Paycheck Protection Program and Foreign Employees: Treasury and SBA Try to Clean Up Their Mess

Note: The U.S. Small Business Administration and the U.S. Department of the Treasury on May 18, 2020, issued a revised Interim Final Rule (IFR), which clarified that Paycheck Protection Program (PPP) borrowers must count all employees — domestic and foreign — when calculating their size for determining eligibility under the PPP's 500-employee threshold. Consistent with the suggestion in Holland & Knight's alert below, the IFR also stated that borrowers who, prior to May 5, 2020, relied on a previous version of the IFR that excluded foreign employees from the size calculation would not be deemed ineligible for PPP loans. For a more detailed summary of the May 18 revisions to the IFR, see Holland & Knight's alert, "New PPP Interim Final Rule Clarifies That Foreign Employees Count for Size."

As Holland & Knight wrote in an alert on May 6, 2020, the latest Frequently Asked Question (FAQ) for the Coronavirus Aid, Relief, and Economic Security Act (Act) Paycheck Protection Program (PPP) loan eligibility underscores yet another compliance concern for large companies, this time with respect to foreign-based companies. The latest FAQ guidance, while presenting a correct interpretation of existing federal law, runs contrary to the U.S. Small Business Administration's (SBA) Interim Final Rule (IFR) implementing the PPP and to prior FAQ guidance. (See Holland & Knight's previous alert, "Paycheck Protection Program: Updated Guidance on Counting Employees in Foreign Affiliates," May 6, 2020.)

The FAQ posted May 5, 2020, addresses how foreign-owned companies should calculate their number of employees for purposes of complying with the 500-employee limitation for small business eligibility set forth in the CARES Act. Specifically, FAQ 44 states:

44. Question: How do SBA's affiliation rules at 13 C.F.R. 121.301(f) apply with regard to counting the employees of foreign and U.S. affiliates?

Answer: For purposes of the PPP's 500 or fewer employee size standard, an applicant must count all of its employees and the employees of its U.S. and foreign affiliates, absent a waiver of or an exception to the affiliation rules. 13 C.F.R. 121.301(f)(6). Business concerns seeking to qualify as a "small business concern" under section 3 of the Small Business Act (15 U.S.C. 632) on the basis of the employee-based size standard must do the same.

FAQ 44 requires the counting of all employees (foreign and domestic) of a concern and its affiliates and is consistent with SBA's underlying regulations governing its size and loan programs (see discussion below). However, it is at odds with SBA's IFR under the PPP first issued on April 2, 2020, and which became effective on April 15, 2020, and with previous FAQ guidance, in particular FAQ 3 issued April 7, 2020. Those documents included language that only require a foreign-owned firm to count its employees who are U.S. residents for purposes of determining their size eligibility for the PPP program. For example, the IFR provides:

"You are eligible for a PPP loan if you have 500 or fewer employees whose principal place of residence is in the United States, or are a business that operates in a certain industry and meet the applicable SBA employee-based size standards for that industry."

Likewise, FAQ 3 states:

In addition to small business concerns, a business is eligible for a PPP loan if the business has 500 or fewer employees whose principal place of residence is in the United States.

As a matter of law, the IFR became part of SBA's regulations as of its effective date. As a regulation, it trumps language in guidance (i.e., the FAQs, and FAQ 44 in particular), unless and until the IFR itself is amended. (Side note: the amount of the loan a PPP borrower can receive is tied to the number of U.S. resident employees it has, but that presents a different question.)

The IFR Is at Odds with SBA's Underlying Regulations and FAQ 44, but SBA Has Not Amended the IFR, Which Remains as the Governing Regulation for the PPP

As noted, the IFR and FAQ 3 are contrary to SBA's pre-existing size regulations. However, the IFR and FAQ 3 further the PPP's purpose of getting wages out to American workers in an emergency and allowing American business operations to continue to exist.

The other side of the coin is that the IFR and FAQ 3 would permit a foreign-owned firm with 50,000 employees worldwide, but only 490 U.S. resident employees to qualify for a PPP loan, but a domestic, U.S.-based concern with 501 employees, all U.S. residents, would not qualify. But those 490 resident U.S. employees are also in need of pay and a job and fit within the policy intent of the PPP – to maintain payroll for the U.S. workforce.

Despite concerns being raised about this issue, the government reissued the IFR two additional times and all iterations to date have contained the foreign employee exclusion language. The IFR became effective April 15, 2020, and comments on the IFR must be submitted by May 15, 2020.   

As noted above, SBA's pre-existing regulations define "employee" broadly.

§121.106 How does SBA calculate number of employees?

