News that companies like Shake Shack had received loans provided by the Paycheck Protection Program (PPP) set off a flurry of activity, resulting in additional joint guidance from the Small Business Administration (SBA) and the Treasury Department (Treasury), as well as social media activity. Such guidance and social media communication have caused worry and uncertainty among independent schools, leaving them to consider whether it was wise to still seek PPP loans or, if they have already received the loan, whether to return the money.
What Is New?
On April 23, 2020, the SBA and Treasury updated their PPP Frequently Asked Questions with FAQ 31, which provides that, in making the good faith certification of need for the loan, borrowers should consider their current business activity and whether they are able to access other sources of liquidity in a manner that would not be significantly detrimental to their business. On April 24, 2020, Treasury issued additional Interim Final Rules that formalized and expanded on FAQ 31, specifically providing, among other things, a "limited safe harbor with respect to certification concerning need for PPP loan request." The Safe Harbor Rule provides that "[a]ny borrower that applied for a PPP loan prior to issuance of this regulation and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith."
On April 28, 2020, Secretary Mnuchin announced in a news conference that Treasury would audit every loan made for more than $2M, adding that companies that made false certifications could face criminal liability. On April 29, 2020, the SBA and Treasury published FAQ 39, which provided that "it will review all loans in excess of $2M, in addition to other loans as appropriate." On May 1, 2020, Secretary Mnuchin directed his attention to independent schools when he tweeted, "[i]t has come to our attention that some private schools with significant endowments have taken #PPP loans. They should return them." Most recently, May 6, 2020 joint guidance extended the deadline for institutions to repay the loan under the Safe Harbor Rule to May 14, 2020 and indicates that additional guidance will be provided before May 14.
FAQ No. 31, the Safe Harbor Rule, and Secretary Mnuchin's announced audit plans collectively reflect a significant departure from the plain language of the CARES Act, which seemingly encourages PPP loan applications and maximum loan amounts by imposing very few borrower requirements. For example, the CARES Act dispenses with the typical SBA requirement that borrowers of 7(a) SBA loans must show they are unable to obtain "credit elsewhere." The CARES Act directs the SBA to defer payments of principal and interest on PPP loans for at least 6 months because eligible recipients are "presumed to have been adversely impacted by COVID-19." Moreover, the SBA's Interim Final Rule encourages borrowers to apply for the maximum loan amount, indicating a lack of concern that borrowers would receive more PPP funds than they actually need.
Are Schools Still Eligible for the PPP Loan in Light of the New Guidance?
Under the CARES Act, independent schools are required to "make a good faith certification . . . that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient." FAQ 31 appears to add a new standard for receiving a loan, namely that schools must "assess their economic need for a PPP loan." FAQ 31 also requires – for the first time – that borrowers must "tak[e] into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business." Though the additional guidance does not appear to be directed at nonprofit organizations, in light of the focus on independent schools and their endowments, schools should use the time provided under the Safe Harbor Rule to evaluate (or reevaluate) their good faith certification of their need for a loan, including whether they have access to other sources of liquidity.
What Should Schools Consider in Assessing Their Need for the Loan?
Evaluating the Uncertainty of the Current Economic Conditions and Ongoing Operations
While each school must make an individual determination of its need for a loan, there are common factors impacting the industry as a whole that create substantial economic uncertainty. For example, many parents have lost jobs, been furloughed, or are experiencing salary cuts or steep declines in the value of their investments. Such families have either already requested or may likely request deferral of tuition binding dates, as well as reductions in tuition or increased financial aid. Summer programs, which often account for a large percentage of auxiliary revenue, may be cancelled or substantially modified. Enrollment numbers may decrease by large percentages, with fewer new families enrolling and current families withdrawing. The independent school business model is heavily tuition dependent, and, for many schools, tuition does not cover the full cost of a school's expenses. Many schools also rely on other sources of revenue, such as investment income from the endowment, charitable giving, fundraising events, and rentals of the school's physical plant. The economic effects of the COVID-19 pandemic have already severely impacted these other revenue sources and will continue to do so as response to the pandemic continues.
