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Law360 (May 26, 2020, 3:21 PM EDT) --
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| Richard Gottlieb |
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| Brett Natarelli |
Likewise, those same lenders are waiting to find out whether they will be the next to get slapped with suits alleging failure to pay agent fees to those that help to facilitate or process the loan applications.
For the most part, both categories of lawsuits are based on the flimsiest of legal theories, but there are traps for the unwary, including from a recent federal court decision from Michigan. We explain below.
Background
Congress passed, and on March 27 the president signed into law, the Coronavirus Aid, Relief, and Economic Security Act "to provide emergency assistance and health care response for individuals, families and businesses affected by the coronavirus pandemic."[1]
Under the CARES Act, the U.S. Small Business Administration, through its administrator, is granted the authority "to modify existing loan programs and establish a new loan program to assist small businesses nationwide adversely impacted by the COVID-19 emergency."
Section 1102 of the CARES Act amended the Small Business Act and established an initial $349 billion in funding for the PPP under the auspices of the SBA's preexisting Section 7(a) loan program, under which participating lenders are authorized to make loans to eligible small businesses.
To implement the CARES Act, the SBA issued an interim final rule, which provides that PPP loans would be federally guaranteed up to $10 million per loan and grants forgiveness of up to the full principal amount on qualifying loans if the funds are used for permissible purposes.
Neither the CARES Act nor the interim final rule dictates the way SBA lenders are required to prioritize the loan applications, nor do either expressly authorize any prioritization methodology.
Instead, in evaluating eligibility, lenders "shall consider" two factors: whether the applicant (1)"was in operation on February 15, 2020," and (2) either "had employees for whom the borrower paid salaries and payroll taxes" or "paid independent contractors." To facilitate expedited processing in the absence of the type of due diligence that would normally accompany a Section 7(a) SBA loan, the PPP lender application form requires the applicant to certify that these facts are true.
The applicant must also certify, among other things, that current economic uncertainty makes the loan request necessary to support ongoing operations; that the funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments and utility payments; and that the applicant has not received another PPP loan.
The applicant must also certify either that it: (1) is an independent contractor, eligible self-employed individual or sole proprietor; or (2) employs no more than 500 employees or, if applicable, meets the industry size standard in number of employees established by the SBA for Section 7(a) loans.
While the interim final rule lists a number of reasons why an applicant may be deemed ineligible for a PPP loan, neither the CARES Act nor the interim final rule otherwise imposes prohibitions on what lenders may do in their processes for accepting or reviewing applications.
Banks and certain others receive compensation for these arrangements, and such fees are set by regulation. The SBA will pay lenders a fee for processing PPP loans in the amount of 5% for loans of not more than $350,000; 3% for loans of more than $350,000 and less than $2 million; and 1% for loans of $2 million or more.
Likewise, there are also provisions for payment of an applicant's authorized representative and who helps to prepare the application. The fee is 1% for loans of $350,000 or less; 0.5% for loans between $350,000 and $2 million; and 0.25% for loans of $2 million or more. Lenders, and not the SBA, pay agents directly for these latter fees.
The Lending Begins
In the rush to enact emergency legislation and rulemaking, many of the program details were left for future regulation. Notwithstanding this issue, banks moved quickly to analyze the law and regulations and to mobilize to accept these applications.
From the beginning, many of the banks chose to focus on their own small business customers, for some obvious reasons. First among them, these are the bank's loyal customers.
Second, and equally important, there was a preexisting relationship between the bank and its customers such that there was a greatly decreased likelihood that the applicant would be able to defraud the bank or, ultimately, its guarantor, the United States.
And Then the Lawsuits
Some politicians and social media commentators immediately criticized banks for prioritizing their own customers over other applicants. The putative class actions followed shortly thereafter.
Numerous class actions have now been filed, and more are threatened daily. The suits generally rely on three types of legal theories: (1) claims based on violation of the federal laws under which the lending is made; (2) claims based on violation of state unfair deceptive acts and practices or false advertising statutes; and (3) common law claims based on fraud or unjust enrichment.
In the first category, plaintiffs have attempted to assert a cause of action for violation of the CARES Act itself. But nothing in that statute provides a legal remedy for applicants or borrowers who may be harmed by its provisions or alleged violations of it.