(a) In determining a concern's number of employees, SBA counts all individuals employed on a full-time, part-time, or other basis. This includes employees obtained from a temporary employee agency, professional employee organization or leasing concern. SBA will consider the totality of the circumstances, including criteria used by the IRS for Federal income tax purposes, in determining whether individuals are employees of a concern. Volunteers (i.e., individuals who receive no compensation, including no in-kind compensation, for work performed) are not considered employees.

There is a conflict between the SBA's regulations and the IFR which governs the PPP.

What Should Borrowers Who Excluded Foreign Employees from Their Size Calculation Do?

So what is a borrower to do if they relied on the IFR language and FAQ 3 and applied for a PPP loan but they (and their affiliates) have more than 500 employees, foreign and domestic? While FAQ 44 calls into question the corresponding language in the IFR, the IFR as a regulation still stands as the law governing the PPP (not mere guidance like an FAQ) and was effective as of April 15, 2020. The IFR is now part of SBA's regulations governing the PPP, unless and until SBA amends it. 

A borrower might also take some comfort in the introductory language in the FAQ document that "borrowers and lenders may rely on guidance provided in this document." That language was expanded with FAQ 17 which provides:

Borrowers and lenders may rely on the laws, rules, and guidance available at the time of the relevant application. However, borrowers whose previously submitted loan applications have not yet been processed may revise their applications based on clarifications reflected in these FAQs.

Borrowers who submitted applications and received funding prior to May 5, 2020, and relied on the IFR and FAQs as they existed at the time of the application, likely have a defensible position.  Applicants who have not yet had their applications processed, may wish to reconsider based on FAQ 44. 

All that said, given the language of SBA's existing regulations and the issuance of FAQ 44, a more conservative course of action would be to withdraw any pending PPP loan application. A borrower whose application was accepted and who received funds before May 5, 2020, in good faith reliance on the IFR and FAQ 3 is in a stronger position to retain the funds.

The context in which FAQ 44 was presented is a factor in the decision-making. FAQ 44 was issued the same day as FAQ 43 which extended a previously announced "safe harbor" for ineligible borrowers to return PPP funds by one week to May 14 (See Holland & Knight's previous alert, "Safe Harbor Deadline for Repayment of PPP Loans Extended from May 7 to May 14," May 6, 2020). While the "safe harbor" announcement has its roots in the evolving "necessity" certification, the FAQs do not expressly limit the safe harbor deadline to the necessity issue. (See Holland & Knight's previous alert, "Key Factors for Companies to Consider When Certifying Their PPP Need," April 25, 2020.)

The size of the loan is also a factor to consider. The government has stated that loans of $2 million or more will be reviewed. Borrowers with foreign parents or affiliates will likely be given even closer and less sympathetic examination, given the political environment. 

Finally, and perhaps most importantly, the government has powerful enforcement tools to deal with bad actors, including the Civil False Claims Act, which provides for statutory penalties and recovery of damages up to three times the amount of the a fraudulently obtained loan. More traditional bank and loan fraud civil and criminal remedies are also available. However, good faith reliance on the IFR would make it difficult for the government to prove fraud or to consider a borrower a "bad actor."

Conclusion

Beyond these reasons potentially favoring return of PPP money by foreign entities with more than 500 employees total, the broader enforcement landscape strengthens the case for return of PPP funds by them. Large foreign firms will find themselves in no better position than the large businesses who were under pressure to return PPP funds in late April. Indeed foreign borrowers will likely receive even  less favorable treatment and greater scrutiny by virtue of their foreign status, particularly when domestic, truly small concerns continue to get passed over for PPP loans. Even if at the end of the day a foreign borrower mounts a successful defensible legal position supporting keeping the loan proceeds, the process penalty and reputational damage of keeping the PPP funds potentially outweighs any benefit in keeping the proceeds.

For its part, the government could do a better and more precise job of cleaning up the mess it created with conflicting FAQs. Finally, to be fair to borrowers who relied in good faith on the existing IFR and FAQ 3, if the government amends the IFR it should "grandfather" these borrowers and allow them to retain their loans, which were obtained in compliance with the IFR in effect at the time, provided they, like other borrowers, comply with the PPP as to uses of the loans. And for those borrowers who are unsure about whether to retain their loan, the SBA also should extend the safe harbor date yet again to give such borrowers a chance to decide whether to retain or return the loans.

Since the beginning of the response to this pandemic, Holland & Knight has made it a point to caveat our advice as reflecting what is known as of that moment, and that the regulatory and implementation landscape can change materially and quickly. This issue presents a good example of why it's necessary to do so. It likely won't be the last time those caveats are invoked.

DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis. Please contact your responsible Holland & Knight lawyer or the author of this alert for timely advice.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.