Tax Monitor

By: James M. Davis

Mark Twain once observed that while history does not repeat itself, “it rhymes.” The federal government’s response to COVID-19 is likely to follow a familiar pattern: (a) the federal government will continue to provide massive amounts of financial aid in an effort to stave off the worst economic effects of the crisis; (b) some of those funds will be allocated to entities that the public perceives as unscrupulous and unworthy; (c) in response, the government will selectively audit aid recipients, and target many of them for civil and potentially criminal prosecution.

The federal government uses the False Claims Act (the “FCA”) (31 U.S.C. §§3729-3733) as the primary means to pursue civil remedies and recoup fraud-related losses. The FCA was enacted in 1863 to discourage contractors from cheating the Union Army. The FCA, however, applies not only to government contractors, but to anyone seeking payment – via loans, grants, or other monies – from the federal government. FCA violations are frequently litigated, and since 1986 have led to the recovery of over $62 billion in government funding.

Certifications & the Paycheck Protection Program

We anticipate a significant increase in FCA claims in the coming months and years, as the federal government recently disbursed (or provided for the disbursement) of over 2.2 trillion dollars in federal aid through the CARES Act. Three-hundred and forty-nine billion dollars of that aid was earmarked to fund the Paycheck Protection Program (“PPP”), which, in turn, provides forgivable loans to small businesses that have been adversely affected by COVID-19.¹ As a result of that funding, many businesses owners who never applied for federal monies now find themselves scrambling navigate the complicated path to PPP funding.

In particular, to qualify for PPP loans, § 1102 of the CARES Act requires a borrower to certify in good faith to the Small Business Association (“SBA”) that: (i) the loan is necessary due to the uncertainty of current economic conditions to support ongoing operations; (ii) loan proceeds will be used to retain workers and maintain payroll, or make lease, mortgage and utility payments; and (iii) it is not receiving duplicative funds for the same uses from another SBA program. In Interim Rules, the SBA added five additional certifications: (1) the applicant was in operation on February 15, 2020 and had employees, (2) documentation verifying the number of full-time equivalents, dollar amounts and other permitted expenditures will be provided to the lender following the eight week period after the loan; (3) loan forgiveness will be provided for all documented payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities, provided that nor more than 25 percent of the forgiven amount may be for non-payroll costs; (4) certifying the accuracy of all information provided in all material respects; and (5) affirming tax documents submitted. Additionally, under § 1106(e), in order to qualify for loan forgiveness borrowers must to verify to the SBA any eligible, forgivable payments, and provide:

1. documentation verifying the number of full-time equivalent employees and their pay rates to determine any potential forgiveness reduction;
2. documentation verifying payments on covered mortgage obligations, rent obligations, and utility payments (e.g., canceled checks);
3. a certification from a representative of the eligible recipient authorized to make such certifications that the documentation is true and correct and that amount to be forgiven was used to retain employees, make interest payments, make rent payments, and make utility payments, as applicable; and
4. any other documentation the Small Business Association determines is necessary.

The public outcry against “unworthy” borrowers acquiring PPP funding has already begun.  In response that backlash, on April 23, 2020, the SBA promulgated additional guidance reiterating that applicants must certify in “good faith” that PPP funding is “necessary to support ongoing operations”. While the new guidance largely targets publicly-traded companies, it unequivocally applies to all borrowers. The guidance emphasizes that the economic necessity certification requires a potential borrower to determine in good faith that PPP funding is “necessary” due to: (a) uncertainty about current business conditions taking into account their current business activity; and (b) the absence of the business’ ability to access alternate sources of liquidity “sufficient to support … ongoing operations in a manner that is not significantly detrimental to the business.” The guidance is vague, and will undoubtedly result in disputes, investigations, and litigation regarding many borrowers’ “need” for PPP funding.  

On May 13, the SBA updated its online “frequently asked questions” to provide the following safe harbor: any borrower who received less than $2.0 million in PPP loan proceeds will be deemed to have made the economic necessity certification in good faith. This relief is only a safe harbor, and we recommend that all borrowers – including those that fall below the $2.0 million threshold – maintain documentation to support their current financial situation and the reasons behind their belief the PPP loan is economically necessary. The updated guidance also states that if a borrower (including those receiving $2.0 million or more in loan proceeds) is determined not to have adequate basis for making the required certification, the SBA will not pursue administrative enforcement or make referrals to other agencies if the borrower repays the PPP loan proceeds.

Additionally, in prior supplemental guidance, the SBA also provided an escape clause which states that a if a borrower that applied for a PPP loan and repays the loan in full by May 18, 2020, “the borrower will be deemed by SBA to have made the required certification in good faith.” (A number of high-profile, would-be borrowers have already made use of that provision.) The inclusion of a provision that allows borrowers to return PPP funding reflects the government’s sensitivity to the public’s concerns about the distribution of PPP loans, and suggests that it will deal harshly with borrowers that acquire “unnecessary” funding.