In the first such case to address the issue, a Marylan federal judge concluded that "the CARES Act does not expressly provide a private right of action" nor does it create an implied one.[2] "To the extent Congress intends to create such a private right of action," the U.S. District Court for the District of Maryland concluded, "it will be able to make its intent clear, if it ultimately amends the CARES Act, as is widely anticipated. Creation of that remedy, however, is not within the purview of this Court."
The court went on to consider whether, assuming the plaintiffs had a private right of action, they had stated any actual violation of the CARES Act in making PPP loans. The court concluded that the CARES Act simply does not prohibit a bank from considering factors like a preexisting relationship with the bank in deciding whether to make loans, nor does the CARES Act proscribe "in what order to process application[s] [the bank] accepts."[3] The court noted that Congress had considered language limiting banks to certain underwriting criteria in the drafting process, but such language was not enacted into law.[4]
The Maryland federal court's decision appears to be the first and, as of yet, only decision of its kind and is now on appeal to the U.S. Court of Appeals for the Fourth Circuit, but at least a half dozen similar lawsuits have been filed and remain pending. While some suits rely solely on the CARES Act, others articulate a similar theory (that a preexisting relationship with a lender is not an acceptable underwriting or prioritization criterion) under 15 U.S.C. 636(a), the preexisting SBA loan program on which the PPP is built.
In the second category, other lawsuits have attempted to articulate claims sounding in deceptive acts or practices based on allegedly false public statements made by the financial institution as to how it would review applications.[5] Plaintiffs in that case allege that it was "unfair" of banks to prioritize applications for existing customers, though the basis for that unfairness is not explained.
The plaintiffs further allege it was fraudulent of banks to inadequately disclose, or misrepresent, the limitations on eligibility and the intended order of prioritization for certain applications. Finally, the plaintiffs allege such conduct was "unlawful" under California's Section 17200 because of the above-discussed alleged inconsistencies with the PPP eligibility criteria stated in federal statute.
In the last category, some plaintiffs are attempting to pursue common law claims based on theories of fraud, fraudulent inducement or unjust enrichment. Although beyond the scope of this short discussion, the ability of plaintiffs to maintain these claims will depend on evidence of conduct independent of the alleged statutory violations, such as affirmative proof of false or misleading statements that may not be susceptible to class action treatment.
Are Claims of Improper Prioritization of Certain PPP Applications Frivolous?
Only time will tell. So far, only one court has issued a substantive ruling, and only in the context of denying a temporary restraining order. As readers will likely recall, many borrower or potential borrower causes of action in the wake of the 2008 financial crisis were similarly rejected at first, but eventually some at least survived the pleadings stage.
Courts routinely held, for example, that the Troubled Asset Relief Program offered no private right of action, but some borrowers gained traction in some jurisdictions on theories sounding in deceptive acts and practices in implementation. This was especially true with respect to the Home Affordable Modification Program, which offered no private right of action, but borrowers in some cases successfully survived motions to dismiss on allegations that the defendant violated its own policies or breached its own contractual agreements.
That said, surviving a motion to dismiss is one thing; proving liability and damages is another matter altogether. In the TARP and HAMP litigation, even after surviving a motion to dismiss, borrowers had difficulty proving eligibility for assistance or that the assistance would have been sufficient to prevent foreclosure and eviction.
Similarly here, plaintiffs may ultimately survive motions to dismiss on some theories but be unable to prove that they failed to obtain a PPP loan or that any delay was material in causing them private damage. Plaintiffs may also encounter difficulty in proving their allegations about lenders' processes.
Some of the suits allege, for example, that lenders prioritized larger loan applications in order to maximize profits. Nothing in the CARES Act appears to prohibit this, but as a factual matter, larger loan amounts generate smaller permissible fee percentages under the PPP, not larger ones. And it still remains to be seen whether PPP lending will even be profitable at all for participating lenders.
We are also in the early going. Many plaintiffs will likely be subject to ripeness and mootness defenses — ripeness because it may still be possible for the applicant to be given the PPP loan applied for as more funds become available and processing finishes, and mootness because, if the loan is obtained, there may be nothing left to litigate. We saw in HAMP litigation that borrowers who actually obtained loss mitigation relief rarely prevailed in litigation, even if the servicer's processing of the application was imperfect.
What About the PPP Agent Fees Class Actions?
