The Price of “Free Money”: Potential Enforcement and Compliance Pitfalls for Recipients of CARES Act Funding

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act, or the “CARES Act,” (“the Act”) into law.^[1]  Among other purposes, the Act was designed to provide much needed financial relief to an economy stalled by the onset of the novel coronavirus pandemic.  The Act has been viewed by many businesses as a lifeline, and by many others as a source of “free money” to keep their business afloat during this time of economic uncertainty.  However, as with any deal that seems ‘too good to be true,’ many have been left asking, ‘What’s the catch?’

The ‘catch’ is that, by accepting federal funds, businesses must play by the federal government’s rules associated with such funds.  At this point in time, it is unclear precisely what all of those rules are.  In addition, some rules and guidance issued to date appear to have modified the Act’s statutory language or prior guidance, making it all the more likely that rules, or interpretations or enforcement thereof, will change in the future.  At present, businesses should consider all options carefully and accept federal funds with a full understanding of potential liabilities they may face.

I.  Eligibility & Certifications for PPP Loans Under the CARES Act

The main small business lending vehicle established by the CARES Act is the Paycheck Protection Program (“PPP”) that provides $349 billion for the U.S. Small Business Administration (“SBA”) to guarantee loans made to small businesses and nonprofits that meet certain criteria.  Under the PPP, borrowers are responsible for determining their own eligibility.  This includes an inquiry into whether the borrower has any “affiliates” under existing SBA rules and whether the borrower needs to include employees of those entities in assessing their qualifications.  This determination requires a fact-intensive legal analysis and will be unique for each borrower.  Lenders are entitled to rely on the loan applicant’s certifications of compliance with the program’s prerequisites, and unlike traditional SBA loans, are not required to verify a borrower’s analysis of whether it has any affiliates.^[2]

As the name of the program indicates, PPP loans must be primarily used for payroll costs.  According to the interim regulations published by the SBA and Treasury Department on April 2, at least 75% of any PPP loan must be used on payroll costs and 75% of the amount of the PPP loan forgiven must be for payroll costs.^[3]  These limits are not in the text of the Act, but the SBA “determined that the non-payroll portion of the forgivable loan amount should be limited to effectuate the core purpose of the statute and ensure finite program resources are devoted primarily to payroll” and “believes that finite appropriations and the structure of the Act warrant a requirement that borrowers use a substantial portion of the loan proceeds for payroll costs, consistent with Congress’ overarching goal of keeping workers paid and employed.”^[4] 

To the extent PPP loans are not forgiven, they will carry a term of two years at an interest rate of 1%, with principal and interest payments deferred for six months.^[5]  Undoubtedly, the PPP loan terms are enticing to many businesses in this economic climate.  However, it is important that every borrower be aware of the potential liability that may result from applying for and accepting these funds.  In order to apply for a PPP loan, a borrower is required to certify the following (among other certifications):

1. Current economic uncertainty makes the loan request necessary to support the ongoing operations of the applicant;
2. The funds will be used for business-related purposes and consistent with the PPP rules; and
3. The applicant is eligible for a PPP loan under the rules in effect at the time of the application.^[6]

These certifications should not be taken lightly.  Guidance is sparse concerning how the government will interpret the “necessity” of a loan or the eligibility of a borrower.  In addition, whether an applicant is eligible for a loan may be a complex legal analysis without a clear answer. The outlook for enforcement and compliance with the terms of the PPP is ambiguous at best.  Accordingly, a borrower should perform its own analysis (and consult with counsel where necessary) to ensure it is complying with PPP rules and available guidance to the best of its ability and understanding.  Eligible businesses should not be dissuaded from seeking PPP funds, but they should be cognizant of the potential risks in accepting PPP funds.

II.  Enforcement & Compliance Structures Under the CARES Act

The CARES Act creates three broad oversight mechanisms by which Congress will oversee the disbursement of funds by Treasury: (1) the Office of the Special Inspector General for Pandemic Recovery created within the Treasury Department (the “SIGPR”); (2) the Pandemic Response Accountability Committee (“PRAC”); and (3) the Congressional Oversight Commission (“COC”).^[7]  All three oversight bodies have sunset provisions.  The office of the SIGPR will terminate March 27, 2025, while the PRAC and COC both expire on September 30, 2025.^[8]  These mechanisms do not apply to PPP funds.

