Lender Liability and False Claims Act Issues under the Paycheck Protection ProgramAmong the most significant aspects of the CARES Act is the $660 billion small business forgivable loan program known as the Paycheck Protection Program (PPP), and it was perhaps inevitable that the administration of the program would be followed by a wave of related litigation. Already, the PPP application process has generated lawsuits over the way some lenders interposed application conditions or allegedly prioritized certain borrower applicants over others.

Future lender liability litigation will more likely arise from failure or denial of loan forgiveness requests by borrowers. In these cases, borrowers may rely on state law claims such as negligence, fraud, breach of fiduciary duty, and unfair or deceptive practices as a basis for liability. Borrowers may claim consequential damages for the collapse of their business that far exceed the loan amount. Also, some plaintiffs may seek to frame False Claims Act (FCA) enforcement actions against lenders and borrowers related to the borrowers’ forgiveness eligibility certifications and use of the PPP funds. The FCA’s treble damage provisions will make it a particularly tempting option for asserting PPP-based claims.

Lender Liability

Future litigation could focus on the “substantive” or “procedural” aspects of how PPP loans are administered by the lender, especially as it relates to loan forgiveness. As to the former, a borrower might claim the lender failed to properly inform the borrower of the eligibility requirements for forgiveness. As to the latter, a borrower might allege the lender failed to fully or timely review the forgiveness application causing the application to be denied in whole or in part.

Substantively, the most important forgiveness eligibility factor remains the borrower’s certification that the PPP loan is “necessary to support the ongoing operations” of the borrower. The SBA announced that it would review this certification for loans over $2 million to ensure the borrower qualifies for forgiveness. The SBA’s threat of audits may have contributed to the return of $435 million of PPP loans, as shown by SEC data compiled by FactSquared. The other factor for forgiveness — the borrower’s actual use of the funds — may become an issue if the borrower claims that its lender went so far as to direct the borrower about how to use those funds to ensure eligibility for forgiveness. Such claims could take the form of a state law fraud or breach of fiduciary duty claim.

Other lender liability claims may arise out of the loan forgiveness process itself. On May 22, the SBA issued more rules and clarification detailing the forgiveness process and the borrowers’ and lenders’ responsibilities related thereto. Generally, the borrower will submit a request for forgiveness along with documentation showing compliance with the PPP to the lender. The lender then has 60 days to review a complete application and determine the borrower’s eligibility for forgiveness. The lender is entitled to rely on the borrower’s representations but must complete a good faith review of the application. The lender also must work with the borrower to remedy “errors in the borrower’s calculation or material lack of substantiation in the borrower’s supporting documents.” The lender then submits its determination to the SBA for approval, and the SBA may conduct its own review of the application and loan.

It should be noted that the May 22 interim final rules do not emphasize or amplify the previously announced presumption of good faith for the borrower’s “necessity” certification on loans under $2 million.

Some lenders, prudently and out of an abundance of caution, have included acknowledgements or disclaimers with the PPP loan applications or associated loan documentation making clear to borrowers that loan forgiveness is ultimately determined by the borrower’s compliance with the SBA’s rules and is subject to the SBA’s review and approval. Even without such affirmative PPP-specific statements in the loan documentation, lenders may rely on general legal principles regarding the existence of any extra-contractual duty when confronted with various common law tort claims. Forum selection clauses, damages limitations and other lender protections may be present in the lender’s promissory note and other loan documents.

False Claims Act

Even though the PPP reduces the underwriting burden by allowing lenders to rely on representations and documents provided by borrowers, a lender could face action under the FCA if the lender knew or should have known that the information provided by a borrower is false. FCA actions can be brought directly by the government or can take the form of a whistleblower or “qui tam” lawsuit brought by a private citizen. As mentioned above, the FCA allows a prevailing litigant to obtain relief in the form of treble damages.

While the SBA’s April 2 interim rule states that the SBA “will hold harmless any lender that relies on … borrower documentations and [an] attestation from the borrower,” the SBA also requires a lender to conduct a good faith review and to comply with the lender obligations set forth in the May 22 interim rule, which specifically include Bank Secrecy Act and anti-money laundering compliance protocols. Diligent compliance with these protocols might ward off any charge that the lender blindly rubber-stamped forgiveness determinations in a way that could trigger application of the FCA.

Some Good News

Not all the news is bad in terms of PPP-related litigation. The approval of subsequent increased funding availability may well serve to limit future application-related claims. Additionally, and more significantly, at least one court has found that the CARES Act itself does not provide a private right of action to borrower applicants. And, as more PPP-related lawsuits are filed, financial institution defendants also will continue to develop defensive theories designed to defeat those claims.

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These lender liability and FCA-related questions remain a moving target as federal loan administration rules and guidance evolve on a daily basis. We continue to track these issues and will publish additional blog posts in this area to address relevant new developments.