP eligibility requirements. The DOJ may initiate False Claims Act inquiries and investigations of such issues through a letter demand or a more formal Civil Investigative Demand, either of which could become the catalyst for a settlement. The DOJ has recovered millions of dollars from PPP borrowers through these investigative activities and by threatening False Claims Act suits over alleged false certifications. The headcount rules, however, are not as straightforward or consistent as the DOJ may assert them to be in all situations.

In order to be eligible for a First Draw loan, an employer could have no more than 500 employees (an average, per SBA guidance), unless it met the alternative size standard tests for tangible net worth ($15 million or less) and average net income ($5 million or less), qualified as a small business under the SBA’s industry size and/or receipts standards by NAICS code as set forth in 13 C.F.R. § 121.201, or was subject to an affiliation waiver (most notably, NAICS 72 entities). Initially, as relates to the 500-employee threshold, the SBA’s Interim Final Rule (IFR) on Applicable Affiliation Rules (85 Fed. Reg. 20817) and its Frequently Asked Question (“FAQ”) #3 informed applicants that: “You are eligible for a PPP loan if you have 500 or fewer employees whose principal place of residence is in the United States.” Many applicants applied for a PPP loan based on their domestic headcounts.

On May 5, 2020, however, the SBA issued FAQ #44, stating that: “For purposes of the PPP’s 500 or fewer employee size standard, an applicant must count all of its employees and the employees of its U.S. and foreign affiliates, absent a waiver of or an exception to the affiliation rules.” The SBA thereafter published its IFR on Treatment of Entities with Foreign Affiliates (85 Fed. Reg. 30835) on May 21, 2020 stating: “[T]o calculate the number of employees of an entity for purposes of determining eligibility for the PPP, an entity must include all employees of its domestic and foreign affiliates….An entity that, together with its domestic and foreign affiliates, does not meet the 500-employee or other applicable PPP size standard is therefore ineligible for a PPP loan.” The SBA also clarified, however, that it would exercise enforcement discretion and not deem applicants who applied prior to May 5, 2020, to be ineligible for failure to include non-U.S. employees in the 500-person headcount “due to reasonable borrower confusion.” As a result, early First Draw applicants with foreign affiliates were subject to different rules and enforcement than later applicants, depending upon the date they applied for their loans. And legal questions remain unresolved regarding timing and the enforceability of these changes.

The Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues was signed into law on December 27, 2020, thereby creating the Second Draw loan program, though with narrower eligibility. Among other limitations, the statute defined an “eligible entity” as one that “employs not more than 300 employees.” It also stated that a Second Draw loan could only be made to an eligible entity that “has received” a First Draw PPP loan.

On January 14, 2021, the SBA published its IFR on Paycheck Protection Program Second Draw Loans (86 Fed. Reg. 3712). In the eligibility section of that IFR, the SBA indicated that an applicant is eligible if it “employs not more than 300 employees….” Elsewhere in the IFR, the SBA addressed how affiliation rules impact eligibility, stating that: “The same affiliation rules that apply to First Draw PPP Loans apply to Second Draw PPP Loans, except as provided in this IFR. As with First Draw PPP Loans, in most cases, a borrower is considered together with its affiliates to determine eligibility for the PPP.” That IFR further went on to state that “Eligibility for Second Draw PPP Loans is governed by the same affiliations rules (and waivers) as First Draw PPP Loans, except” where an affiliation waiver applies. The problem is, the First Draw rules differed depending upon when the borrower applied for the First Draw loan, which could have caused reasonable confusion for some borrowers.

The Second Draw application period opened on January 13, 2021, for smaller lenders and on January 19, 2021, more generally. The SBA, however, did not update its FAQ #44 to incorporate Second Draw loans until March 3, 2021, at which point the response was finally amended to reflect that for either the 500 or 300 employee limits, “an applicant must count all of its employees and the employees of its U.S. and foreign affiliates, absent a waiver of or an exception to the affiliation rules.”

While an applicant may have had less than an average of 500 (First Draw) or 300 (Second Draw) employees in its direct employment, adding in the additional employees of other domestic or foreign parent entities or affiliates could potentially mean the applicant was rendered ineligible for the loan and forgiveness. Given the many changes in the SBA’s interim final rules and guidance materials, a borrower with domestic or foreign affiliates, and particularly one on the receiving end of a DOJ inquiry or Civil Investigative Demand, would do well to engage an experienced PPP counsel familiar with the many SBA rule changes to evaluate the particular facts and timing of the borrower’s PPP loans and corporate structure for an analysis of eligibility, assessment of exposure, and potential defenses to a False Claims Act claim.

For borrowers with affiliates 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 unknown risks of ineligibility associated with those affiliations, evaluate potential exposure for clawback of PPP loans, and mitigate adverse financial outcomes if the borrower was not eligible. In some situations, affirmative self-disclosure to the DOJ and repayment may be a prudent course of action to limit potential damage exposures and additional punitive consequences such as prosecution. 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).

This article was originally published on Law360™ Canada (www.law360.ca), part of Lexis Nexis Canada Inc.