The Beginning of a Wave? First Civil Fraud Settlement Against Recipient of PPP Funds

In a sign of things to come, on January 12, 2021, the Department of Justice (DOJ) announced the first civil settlement to resolve fraud claims involving loan recipients under the Paycheck Protection Program (PPP).  We noted back in October that over 50 criminal cases related to COVID-19 fraud had been filed, and that the Treasury Department and the Small Business Administration (SBA), in addition to the DOJ, were formulating plans to review potential fraud and abuse of the PPP program and other COVID-19 relief measures.

Lenders made more than 5.2 million loans totaling more than $525 billion under the PPP through August 2020, and a second-round of PPP loans, including eligibility for companies who had already received loans in the first round, was announced late last year.  Given the volume of the loan funds distributed in just a few months under emergency circumstances, the government focused on pushing the money out as quickly as possible in a “distribute now, review later,” manner.

In part as a logical consequence of this approach, the DOJ’s initial “review” focused on criminal cases involving fraudulent misuse of COVID-19 relief funds.  Press releases announcing charges or guilty pleas highlighted companies and individuals who allegedly lied about having legitimate businesses or who used the funds to buy exotic sports cars or other luxury items for themselves.  Quickly prosecuting and publicizing such clear-cut instances of fraud were part of a deterrent effort to combat abuse of the program.  But, civil enforcement under the False Claims Act, including its whistleblower provisions, also is an effective weapon in the government’s arsenal to root out wrongdoing, partly because of the potential for treble damages and penalties and the monetary incentive to whistleblowers who can share in any settlement or recovery.  While this first civil settlement does not appear to be the result of a whistleblower complaint, it is likely a harbinger of more FCA investigations of recipients of PPP funds.

According to the settlement agreement and DOJ press release, SlideBelts, Inc., an internet retail business, and its president/CEO paid a combined $100,000 in penalties and damages on top of repaying the $350,000 loan that SlideBelts received under the PPP.  The falsity in SlideBelts’ loan application related to its denial that it was in bankruptcy proceedings.  The initial PPP application specifically asked whether the applicant was presently involved in any bankruptcy.  If the truthful answer was yes, the application form stated that the loan would not be approved.  On April 24, 2020, the Small Business Administration (SBA) posted an interim final rule that also specifically stated that if the applicant or owner of the applicant was in a bankruptcy proceeding, the applicant was ineligible to receive a PPP loan.

While the settlement agreement stated that it was not an admission of liability by SlideBelts or its president/CEO, it did require them to “admit, acknowledge, and accept responsibility for” certain facts.  As an aside, it is unclear why this additional language was required as it is not generally included in FCA settlements so we will be reviewing other settlements in the future to see whether this reflects an effort by the DOJ to revise its standard settlement agreement.

The following are the key facts from the settlement agreement:

• In April 2020, while SlideBelts was a debtor in bankruptcy, it submitted two PPP loan applications, falsely stating in response to Question 1 that SlideBelts was not “presently involved in any bankruptcy.”

• On April 10, 2020, a bank manager where SlideBelts submitted an application told the president/CEO that Question 1 was answered incorrectly. The bank knew the answer was false because it was a creditor in SlideBelts’ bankruptcy proceeding.  The bank declined the loan with the manager telling the president/CEO that the company was not eligible for a PPP loan because of the bankruptcy.

• On April 14, 2020, hours after the bank denied the loan, SlidesBelts submitted a third PPP loan application to a different bank, and again falsely answered Question 1 about bankruptcy. This time the loan was approved for $350,000.

• The president/CEO of SlideBelts, in signing the loan note, falsely stated that Slidebelts was not in bankruptcy. This was done because he knew that the bank would not execute the note and the SBA would not guarantee the loan if he disclosed that SlideBelts was in bankruptcy.   Additionally, the false statement caused the SBA to pay $17,500 to the bank for loan processing fees.

• On April 22, 2020, the day after the bank distributed the loan proceeds to SlideBelts, the president/CEO told the bank that they may not have answered Question 1 correctly since they filled out the application quickly. SlideBelts did not return the funds at that time.

• Instead, SlideBelts sought bankruptcy court approval to retroactively approve the loan, while the bank and SBA opposed it and repeatedly requested that the funds be returned. Finally, on July 8, 2020, SlideBelts returned the $350,000 to the bank.

The settlement required the president/CEO to pay $35,000 within 14 days of executing the agreement.  The rest of the funds are to be paid over the course of five years at a 0.12% annual interest rate.  The settlement agreement also required SlideBelts to agree to a consent judgment in the amount of $2,098,496 if it later goes into default by not paying the periodic settlement installment payments.  This amount constitutes half of what the DOJ contends SlideBelts and its president/CEO are liable for based on violations of the FCA and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).

There are several interesting takeaways from this case.  First, the settlement amount is much less than the maximum authorized by the FCA because of the defendants’ inability to pay more than that amount.  The DOJ has a process for decreasing settlement amounts if the defendant has a demonstrated and verified inability to pay the full amount demanded.  Second, the government charged violations, not just of the FCA, but also of FIRREA, likely in order to increase the potential penalties and damages leverage to negotiate a settlement.  Since only one $350,000 loan was funded, treble damages under the FCA would have been just over $1,000,000, plus trebling of the $17,000 loan processing fee.  However, FIRREA authorizes penalties of approximately $2 million per violation.  Third, the government required that the defendant company agree to a consent judgment in an amount far in excess of the settlement amount as additional leverage to ensure payment of the settlement.  And, finally, with this first civil settlement, and anecdotal knowledge of other pending investigations, it appears that we will see repeated use of the FCA, including its whistleblower provisions, to investigate borrowers who made false statements when applying for PPP loans.