In an entirely separate series of filings, lawyers (often the same group) are beginning to file putative class actions alleging that PPP lenders are failing to pay agent commissions. To date, suits have been filed in a number of federal district courts in, among other venues, the U.S. District Court for the Northern District of California, the U.S. District Court for the Northern District of Illinois and the U.S. District Court for the Southern District of Ohio.
The suits generally allege claims for declaratory relief and unjust enrichment, and sometimes pursue claims purporting to arise under state unfair or deceptive acts and practices statutes, such as California Civil Code Section 17200 and the Illinois Consumer Fraud Act. Likewise, the suits are filed as putative class actions, naming several alleged lender defendants as well as thousands of "Doe" defendants.
Traps for the Unwary
Do not assume that early court rejection of borrower theories on PPP claims means such theories will always be rejected. The law will evolve, and such evolution will likely be influenced by the political climate even years from now. Perhaps most important, do not assume that compliance with the CARES Act or SBA rules will provide a complete defense.
An example: A recent order from the U.S. District Court for the Eastern District of Michigan, in DV Diamond Club of Flint v. U.S. Small Business Administration,[6] has enjoined the SBA from enforcing its so-called PPP ineligibility rule that purports to narrow the eligibility of a wide variety of businesses to obtain PPP loans.
Under that rule, banks, political lobbying firms, certain private clubs with restrictive admissions practices, and sexually oriented businesses that present entertainment or sell products of a "prurient" (but not unlawful) nature are ineligible for the loans. For those lenders (especially ones that have long acted as SBA lenders) that relied on the ineligibility rule alone to deny applicants within these categories, creative plaintiffs may attempt to impute liability even though lenders were strictly following the SBA's formal guidance.
And the CARES Act itself is no buffer because regulations or guidelines that conflict with the statute may be entitled to little or no deference. Further, the hastily crafted statute offers no such safe harbors, nor does there appear to be political will at the moment to add them.
But even setting that aside, courts are not likely to be sympathetic to PPP lenders who publicly announce one set of underwriting criteria but in fact are following another. PPP lenders should be careful to be truthful and accurate when making public statements about implementation.
In weighing risks, consider, for example, that courts are likely to be sympathetic to minor variations or even deficiencies in programs given the difficulty attendant to navigating a new and complex federal program in the midst of a once-in-a-century pandemic and economic crisis.
Courts are likely to be receptive to arguments that Congress clearly articulated a legislative purpose of pushing cash into the marketplace as quickly as possible, and existing banking laws — Bank Secrecy Act, Anti-Money Laundering and Know Your Customer — made it much more practical for lenders to more quickly approve loans to existing customers rather than new ones.
Such crisis-inspired leeway is unlikely to extend, however, to inaccurate representations to borrowers about the lender's policies, especially as the crisis fades into the rearview mirror or becomes the new normal. If the reality is that your institution will not or cannot offer a particular type of loan, or serve a particular group of customers, your institution should not make public statements claiming it is doing so.
Conclusions
As presently crafted, lenders should be absolutely entitled to prioritize their own customers in the processing of PPP loans, and nothing in the statutes or regulations currently prohibits that. That said, lenders should take care to avoid broad pronouncements or to make promises that, when misinterpreted or misread, could give rise to legal claims that might survive early motion practice.
On the agent theory cases, those suits will survive or fall based on evidence of whether lenders actually engaged in a practice of systematically depriving "authorized" representatives of agent fees, a dubious scenario. In most cases, there are likely solid defenses to these claims, including lack of standing, ripeness, the absence of any relationship between the plaintiff and the defendant, the agent's failure to disclose its involvement to the lender or otherwise document its authorization to act in that regard, and many others.
Stay tuned.
Richard E. Gottlieb and Brett J. Natarelli are partners at Manatt Phelps & Phillips LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] See Interim Final Rule, 13 C.F.R. Part 120.
[2] See No. SAG-20-0894, Dkt. No. 17 at 7 (D. Md. Apr. 13, 2020).
[3] Id. at 13-14.
[4] Id. at 14.
[5] See, e.g., No. 2:20-cv-03591, Dkt. 1 (C.D. Cal. Apr. 19, 2020) (asserting unlawful, unfair and deceptive business practices under California's Section 17200, and false advertisement under Section 17500).
[6] No. 20-cv-1089 (E.D. Mich. May 11, 2020)
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