Certifications & the Provider Relief Fund

In addition to the PPP, $100 billion in CARES Act funding is earmarked for certain health care providers impacted by COVID-19 (the “PRF”). Like the PPP, receipt of monies from the PRF is conditioned on the acceptance of certain “Terms and Conditions.” The Terms and Conditions apply to recipients and sub-recipients of PRF funding. Among other things, the Terms and Conditions require PRF recipients to provide “diagnoses, testing, or care for individuals with possible or actual cases of COVID-19” and to only use the funds to “prevent, prepare for, and respond to [COVID-19].” The Terms and Conditions further state that the payment “shall reimburse the [r]ecipient only for health care related expenses or lost revenues that are attributable to [COVID-19].” It is important to note that PRF funds cannot be utilized to cover the same expenses as PPP funds. Recipients of both the PRF and the PPP will be required to demonstrate the differentiation in the use of funds. 

Recipients must also agree not to seek collection of out-of-pocket payments from a COVID-19 patient that are greater than what the patient would have otherwise been required to pay if the care had been provided by an in-network provider. To ensure compliance with the Terms and Conditions, fund recipients must maintain appropriate records and cost documentation, and submit reports as the United States Department of Health and Human Services (“HHS”) determines necessary. Recipients must ultimately sign an attestation with the HHS confirming receipt of the funds and agree to the Terms and Conditions within 45 days of payment.

Certifications & FCA Liability

In preparing and submitting the documentation and certifications described above, borrowers and fund recipients should be fully cognizant of the FCA, which imposes liability on anyone who:

1. knowingly presents or causes to be presented a false or fraudulent claim for payment or approval; 
2. knowingly makes, uses, or cause to be made or used a false record or statement; 
3. conspires to commit a violation of (a) or (b); or
4. knowingly makes, uses, or causes to be made or use a false record or statement material to an obligation to pay or transmit money or property to the government, or knowingly conceals or knowingly and improperly avoids or deceases and obligation to pay or transmit money or property to the government. 

31 U.S.C. § 3729(a)(1)(A), (B), (C), & (G) (sections D, E, and F are rarely invoked, and fall outside the scope of this article).  

The common thread that runs through each of basis of liability is knowledge: the act requires one to act knowingly to violate the act. That said, liability extends to a claimant who “acts in deliberate ignorance” or “in reckless disregard of the truth”, and “specific intent to defraud” the government is not required to prove a violation of the statute.  31 U.S.C. § 3730(b)(1). Borrowers should therefore exercise caution in delegating tasks related to certifications to junior staff. Any such delegation should be done with appropriate training and oversight. Finance, legal, and compliance departments should work closely together if delegation of these tasks is contemplated.  Inappropriate delegation could be construed as “deliberate ignorance,” and failure to confirm the veracity of the information provided to the SBA in connection with the PPP may constitute “recklessness.”

FCA Penalties

While the act imposes only civil, not criminal, liability, penalties are harsh.  A violation – that is, any single false claim – triggers a fine of $5,500-$11,000, plus three times the amount of the government’s damages. (Fines are, in some instances, reduced if the violating individual or entity self-reports.) And while FCA fines are high, monetary liability is not the worst potential outcome for those who violate the act: a civil investigation can very quickly turn into a criminal one, and in the more extreme case of fraud (i.e., those instances where the actor harbored the “specific intent” to defraud the government), the U.S. Attorney’s office is likely to prosecute the violator criminally as well as civilly.

Whistleblowers & the FCA

The most unique aspect of the FCA is that it empowers and strongly incentivizes individuals to file suits alleging violations of the act. Specifically, 31 U.S.C. § 3730(b) states that an individual may file a qui tam action – more commonly referred to as a relator or whistleblower action – alleging a violation of the FCA. A whistleblower must serve the his or her complaint and a written disclosure of all relevant facts on the United States Attorney in the district where the alleged violation occurred.  The complaint will remain sealed – unavailable to the public – for 60 days. The U.S. Attorney’s office is required to conduct an investigation during that 60-day period, and may then choose to pursue the action, or step back and allow the whistleblower to pursue it.  In the former instance, the whistleblower is entitled to 15-25% of the amount recovered by the government; in the latter, the whistleblower’s share is increased to 25-30%. See 31 U.S.C. § 3730(d).

Conclusion

Given the highly-publicized concerns regarding distribution of CARES Act funding, the federal government is likely to audit the applications, certifications, and verifications described above for borrowers receiving $2.0 million or more in loan proceeds. (Indeed, on April 28 Treasury Secretary Steve Mnuchin announced that all SBA loans in excess of $2 million will be audited.) We also expect some prosecutions to arise out of the “whistleblower” section of the FCA: whistleblowers are generously rewarded for successful FCA claims (including those that settle) and the plaintiffs’ bar is likely to encourage FCA claims going forward.

Any recipient of PPP or PRF funding should therefore: 

• Assume that it may, at some point, become the target of a federal audit or investigation. 
• Be proactive. Now is the time to prepare to justify and document each of the certifications and representations required under the CARES Act. Organize and file relevant documentation so that it is readily accessible in the event of an investigation or audit. Recipients of PPP funding should prepare a statement regarding good faith certification and their belief as to economic necessity of PPP funding (including planned uses of proceeds and other available funds for supporting ongoing operations). An entity that receives PPP and PRF funding should also maintain documentation that shows the funds were used for different purposes.
• Immediately contact an attorney in the event of an investigation or audit into the recipient’s acquisition or use of PPP or PRF funding. Competent counsel can assist and protect the recipient through the investigatory process, and help the recipient avoid making missteps that might turn the civil investigation into a criminal one.  

¹  The PPP’s initial funding was quickly exhausted, but Congress recently allotted an additional $310 billion to the PPP program.