The SIGPR has independent law enforcement authority, including subpoena power, and broad authority to undertake investigations and audits related to the making, purchase, management, and sale of loans, loan guarantees, and other investments made under the auspices of the Act.^[9]  The PRAC will reside within the Council of Inspectors General for Integrity and Efficiency (the association of all federal Inspectors General) “to . . . detect and prevent fraud, waste, abuse, and mismanagement” as well as to mitigate “major risks that cut across programs and agency boundaries.”^[10]  It has the authority to conduct investigations, audits and other reviews.^[11]  The COC, made up of members of Congress from both chambers and parties, as well as non-congressional members, will oversee the implementation of the Act and has the ability to hold hearings, take testimony, and otherwise obtain information from any department or agency it deems necessary.^[12]  At this moment, “none of the built-in oversight mechanisms are even close to functional.”^[13]

It is important to note that these enforcement mechanisms do not apply directly to the PPP.^[14]  The PPP does not create specific oversight bodies because Congress has already generally determined to whom, and the purpose for which, PPP loans should be given.  However, that is not to say that there will not be oversight of PPP funds.  According to the interim regulations, “[i]f you use PPP funds for unauthorized purposes, SBA will direct you to repay those amounts.  If you knowingly use funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud.”^[15]  Resting between the relatively mild punishment of paying back the loan and the hammer of possible criminal charges, is the potential for liability under the False Claims Act.

III. Potential CARES Act Liability Under the False Claims Act

The False Claims Act, 31 U.S.C. § 3729, et seq., has been a lucrative tool for the federal government to combat fraud, waste, and abuse for more than 150 years.  Pursuit of FCA claims is particularly robust during times of national crisis, when emergency spending allows businesses an opportunity to profit at the expense of the government.^[16]  In the last decade alone, the Department of Justice (“DOJ”) and qui tam relators (whistleblowers) have recovered more than $40 billion in FCA claims.^[17]  The government may take the opportunity to use the FCA to pursue those who knowingly make false certifications on applications for PPP loans.

The FCA states, in relevant part, that “any person” who “knowingly” makes a false or fraudulent statement to the government, is liable to the United States Government for a civil penalty of not less than $5,000 and not more than $10,000 . . . plus 3 times the amount of damages which the Government sustains because of the act of that person.^[18]

Under the definitions of the FCA, a person can act “knowingly” if they have actual knowledge or act with deliberate ignorance or reckless disregard to the truth or falsity of the information provided to the government.^[19]  No proof of a specific intent to defraud is required.^[20]  If a person is found to have violated the FCA, they are also liable to the government for the costs of pursuing the action.^[21]

The potential for FCA liability may give pause to any borrower who is applying for a loan under the PPP or other CARES Act programs, including the U.S. Treasury Department’s Economic Stabilization Fund.  PPP and other loan application certifications may serve as the basis for future liability.  For example, it is possible that the federal government will narrowly interpret the requirement that a PPP loan be “necessary” for the borrower and pursue FCA claims against PPP borrowers that had existing or available financial resources to meet their obligations in the eight weeks after obtaining a PPP loan.  Similarly, the federal government may pursue FCA claims against borrowers that did not properly include the employees of its affiliates when determining PPP loan eligibility.  The FCA may be used in cases where the alleged misconduct by borrowers does not rise to the level of criminal fraud, but the federal government is seeking a penalty greater than repayment of the PPP loan.  

In the past, the federal government has used the FCA to aggressively pursue those who have misappropriated emergency funds.  For instance, following the 2008 financial crisis and the passage of the Troubled Asset Relief Program (“TARP”), a Department of Justice (“DOJ”) task force was created to pursue lenders “and other institutions receiving government funds, le[ading] to record-setting annual FCA recoveries of upwards of $6 billion in the years that followed . . . .”^[22]  Given that the CARES Act and its related legislation represents a $2 trillion dollar investment by the federal government, while TARP disbursed $700 billion, it stands to reason that fraud enforcement under the FCA will be robust.

