By Frank A. Hirsch, Jr., Litigation

It has taken a while, but the start of litigation against financial institutions, which made the Paycheck Protection Program (PPP) loans, has begun. Government/regulatory inquiries will follow. Is your business ready?

Smaller banks and nonbank lenders account for a large percentage of PPP loans extended and the total net loan amounts. Some 4,105 relatively small banks and savings and loan associations, each with assets less than $1 billion, extended and approved a total of 1,812,102 PPP loans for more than $101.5 billion.

The risks are many- including state law lender-liability claims, the potential for False Claims Act (FCA) exposure, risks of Anti Money Laundering (AML), Bank Secrecy Act (BSA) infractions, whistleblowers, and DOJ or other government agency investigations, to name a few. What should financial services providers be doing about their PPP exposure?

The CARES Act is (So Far) Not a Complete Shield

In March 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, to provide emergency financial support to the millions of Americans suffering the economic effects caused by the COVID-19 pandemic. The Paycheck Protection Program was a nearly $1 trillion business loan bailout administered by the U.S. Small Business Administration (SBA), and it allowed entities to apply for low-interest private loans to pay for their payroll and certain other costs. Those loans were promoted as subject to complete forgiveness if SBA compliant. If forgiven, PPP loans are paid off by the government. If not forgiven, the loans must be repaid to the lenders.

PPP regulations allowed lenders to rely on “borrower documentations and attestation[s].” This concession encouraged lenders to begin approving PPP loans and processing them quickly. However, the SBA’s regulations also required lenders to conduct a “good faith review” of PPP loan applications and did not relieve them of their obligations under other statutes, such as the BSA.

The SBA’s rules provide that lenders are to be “held harmless” for borrowers’ failure to comply with PPP program criteria and will not be subject to any enforcement action or penalty relating to loan origination or forgiveness of the PPP loan if the lender (1) “acts in good faith relating to the origination or forgiveness of the PPP loan,” and (2) “satisfies all other applicable Federal, State, local, and other statutory or regulatory requirements.”

Thus, lenders received partial immunity under the CARES Act, but how far this extends is yet to be seen. The CARES Act did not establish a private right of action against banks. Profiles Inc. v. Bank of America Corp., No. 1:20-cv-00894, ECF No. 17 (D. Md., filed April 13, 2020). This case is currently on appeal. Taking an alternative legal route, class action claimants have now turned to state law claim theories to pursue lenders – such as negligence, fraud, breach of contract, and Unfair or Deceptive Acts or Practices (UDAP).

The Kabbage Litigation in the NDGA

This suit, filed in late March 2022, alleges that Kabbage failed to appropriately process borrowers’ PPP loan forgiveness applications. See Carr v. Kabbage, Inc., Case No. 1:22-cv-01249 (N.D. Ga.). Allegedly, Kabbage did not process applications within the time required by the federal regulations that asked customers to sign altered forms, and demanded that customers provide unnecessary documents. The suit argues that Kabbage should have participated in the SBA’s loan forgiveness portal, and it alleges that Kabbage has wrongfully attempted to collect on loans that should have been forgiven.

The suit seeks to certify a nationwide class of Kabbage borrowers. As damages, it seeks to disgorge from Kabbage all of its origination fees from PPP loans. Kabbage has filed a motion to dismiss, which has been briefed, but no ruling has been made.

The PNC Litigation in NDIL

US Cargo Direct, Inc. v. PNC Bank, NA, Case 1:22-cv-03925 (ND. Ill. July 28, 2022). This case was filed in the Northern District of Illinois on July 28, 2022. A trucking and logistics company that utilized independent contractor-truck drivers received a PPP loan from PNC on April 14, 2020, in the amount of $1,524,000 and used proceeds to pay its contractors. PNC had solicited US Cargo in March 2020, to apply for a PPP loan since it was an existing bank customer and was a known entity. The bank told US Cargo that it would confirm the eligible PPP loan amount and the bank had the US Cargo tax returns and 1099 forms. The bank had approved the PPP loan within 24 hours of submission.

When US Cargo applied to PNC’s forgiveness portal on July 28, 2021, PNC advised US Cargo for the first time that only $53,017 of the PPP loan was eligible for forgiveness and requested payment of the balance of $1,470,983. Allegedly, PNC loan intake procedures for PPP loans as of April 14, 2020, had not been updated to account for the SBA’s Interim Final Rule dated April 6, 2020, which stated that payments PPP loan recipients might make to independent contractors would not count as payments to employees and thus would not be eligible for forgiveness.

