Lenders and Borrowers Beware: EIDL Fraud Alert
Holland & Knight has learned through customary deal due diligence that some borrowers – especially those who received a Paycheck Protection Program (PPP) loan through the U.S. Small Business Administration (SBA) – may have been subject to fraudulent loan activities involving COVID-19 Economic Injury Disaster Loans (EIDLs) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
In reviewing lien search results, Holland & Knight found that the SBA had filed all asset Uniform Commercial Code initial financing statements (UCC-1s) on some borrowers even if the borrower had not applied for an EIDL. Further research of the SBA EIDL database appears to indicate that third parties, not these borrowers, had applied for the EIDLs in the names of these borrowers and had either 1) actually obtained the requested EIDL funds, or 2) in some cases in which the SBA was not able to confirm a bank account number for the third party, the SBA created an active EIDL account and charged a $100 processing fee even if the EIDL was never funded.
Considerations and Next Steps
Lenders and borrowers contemplating any loan transaction (even if not related to the CARES Act) need to conduct due diligence proactively to uncover whether a potential borrower has become victim to this fraudulent activity and take steps to protect themselves. If a borrower received a PPP loan, it is recommended that either it (or its lender) run a UCC lien search early in the process to learn whether or not the SBA has placed a lien on the borrower's assets. (Please note that any such lien would relate only to an EIDL because PPP loans are unsecured and are not funded by the SBA).
If you find that the SBA has placed such a lien on the borrower and the borrower had not applied for and received an EIDL, the following actions should be taken:
- check a public database, such as the COVID Bailout Tracker, to see if the SBA has reported the company to have been approved for an EIDL
- contact the SBA's EIDL office at 800-659-2955 to discuss the loan and advise the SBA that it was a fraudulent loan, then work with the SBA to have them classify the EIDL as fraudulent and initiate an investigation
Holland & Knight has found that it is currently taking the SBA more than 60 days to conduct its fraud investigations, and it will not file a UCC-3 termination statement terminating the previously filed UCC-1 financing statement until the SBA completes its investigation.
If the SBA has sent the borrower an email notifying the borrower that the SBA has flagged the EIDL as fraudulent, Holland & Knight stands ready to 1) advise lender clients on the steps that its borrower will need to take to terminate the fraudulent UCC filing or 2) assist borrower clients in taking the appropriate steps so that the borrower may terminate the fraudulent UCC filing itself pursuant to the Uniform Commercial Code without having to wait for the SBA investigation to be completed.
If the borrower and lender desire to sign and close a loan transaction before the SBA can complete its investigation and file a UCC-3 termination statement or if the borrower has not taken the appropriate steps under the UCC to be able to terminate the fraudulent UCC filing itself, the loan agreement should include temporary permission via a schedule to the loan agreement for the existence of the financing statement, even if it was filed as a result of fraudulent activity, as well as a covenant of the borrower to work in good faith with the SBA to have the SBA's investigation completed expeditiously and have the SBA file an appropriate UCC-3 termination statement. In order to close the loan before the SBA files an appropriate UCC-3 termination statement, a borrower may need to indemnify the lender for any harm that the lender may incur as a result of the SBA's filed UCC-1 even if it was filed as a result of a third party's fraudulent activity.
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, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.