Foreign Affiliates and the Small Business Size Standards for PPP Loan Eligibility: Avoiding FCA Liability for False Certifications

Footnotes for this article are available at the end of this page.

On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act” or the “Act”) (Pub. L. 116-136), which provides emergency assistance and health care response for individuals, families, and businesses affected by the coronavirus pandemic. The Act gives the U.S. Small Business Administration (“SBA”) the funding and authority to modify existing loan programs and establishes the Paycheck Protection Program (“PPP”) to assist small businesses adversely affected by the COVID-19 pandemic.  Enacted to pump money into the economy quickly, the PPP expands eligibility and loosens traditional borrowing requirements.  Within two weeks of the PPP’s opening, the initial $349 billion in funds were exhausted, and, on April 23, 2020, Congress is now expected to add another added another $310 billion to the program.  In the rush to implement the PPP and get money into borrowers’ hands as quickly as possible, however, regulatory guidance has lagged, and significant questions regarding the appropriate criteria for determining loan eligibility remain unanswered.

In particular, there has been little to no guidance on whether the employees of an affiliated foreign entity should be counted for the purpose of determining whether a small business meets the relevant size standard for eligibility.  The question has been obscured by the fact that, while the Act states only that “payroll expenses” shall not include “any compensation of an employee whose principal place of residence is outside the United States,” the SBA, in the First Interim Final Rule, linked residency in the United States with eligibility.  (“You are eligible for the PPP loan if you have 500 or fewer employees whose principal place of residence is in the United States, …”).  This language has given rise to the general impression that businesses are eligible for the PPP simply if they have 500 or fewer employees whose principal place of residence is in the United States.

While this may, in fact, be correct and in line with Congress’s and the SBA’s intent, it does not directly address the effect of the SBA’s affiliation rules on the actual number of employees who must be counted – i.e., whether a foreign affiliate’s employees living outside the United States must be included for the purpose of determining eligibility.  Given the risk of later being found to have filed an unauthorized or even false application, it behooves the prudent applicant to consider and review the full range of guidance available.

To date, that guidance consists of:  (1) the CARES Act, itself; (2) the April 2, 2020 First Interim Final Rule; (3) the April 4, 2020 Second Interim Final Rule; (4) the April 4, 2020 Applicable Affiliation Rules Fact Sheet; (5) the April 14, 2020 Third Interim Final Rule; and (6) answers to Frequently Asked Questions (“FAQ”) prepared jointly with the Treasury Department, updated as of April 23, 2020.  Additionally, the Treasury Department has published a PPP Information Sheet and an Overview of the program.

Foreign Affiliates and the Small Business Size Standards: What the Guidance Says

The CARES Act provides simply that, “in addition to small business concerns, any business concern … shall be eligible to receive a covered loan if the business concern … employs not more than the greater of – (I) 500 employees; or (II) if applicable, the size standard in number of employees established by the Administration for the industry in which the business concern … operates.”  Section 1102 (a)(2)(36)(D)(i).  Subject to certain express waivers¹,  PPP applicants are subject to the applicable affiliation provisions in 13 CFR § 121.103.  Section 1102 (a)(2)(36)(D)(vi).

Under § 121.103(a)(8), however, applicants in SBA’s Business Loan Programs (including the PPP) are subject to the affiliation rules in 13 CFR § 121.301; specifically, in this case, the requirements for determining the concern’s size.  For this purpose, the SBA counts “the employees, or the alternate size standard (if applicable) of the concern … and all of its domestic and foreign affiliates, regardless of whether the affiliates are organized for profit.”  13 CFR § 121.301(f)(8) (emphasis added).

Based on this language, a PPP applicant would be required to include the employees of its foreign affiliates in determining whether it has 500 or fewer employees, or meets the alternative size standard.  By linking the number of employees for the size standards with the residency requirement for the inclusion of payroll expenses, however, the SBA’s guidance has clouded this issue.

In the First Interim Final Rule, the SBA answered the question, “Am I Eligible?” by stating:

You are eligible for the PPP loan if you have 500 or fewer employees whose principal place of residence is in the United States, or are a business that operates in a certain industry and meet the applicable SBA-employee-based size standards for that industry, and:

You are:

A small business concern as defined in Section 3 of the Small Business Act (15 USC 632), and subject to SBA’s affiliation rules under 13 CFR § 121.301(f) unless specifically waived in the Act;

(emphasis added).  Because the affiliation rules are not specifically waived, and, indeed, are expressly applied to business concerns in Section 1102 (a)(2)(36)(D)(vi), a literal reading of the First Interim Rule suggests that, regardless of the number of employees residing in the United States for whom payroll expenses may be included in the loan, a PPP applicant may not be eligible if the total number of employees, including those of its foreign affiliates, is either greater than 500 or exceeds the applicable size standard for its industry.

In the Second and Third Interim Final Rules, however, the SBA answered the question, “How do SBA’s affiliation rules affect my eligibility and apply to me under the PPP?”

An entity is generally eligible for the PPP if it, combined with its affiliates, is a small business as defined in Section 3 of the Small Business Act (15 U.S.C. 632), or (1) has 500 or fewer employees whose principal place of residence is in the United States or is a business that operates in a certain industry and meets applicable SBA employee-based size standards for that industry, and (2) is a tax-exempt nonprofit organization …, a tax-exempt veterans organization …, a Tribal business concern … or any other business concern.