One key component of evaluating the certification of need is performing predictive modeling and financial forecasting using a wide range of possible scenarios. Some of the factors to consider when reviewing the pandemic's effects on the budget include:
- Declines in new enrollment and reenrollment
- Limitation on the return of international students
- Increased requests for financial aid, including from families who were previously "full pay" families
- The inability to earn from alternative revenue sources, such as summer camps and facility rentals
- Revenues lost from other services, such as boarding, transportation, and meal service
- Declines in charitable giving and inability to operate such events as auctions or other fundraising events
- Market instability and the ability to rely on investment income from the endowment
Schools are likely to experience more than one economic effect of the pandemic – thus effective predictive modeling should address each economic effect in isolation, as well as how they might interact with and affect one another.
While all schools are facing economic uncertainty, the impact of that uncertainty varies between institutions. When considering whether to accept funds from the PPP, it is important to remember that while the PPP loan requires a school to certify to economic uncertainty, it does not require the school to certify that it will be forced to cease operations unless it receives PPP funds.
Evaluating the Availability of Other Sources of Liquidity
As noted above, the SBA issued guidance requiring borrowers to consider their current business activity and their ability to access other sources of liquidity when certifying their need for the loan. When considering access to other sources of liquidity, schools should also consider whether using those sources to support ongoing operations would be significantly detrimental to the business.
As a first step, identify all other potential sources of liquidity. Common potential sources of liquidity for independent schools are endowments, lines of credit, reserves, or access to other financial resources. Once the list of resources is established, thoroughly assess the various factors that may limit the use of the funds, or whether use of the funds would otherwise be significantly detrimental to the school. For example, while schools may have substantial endowments, if those funds are restricted the school is not able to utilize the resource. There are also legal requirements that impact the amount a school may remove from endowment funds. Furthermore, many schools use investment proceeds from the endowment to make up the delta between tuition and the full cost of running the school. Accessing endowment funds, particularly in this economic climate, could have a long-term detrimental effect on the ability of the school to operate. Access to other lines of credit may also be similarly restricted.
As part of the evaluation of liquidity, schools should also review the debt held by the school and the impact that debt may have on the institution's finances and the sources of liquidity. While the school may have resources that appear to be liquid, they may in fact be restricted. For example, a school may have a debt covenant in place that restricts the school's ability to access current liquidity or limits the ability to take on additional debt.
Description of Cost Savings Measures the School Is Implementing or Considering
It is wise to proactively consider the additional steps the school may need to consider even if the school accepts the loan. Schools are evaluating the need to cut costs and spending to prepare for the possibility of a significant financial impact on the operations of the institution. It is prudent to create an outline of cost savings measures and the amount of savings associated with each action that can be implemented should the need arise. These can include reductions in faculty and staff after a careful review of programs and staffing needs, freezing or reductions in salary, reduction or suspension in retirement contributions, or elimination of activities or programs.
Evaluating the Cost of Declining the Loan
In addition to reviewing the uncertainty of the economic conditions and availability of other sources of liquidity, schools should also contemplate the long-term effects of declining or returning the PPP loan. Among other things, consider any steps the school will need to take to continue its program, retain its faculty, and ensure students across the economic spectrum have access to the school. To the extent that the unavailability of the PPP loan and other sources of liquidity would cause a school to take more drastic measures, such as layoffs or eliminating programs, consider those as well. For example, retaining talented and engaging faculty members is essential to the school's ability to continue to attract and retain a student body. English teachers who are adept at making the Iliad come alive for students are not easily found, and not easily replaced. Similarly, the inability of a school to provide adequate financial aid for a student may result in the loss of a cherished family within the community.
Should Schools Document the Decision to Apply for and/or Retain the Loan?
Any school that seeks a PPP loan would be well advised to meticulously document the ways that it can make a good faith showing "that the uncertainty of current economic conditions makes necessary the loan request to support the [borrower's] ongoing operations."
Document the Economic Uncertainty That Necessitates the Loan Request
This analysis should meaningfully describe the circumstances and factors that support the school's need for a loan. Schools may wish to reference or attach revenue and budget projections and predictive modeling that evaluates how the economic uncertainty will reduce sources of revenue and increase costs to the school. In addition, narratives and or documentation contracts, programs, and other activities that are likely to be cancelled and opportunities that are likely to disappear should be included, as should other difficulties that inform the school's assessment of need.
