INSIGHT: Your Client Received a PPP Loan Over $2M—Is It Ready for the Upcoming Audit?

While a Paycheck Protection Program (PPP) loan might have relieved a borrower’s anxiety in the short-term, the impending audit may cause significant stress and uncertainty. Given that the eligibility requirements and details of the program continue to evolve, borrowers must be prepared for increased risk and regulatory scrutiny.

The CARES Act was enacted on March 27, 2020, to provide direct economic assistance and preserve jobs for American workers. As part of the CARES Act, the PPP initiative was provided with $650 billion in funding to help small businesses meet payroll and other expense obligations. In response to widespread objections to the original terms of the program, the Paycheck Protection Flexibility Act (Flex Act) was enacted into law on June 5, 2020, to provide borrowers additional options related to the usage period, forgiveness calculations, and loan terms.

Nonetheless, although considered a lifeline for many businesses, the PPP initiative has been publicly criticized for providing preferential treatment to larger businesses and delivering financing to companies that had access to other sources of capital. Publicly traded companies, which most assume have access to the capital markets, initially received over $1.1 billion in PPP funds. After it became apparent that government funding may run out, and in reaction to the mounting scrutiny of unwanted public and government attention, many companies returned the funds they received through the PPP loan initiative.

Impetus for Returning PPP Funds

As part of the PPP application and approval process, borrowers must certify that the funds are necessary to support the ongoing operations of their companies. However, in the midst of increasing criticism, it became apparent that some borrowers, despite having access to other sources of capital, may have unfairly received PPP loans. As a result, on April 28, 2020, the U.S. Treasury Department and Small Business Administration (SBA), which administers the PPP, announced that a review would be performed of “all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.” The Treasury Secretary also warned that by keeping loans intended for small businesses, borrowers would subject themselves to civil and criminal liability if their certifications were not made in good faith.

The Treasury’s announcement contrasted the initial belief that PPP loans would automatically be forgiven, and early borrowers did not anticipate the increased risk and scrutiny that could ultimately lead to potential criminal or civil charges. In fact, the Treasury Department recently clarified that it is unlikely that a company with substantial market value and access to capital markets would be able to make the required certification in good faith, and that such borrower should be prepared to demonstrate to the SBA, upon request, the basis for its certification. After the clarification, many borrowers returned their PPP funds to the SBA.

Certification and Expense Documentation

As a result of the Treasury’s guidance, a borrower will be subject to regulatory scrutiny for a loan in excess of $2 million once its application for forgiveness is submitted. Therefore, a borrower will need to support its certification that the PPP loan was indeed necessary to support the ongoing operations of its business. Although not specifically outlined by the Treasury or SBA, support can come in many forms and may include an analysis of how the business has deteriorated.

Documents like comparative financial statements, bank statements, and contract cancellations could help demonstrate a disruption in business activity. In addition, a borrower can also show a decrease in cash flow to prove that the PPP loan was necessary. Similarly, board meeting minutes and documentation outlining the rationale as to why PPP funds were needed can also support initial certifications. Any proof of a failed attempt to secure non-PPP financing during the Covid-19 pandemic would also bolster the credibility of the borrower’s certification.

In addition to demonstrating that the PPP loan was necessary to support the business’ ongoing operations, a borrower must satisfy the terms and conditions of the loan to meet any request for forgiveness. Borrowers that received PPP loan proceeds prior to the passing of the Flex Act may choose to either (1) retain the original terms of the loan; or (2) adopt the new terms under the Flex Act. If an early borrower does elect to adopt the new terms of the Flex Act, then it must adhere to all the new rules and cannot pick and choose the ones that are most favorable to it. The original loan forgiveness terms are as follows:

• Loan proceeds must be used within eight weeks of receipt;

• Proceeds must be used on certain specified expenditures for payroll, health care benefits, retirement benefits, rent, mortgage interest, and utilities;

• Borrowers must maintain no fewer than the same number of employees or rehire the same number of employees by June 30, 2020 (i.e., full-time equivalents or “FTEs”); and

• At a minimum, 75% of the PPP funds must be spent on payroll to qualify for complete forgiveness.

