August 25, 2020
Brad S. Keeton
Member, Stoll Keenon Ogden PLLC
For borrowers who took Paycheck Protection Program (“PPP”) loans in excess of $2 million, there are insurance products available to protect against an adverse result from Small Business Administration (“SBA”) audits. The SBA announced previously that it would audit all PPP loans in excess of $2 million primarily to examine each borrower’s certification that the PPP loan request was necessary. There is significant uncertainty as to how these audits will be conducted and what criteria the SBA will look for to determine whether the borrower’s necessity certification was made in good faith.
The certification at issue required borrowers to certify, in good faith, that “…current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” SBA guidance on this certification states:
Borrowers must make this certification in good faith, taking 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.
The vagueness of this guidance and the lack of audit-specific guidance from the SBA has created significant uncertainty and risk for borrowers that the SBA may ultimately determine that a borrower’s certification was not made in good faith, requiring the borrower to return all or a portion of its PPP loan along with interest and potentially fines and penalties. Borrowers may also incur attorneys’ fees if they decide to challenge the SBA’s determination. If the SBA determines that a borrower’s certification was particularly egregious or fraudulent, that borrower may face liability under the federal False Claims Act (“FCA”). The SBA has six years to complete its audits, meaning that this risk and uncertainty may hang over the business long after the COVID-19 pandemic is over.
In light of this risk and uncertainty, insurers have created products to give borrowers peace of mind. The basic products insure against an adverse eligibility determination by the SBA and protect the full amount of the PPP loan plus certain other expenses. Many insurers are offering add-on products that also protect against FCA liability and the employee count certification, which is particularly useful the businesses that run afoul of the confusing SBA affiliation rules. Based our review of various offerings, the terms generally are as follows:
1. Premiums for the basic necessity certification product generally range from 3% to 5% of the loan amount or the limit of liability. In the case of a limit of liability policy, the coverage includes the loan amount and applicable interest, fines, penalties, and defense costs. Some insurers have minimum premiums ranging from $100,000 to $125,000. It is important to ensure that the product you choose sufficiently protects your business.
2. Most products have a minimum retention (deductible) of $200,000. The higher the retention amount, the lower the premium.
3. We have seen policy terms ranging from four years to six years. Remember that the SBA audit window is six years, so it is important to choose a product that covers the full SBA audit window.
4. It is typical that in addition to the premium, there is an underwriting or due diligence fee ranging from $25,000 to $30,000. This fee covers the insurer’s investigation into your certifications, often utilizing outside law firms and accounting firms, depending on the complexity of your loan application and business structure. Generally, this due diligence phase takes one to two weeks for the insurer to complete.
5. Premiums generally are due at the time you enter into the insurance contract and cannot be spread out over the life of the policy. You should speak to your insurer or broker if you are interested in an alternate payment arrangement.
6. You should note that these products generally do not insure against a determination by your lender that you are not entitled to full forgiveness of your loan. These products only insure against adverse SBA audit outcomes. You also should be aware that some products contain exclusions for losses resulting from your use of the PPP loan and fraud. Please review, or have your legal counsel review, all policy limitations and exclusions carefully before entering into the insurance contract.
These insurance products certainly are not inexpensive. For a loan of $2 million, the minimum most insurers are willing to insure, your total cost would be at least $110,000, which includes a premium of 4% of the loan amount, or $80,000, assuming no higher premium minimum, plus the $30,000 underwriting/due diligence fee. In the event of a claim you would only recover $1.8 million of your $2 million loan, assuming a $200,000 retention. For many businesses, however, this expense may be worth the peace of mind that even with an adverse SBA determination, most of its PPP loan is protected.
As you consider whether these insurance products are right for your business, make sure the product you consider (1) adequately protects your liability exposure, (2) adequately covers the SBA audit window, (3) adequately indemnifies your potential litigation expenses, and (4) is written by an adequately capitalized insurance company highly rated by A.M. Best and/or Moody’s. If you have questions about these insurance products, options for insurers offering them, or would like for an attorney to review an insurance contract before you sign, you can contact a member of SKO’s COVID-19 Client Response Team.
Stoll Keenon Ogden understands that these are trying times for our clients and our country. Our firm operations have continued uninterrupted and our attorneys are equipped to serve as we always have – for more than 120 years.
If you would like to discuss the Paycheck Protection Program, the Main Street Lending Program, or other business-assistance programs available during the COVID-19 pandemic, please contact SKO’s Jamie Brodsky (502-568-5473) or Brad Keeton (502-568-5439).
Please also be sure to consult the Stoll Keenon Ogden Coronavirus Resource webpage for additional articles and information related to the latest information on new laws and directives enacted by federal, state, and local governments in response to the Coronavirus pandemic.