Document Why Alternative Sources of Liquidity Are Not Available or Are Insufficient
To comply with FAQ No. 31's instructions related to evaluating whether the borrower has access to other sources of liquidity and whether the use of the liquidity would be significantly detrimental to the school, a comprehensive list of the financial resources should be compiled and evaluated, as should the impact the use of these resources will have on the school.
Ensure That You Retain a Complete and Thorough Documentation of the Decision
Should a school be audited, the school will want to be able to quickly and readily present documentation to demonstrate its good faith certification. Documentation of the decision to apply for and/or retain the loan should reflect all of the factors that the school evaluated in making its decision. Schools should consider including documentation of the following:
- the school's existing budget and budgetary needs
- financial forecasting and predictive modeling performed to reflect the impact the economic uncertainty will have on sources of revenue and costs to the school
- a comprehensive list of the school's sources of liquidity, a description of the implications for the school if it utilizes its liquidity and whether accessing such resources would have a significantly detrimental impact on the school
- the measures the school would need to implement if it declines the loan
- any debts, loans, or other financial commitments and encumbrances or covenants on liquidity associated with the financial obligations
- information presented to the board and/or committees of the board for their consideration (for example, copies of presentations, memos, or other descriptive documents or handouts; copies of the regulations, articles, and other resources opining on the regulations; and input solicited from outside professionals, including accounting firms and banks)
- board and or committee meeting minutes and any and all board resolutions
Should Schools Be Prepared for an Audit?
Yes. Note that FAQ No. 31, the newly issued rules, and Secretary Mnuchin's plans to audit loans greater than $2 million are not limited in their application to only publicly traded companies or those with private equity or venture capital investors. The government will be performing a "full audit" of every loan over $2 million, prior to forgiveness.
The audits will likely be conducted by the SBA Inspector General and will most likely evaluate the forgiveness documents, loan eligibility documentation, good faith certification, and use of loan proceeds. The SBA also has the power to conduct an investigation should questions related to whether the certification was submitted in good faith be raised in the audit. Boards concerned about liability associated with an audit may want to review their Directors and Officers insurance to determine the extent of coverage and what is considered a covered claim.
As Always, Weigh the Risks
The analyses described above will help a school document and ultimately explain its decision to accept PPP funds. But if this decision comes under scrutiny for whatever reason, there are, of course, potential reputational and legal risks.
As discussed above, loans above $2M, in addition to other loans as appropriate, will be audited. Given the volume of loans, it is not anticipated that audits will be particularly granular. Nonetheless, audits could give rise to an investigation, and the fact-finding from an audit could be a predicate for pursuing a subpoena. In addition, there is potential liability under the False Claims Act (which imposes liability for any person who knowingly submits a false claim to the government) and the Financial Institutions Reform Recovery and Enforcement Act of 1989 (criminal fraud causes of action where the conduct affects a bank).
Of note, on April 23, Sen. Elizabeth Warren (D-MA) and Rep. Nydia Velázquez (D-NY), chairwoman of the House Committee on Small Business, wrote a letter to the Inspectors General of the SBA and Treasury, requesting that these IGs investigate the implementation of the PPP and the agencies' failure to "take adequate steps to prevent a number of foreseeable errors." The letter stops short of requesting a government investigation into the conduct of the businesses themselves. But nonetheless, if the Inspectors General take up this request, borrowers (and lenders) could find themselves in the public spotlight and/or under a political microscope – notwithstanding the fact that borrowers may have been eligible under the terms of the Act and all applicable rules.
Recently filed lawsuits have largely focused on the conduct of lenders in allegedly prioritizing PPP loan applications for certain customers over others. However, plaintiffs in at least one class action have gone so far as to name a purported defendant class of loan recipients, in addition to lenders. Putting aside the merits, unfounded as they may be, these lawsuits represent a new but anticipated litigation risk for PPP loan recipients that are deemed to be unsympathetic, even if they otherwise satisfy the CARES Act's specific PPP loan requirements.
Even a school that has a well-justified PPP loan may still be attacked in the media. While a school may emerge from a non-public government investigation without an adverse legal finding, the existence of an audit or investigation – and the prospect of potential liability – could affect a school's ability to focus on its mission, operations, and allocation of resources, as well as its reputation. All of these risks are necessarily weighed against the prospect of employee layoffs, drastic reductions in compensation, or an overall inability to continue operations during the COVID-19 pandemic.