PNC was sued on five claims: (1) breach of contract; (2) unjust enrichment; (3) breach of fiduciary duty; (4) negligent misrepresentation; and (5) promissory estoppel. The case is pending and no responsive pleadings have yet been filed.

The BOA Litigation in Maryland

On August 23, 2022, Bank of America (BOA) was sued by a putative nationwide class of PPP borrowers under North Carolina law — since that is where BOA is headquartered and that is the choice of law in all the BOA promissory notes signed by PPP customers.

Allegedly, the bank pushed through many loans which improperly included 1099 worker pay as part of the formula, then discovered the errors [and the BOA legal department wrote a memo detailing that the bank had to deny submissions of forgiveness requests to the SBA or else face False Claims Act liabilities]. Rather than steer borrowers to the SBA forgiveness portal, the bank controlled its own portal and flatly refused to allow borrowers to even seek forgiveness if their submissions/loans included 1099 workers or used loan proceeds to pay 1099 workers. The result was a large amount of unforgiven loans.

1099 workers are typically independent contractors hired by businesses when servicers are needed. 1099 workers are not included on company payrolls. The complaint states that expenses for such workers could not be used to calculate a business’s loan eligibility under the PPP, but BOA did so anyway. The specific allegation is that “BOA instructed small business owners to include such pay in their loan applications to calculate their maximum loan eligibility, and then subsequently included those 1099 worker expenses when securing loans for those amounts. ” The complaint further states “To their surprise, plaintiffs and class members found themselves liable for repayment of the portions of their loans that they used to pay their 1099 workers. Had they known that payments to 1099 workers did not qualify plaintiffs and the class would not have applied for and taken a loan, would have reduced the amount of the loan they applied for, and/or would have allocated their loan funds differently.” The plaintiffs cite that BOA was the second largest PPP lender and earned commissions on these loans of more than $345 million.

The case is pending and no responsive pleadings have yet been filed. Modern Perfection LLC et al. v. Bank of America NA, case number 1:22-cv-02103, in the U.S. District Court for the District of Maryland.

Analytical Imperatives

Lender negligence includes conduct that falls below the standards of reasonable care with regard to a duty that is owed to the potential borrower, which proximately causes injury. This can include the failure to process a loan application with reasonable care. See, First Federal Savings & Loan Ass’n v. Caudle, 425 So. 2d 1050 (Ala. 1982). What is reasonable care in the context of the torrent of loan applications processed in the first few weeks of PPP lending? That is the issue to be vetted by the courts.

The 1099-worker-ineligibility for loan application amounts [or for the use of proceeds] is a vulnerable area for lenders of all types and sizes. The issues are many:

1. How many mistakes were made with these 1099 inclusions?
2. Were the mistakes detected by the lender, and if so, when, in what amounts, and how?
3. Did the lenders ever deny forgiveness to any PPP borrowers based on 1099 taints in the process?
4. Did some 1099 infractions slip through and achieve forgiveness and the lender knew about the mistake?
5. Did any whistleblowers raise the issue with the lenders — asserting the lender knowingly processed PPP loan forgiveness applications for companies with 1099 taints included, and could FCA liability attach to the lender?
6. Has the lender engaged in a PPP loan portfolio analysis in order to look for errors in handling 1099 workers?
7. Has the lender suspended any document destruction policies and practices for the 10 year period applicable to FCA cases?
8. Did the lender access and consider all available information, particularly where a review would have shown inconsistencies. For example, where a PPP loan was extended to an existing bank customer, would tax returns indicate 1099 workers? Was that information facially at odds with the borrower’s documentation provided on the PPP loan application?

Fortunately for lenders, the government has a high burden for proving FCA violations. Liability under the FCA requires proof of some level of knowledge of the fraud. The US Supreme Court has held that this scienter requirement must be strictly enforced. Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016).

But, the government is investigating, and it has a long time to look back for any culpability. If a lender’s response to government requests suggests compliance deficiencies, or if the documents provided suggest that the lender did not act in good faith in originating the loan, or in connection with forgiveness of the PPP loan, the government may open a broader investigation into the lender’s conduct.

Given the increased litigation and/or enforcement, PPP lenders are likely to face in the months and years ahead, lenders would be well advised to take proactive steps to ensure their PPP loan portfolios have been examined for compliance.

Resources

Federal Banking Agencies
CFPB Guidance on Adverse Action Notices for PPP
OCC Guidance on Documentation of PPP Loans
FDIC FAQ on PPP
Federal Reserve PPP Liquidity Facility

SBA/Treasury
PPP Rules and Guidance

The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.