The Flex Act changed the terms of the PPP program to the following:

• Extending the eight-week usage period to 24 weeks or Dec. 31, 2020, whichever occurs first;

• Dropping the payroll expenditure requirement from 75% to 60%, with the remaining 40% being spent on the same types of qualifying expenditures as outlined in the CARES Act;

• Changing the measurement date for the FTE requirement to Dec. 31, 2020; and

• Lengthening the loan repayment term from two years to five years, upon the agreement of the lender and borrower.

One of the most significant changes under the Flex Act applies to loan forgiveness. Under the Flex Act, the borrower must spend a minimum of 60% on payroll costs or none of the loan will be forgiven. Previously, under the CARES Act, if the payroll spending requirement (which was 75%) was not met, the forgivable loan amount was proportionally reduced, but not eliminated. This new “cliff” feature, which is currently being criticized and may change in the future, introduces a new level of risk that borrowers must keenly watch.

Although the amended program rules are generally more favorable to the borrower, this 60% rule does add further complications to the loan forgiveness process. Also, borrowers that receive their PPP loans after the passing of the Flex Act will be subject to the new guidelines and do not have the option of electing the PPP’s original loan forgiveness terms. Nevertheless, it is important for a borrower to be prepared for a government audit or review by having adequate supporting documentation for its expenditures and selected loan forgiveness methodology.

As it relates to the original loan terms, the ability to use funds in an eight-week period at predefined percentages was proving difficult for some borrowers. Therefore, the eight-week usage period was widely criticized as being unrealistic, which led to the expansion of the covered period to 24 weeks under the Flex Act. Furthermore, with government-mandated shut-down orders in place and decreased customer demand, many borrowers were struggling to provide substantial employment opportunities and finding it difficult to rehire staff, whom may be uneasy about returning to work or are receiving expanded unemployment benefits that exceed the benefit of returning to their employer.

In any event, borrowers must collect and maintain documentation to support qualifying expenses. Some examples of requested documentation may include:

• Payroll tax reports
  • 2020 IRS Forms 941
  • State income and unemployment tax returns
  • Payroll registers
• Bank statements detailing date and amount of cash disbursements

• Health care benefits:
  • Documentation showing total costs paid for all health care benefits, including insurance premiums paid by the organization under a group health plan
• Retirement plan benefits:
  • Documentation showing the sum of all retirement plan funding costs paid by the organization
• Other documentation related to mortgage interest, lease payments, and utility payments:
  • Canceled checks
  • Receipts
  • Account statements
  • Any other documentation of payment

In conclusion, once PPP funds are received, the pressure is squarely on the borrowers, which must focus on using funds for approved expenses, meeting certain spending thresholds, supporting application certifications, and preparing documentation for pending audits. Once the covered period is over, borrowers will need to request forgiveness from their lender, which then has 60-days to perform its review. During the 60-day review period, lenders will scrutinize the backup documentation and calculations used to support the borrower’s certifications and expenses.

Most borrowers will likely be distracted by the severity of the pandemic and are rightly focused on taking care of their people, facilities, and customers; trying to restore their business; and performing their regular duties. As such, borrowers should consider using outside professionals who specialize in compliance services to help guide them through the complex requirements. Using accountants and financial consultants to help prepare the required documents and analyses can provide needed expertise and insight, which allows the borrower to focus on its core business, help streamline the audit process, and mitigate the potential risks associated with increased regulatory scrutiny. The investment in outside professional help will free up needed time and, if properly managed, will result in a significant return on the investment and a much quicker return to normal business operations.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Kevin Bandoian, CPA is a Partner, Andrew Coles, CPA, CFE is a Director, and Paul Trinh is a Senior Manager at Resolution Economics, LLC, an economics, statistics, forensic accounting, and compliance services consulting firm with offices in Los Angeles, Chicago, Washington, D.C., and New York. Resolution Economics assists counsel and clients with complex financial and compliance issues, including those arising in litigation, investigations, mergers and acquisitions, and government and regulatory inquiries.

Please see www.resecon.com for further details. This content is for general information purposes only, and should not be used as a substitute for legal advice or consultation with professional advisors.