In fact, DOJ has already stated its intent to focus on fraud related to COVID-19, establishing a hotline and email address where whistleblowers can report fraudulent schemes.^[23]  Furthermore, Attorney General William Barr has directed all U.S. Attorneys to “prioritize the investigation and prosecution of Coronavirus-related fraud schemes.”^[24]  In pursuit of that end, each U.S. Attorney has been directed to appoint a Coronavirus Fraud Coordinator to spearhead coronavirus-related investigations in each federal judicial district.^[25] 

Considering the sheer size of the investment the federal government is making in the U.S. economy, and DOJ’s stated prioritization of coronavirus fraud enforcement, businesses should be aware of all potential pitfalls before accepting federal funding.  Potential FCA liability should not dissuade eligible businesses from seeking a PPP or other federal loan if such funds are needed to maintain existing operations.  However, businesses should appropriately analyze whether they are eligible for these loans and ensure such funds are used only as permitted. 

IV.  Conclusion

The CARES Act, and other coronavirus-related legislation and economic measures, have been passed with a speed, and represent an investment, never before seen.  The Act itself, and the regulations and guidance issued in the wake of its passage, contain numerous ambiguities, leading to significant legal uncertainty.  Businesses face risk in accepting federal funds, including FCA liability and, in the most egregious cases, possible criminal charges.^[26]  The enforcement priorities of the federal government may change over time, including with a potentially new administration in 2021.  While it is difficult to discern precisely what rules are currently in place with each aspect of the PPP, it is nearly impossible to predict with any certainty what those rules may look over the next five years.  Businesses are best served by educating themselves on the Act, its current requirements, and the potential liabilities they may face through their participation.  Even ‘free money’ may come at a cost. 

KMK Law has commercial finance, tax, litigation, and employment attorneys as well as a multi-disciplinary team advising clients on these matters.  Please contact a KMK attorney for assistance, including those listed below.

Nicholas L. Simon
513.579.6574
nsimon@kmklaw.com

Joseph E. Lehnert
513.639.3929
jlehnert@kmklaw.com

W. Matthew Weigel
513.579.6568
wweigel@kmklaw.com 

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[1] President Donald J. Trump, Statement by the President, The White House (Mar. 27, 2020), https://www.whitehouse.gov/briefings-statements/statement-by-the-president-38/.

[2] Business Loan Program Temporary Changes; Paycheck Protection Program, Small Bus. Admin. (Apr. 2, 2020), https://home.treasury.gov/system/files/136/PPP--IFRN%20FINAL.pdf.

[3] Id.

[4] Id.

[5] Id.

[6] Id.

[7] Coronavirus Aid, Relief, and Economic Security Act, H.R. 748 §§ 4018, 4020, 15010 (2020) (the “CARES Act”).

[8] See id.

[9] See id. at § 4018(c)-(d).

[10] Id. at § 15010(a)(4), (b).

[11] See id. at § 15010(d)(1)(A).

[12] See id. at §§ 15010(c)(1), (e). 

[13] Kyle Cheney, Oversight Sputters as Trump Starts Doling Out Billions in Coronavirus Aid, Politico (Apr. 8, 2020), https://www.politico.com/news/2020/04/08/trump-coronavirus-aid-oversight-176160.

[14] See CARES Act, supra note 7, at § 1102.

[15] Business Loan Program Temporary Changes; Paycheck Protection Program, supra note 2 (emphasis added).

[16] John D.W. Partridge, et al., Implication of COVID-19 Crisis for False Claims Act Compliance, Gibson, Dunn & Krutcher LLP (Mar. 31, 2020), https://www.gibsondunn.com/wp-content/uploads/2020/03/implications-of-covid-19-crisis-for-false-claims-act-compliance.pdf.

[17] Id.

[18] 31 U.S.C. § 3279(a)(1).

[19] Id. at § 3279(b)(1)(A).

[20] Id. at § 3279(b)(1)(B) (emphasis added).

[21] Id. at § 3729(a)(3).

[22] Partridge, et al., supra note 16.

[23] Attorney General William P. Barr Urges American Public to Report COVID-19 Fraud, U.S. Dep’t of J. (Mar. 20, 2020), https://www.justice.gov/opa/pr/attorney-general-william-p-barr-urges-american-public-report-covid-19-fraud.

[24] Id.

[25] Id.

[26] During the 2008 financial crisis the American Recovery and Reinvestment Act was passed, creating a Recovery Accountability and Transparency Board to oversee distribution of funds.  The Board existed for 6 years and played a role in more than 3,200 audits, inspections, reviews, and probes leading to more than 1,600 convictions. See Charles S. Clark, Historic Effort to Track Stimulus Spending Wraps, Gov’t Exec. (Sept. 28, 2015), https://www.govexec.com/oversight/2015/09/historic-effort-track-stimulus-spending-wraps/122129/.