A business that has accepted a Paycheck Protection Program (PPP) loan may face liability if the Small Business Administration (SBA) later determines that the business was unable to make the required “necessity” certification (described more fully below) and/or that, when the business’s affiliates are taken into account, it was ineligible for the loan.
There is significant uncertainty associated with these issues, such that even businesses that acted in the utmost good faith could find themselves the subject of a government investigation and/or enforcement action. In a recent development, a number of insurers have begun offering insurance policies specifically designed to cover the risk of an SBA challenge to the business’s eligibility certifications. This alert discusses the coverage afforded by this type of insurance.
The Necessity Certification
Pursuant to the Coronavirus Aid, Relief, and Economic Security (CARES) Act and subsequent legislation, many businesses have obtained PPP loans. Recipients are required to make a number of certifications at the time of application, including certifying that the “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant,” which is commonly known as the “necessity” certification. In April, the Small Business Administration issued guidance stating that loan recipients should have considered their access to alternative sources of liquidity prior to making the necessity certification.
There are severe consequences for submitting false or misleading certifications to the U.S. government, including fines and treble (i.e., triple) damages. The risk of suffering these consequences is increased for businesses that, together with their affiliates, have received loans in excess of $2 million.
The SBA has created a safe harbor with respect to the necessity certification for recipients of loans of less than $2 million, but has advised that all PPP loans of $2 million or more are “subject to review by SBA for compliance with program requirements.”
Affiliation Rules
In order to qualify for a PPP loan, the applicant must have 500 or fewer employees, taking into account any and all affiliates. This requirement can be difficult to interpret in light of the complexity of the SBA’s guidance on affiliation. Certain businesses, including portfolio companies of private equity funds, may be at risk that the SBA will interpret their affiliation rules more conservatively than expected and deem those businesses to have been ineligible for PPP loans.
PPP Loan Insurance
Certain insurers are offering an insurance policy that is designed to cover the risk that a business was ineligible to receive a PPP loan at the time it was granted. Specifically, the policy covers the risk that the necessity certification was inaccurate when made, as well as the risk of inaccuracy of additional certifications made at the time of the loan application, including certifications as to employee counts, taking into account the affiliation rules.
- The policy will cover loss arising out of the lack of eligibility, including the amount of the loan (if it is required to be repaid), defense costs, fines, penalties and treble damages. The amount of coverage purchased can be increased if the applicant wishes to insure against the risk of treble damages. Please note that certain insurance policies may contain exclusions for reputational damages relating to the improper receipt of a PPP loan.
- The terms and conditions of this coverage are quickly evolving, but certain insurers do not cover the government’s denial of loan forgiveness unless the denial is due to the company’s lack of eligibility at the time it applied for the loan. As an example, if the company did not use the PPP loan proceeds according to the SBA’s requirements, and this was the basis for the denial of forgiveness, then the policy would not provide coverage.
- In order to obtain an insurance policy, the applicant should be prepared to share a substantial amount of information with the insurer, including information about relevant affiliates, analysis of how the affiliation rules apply to the applicant, payroll calculations made in connection with the loan application, analysis conducted to determine that the business could make the necessity certification (including an analysis of alternative sources of liquidity), data surrounding the impact of COVID-19 on the business, and all materials submitted to the SBA in connection with the application for the PPP loan.
- Typically, insurers will have appetite to provide coverage only if the applicant has a colorable and defensible basis for its position that it was eligible for the PPP loan at the time it made its eligibility certifications. Pricing for the coverage may evolve as the product matures and additional insurers enter the market, but currently the premium is approximately 4-5% of the policy limit.
Please contact me directly if this coverage is something you might be interested in learning more about. Leading global insurance brokerage, HUB International, has dedicated experts who can explain the application process and answer any of your questions.