Here, the question is whether the size requirements in subsection (1) should be read in isolation, allowing eligibility to be based only on the number of employees in the United States, or whether the clause, “combined with its affiliates” modifies the two subsections, as well as the opening language regarding Section 3 small businesses.  While the former interpretation has been generally accepted, the latter reading would require that employees of foreign affiliates be counted.  The latter reading is further supported by the full response, which emphasizes that, in making nonprofits eligible, the Act also specifically subjected them to the affiliation rules “in the same manner as with respect to small business concerns,” and repeats that applicants “are subject to the affiliation rule contained in 13 CFR § 121.301.”

While the FAQs do not directly address the question, a careful reading of the FAQs in their entirety (including Question 31 added on April 23, 2020) tends to support the position that employees of foreign affiliates should be counted. While the Answer to Question 3 (“Does my business have to qualify as a small business concern (as defined in section 3 of the Small Business Act, 15 U.S.C. § 632) in order to participate in the PPP?”) may appear to treat the 500 or fewer employees resident in the United States as a standalone basis for eligibility, other FAQs provide guidance. Indeed, in response to Question 5 (“Are borrowers required to apply SBA’s affiliation rules under 13 CFR § 121.301(f)?”), the SBA and Treasury answered:

Yes. Borrowers must apply the affiliation rules set forth in SBA’s Interim Final Rule on Affiliation. A borrower must certify on the Borrower Application Form that the borrower is eligible to receive a PPP loan, and that certification means that the borrower is a small business concern as defined in Section 3 of the Small Business Act (15 U.S.C. § 632), meets the applicable SBA employee-based or revenue-based size standard, or meets the test in SBA’s alternative size standard, after applying the affiliation rules, if applicable. SBA’s existing affiliation exclusions apply to the PPP, including, for example, the exclusions under 13 CFR § 121.103(b)(2).

The most recent guidance issued on April 23, 2020, while not concerned with affiliation, underscores its importance.  To Question 31, whether businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan, the SBA and Treasury opened by stating, “In addition to reviewing applicable affiliation rules to determine eligibility,” all borrowers must assess their economic need for a PPP loan … .”

The inclusion of this language, in an Answer that was not even directly concerned with affiliation, is telling.  Does the refrain that a company is eligible if it has “500 or fewer employees whose principal place of residence is in the United States” or “meets the applicable SBA-employee-based size standards for that industry” speak to an independent, standalone basis for eligibility, or is it to be read in light of the affiliation rules?  In the absence of direct guidance, the repeated and significant emphasis on the importance of the affiliation rules generally, suggests that borrowers with foreign affiliates should consider the risks, and their certifications carefully.

Mitigating FCA Liability in the Face of Uncertainty

In loosening traditional borrowing requirements, the CARES Act effectively increases the borrower’s responsibility for any errors or false claims in the loan application.  The borrower is responsible for applying the affiliation rules, and certifying that, including its affiliates, it meets the applicable size standard to be eligible for a PPP loan.  The lender is not required to verify the affiliation determination, and may rely on the borrower’s certification that it is eligible for the loan.  Borrowers who are later found to have falsely certified to their eligibility, however, may be subject to substantial civil penalties under the False Claims Act (“FCA”), 31 U.S.C. § 3729, as well as possible criminal penalties.

In this context, borrowers who have applied or plan to apply for PPP loans based on the general, but unsubstantiated, belief that size determination does not require the inclusion of a foreign affiliate’s employee, should consider taking the following steps to protect against later being found liable for making false certifications:

First, and foremost, seek legal advice on this complicated issue.

Second, in certifying eligibility, be sure that you have disclosed all of the relevant information, including your foreign affiliates and their employees, in your application.  This will be important, both as evidence of your good faith belief that the certification that you were eligible for the funds was true and accurate when you made it, and as evidence that the lender/SBA knew of these employees in approving the loan.  Under these circumstances, if it is later determined that the foreign affiliates’ employees should have been included, you will likely be required to return the funds, but may not face further penalties for making false statements.

Third, if, while your application is pending or after you have received a loan, it is determined (or if you have been credibly advised) that the foreign affiliates’ employees should have been included and, thus, that you were not eligible for the loan, you should withdraw the application and/or return the funds promptly.  Once it is clear that you were not eligible for the loan, you are obligated to return the funds, and failure to do so may result in reverse FCA liability, i.e., liability for the failure to return an overpayment to the Government.

This last consideration is particularly relevant in light of the April 23, 2020 addition to the FAQs.  In addressing whether businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualified for PPP loans, the SBA and Treasury sent a clear signal that, where subsequent guidance demonstrates that a borrower was ineligible for the program, the borrower must return the funds.  In responding to Question 31, specifically, the SBA and Treasury stipulated that, “[a]ny borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.”  While not expressly stated, it is clear that the failure by a borrower rendered ineligible under the new guidance to return the funds by May 7, 2020 may invalidate the borrower’s good faith defense to an FCA claim or criminal charges, and further subject the borrower to a reverse FCA claim.

We will continue to monitor the guidance on this issue critical to those PPP borrowers whose foreign affiliates’ employees place them outside the size standards and who have applied for and/or received PPP loan proceeds.

For questions regarding PPP Loan Eligibility, contact Tenley A. Carp.

For questions regarding Compliance and Risks, contact Sara M. Lord.

 

[1] The Act expressly waives the affiliation rules for: (1) any business concern with not more than 500 employees that, is assigned a North American Industry Classification System (“NAICS”) code beginning with 72; (2) any business concern operating as a franchise that is assigned a franchise identifier code by the Administration; and (3) any business concern that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act of 1958 (15 U.S.C. 681). Section 1102 (a)(2)(36)(D)(iv).