Litigation Client Alert – Litigation/PPP Enforcement Risks Pending | Kaufman & Canoles

It took a while, but the onset of litigation against the financial institutions, which provided the Paycheck Protection Program (PPP) loans, began. Government/regulatory investigations will follow. Is your business ready?

Small banks and non-bank lenders account for a large percentage of PPP loans disbursed and total net lending. Some 4,105 relatively small banks and credit unions, each with assets of less than $1 billion, have issued and approved a total of 1,812,102 PPP loans for more than $101.5 billion.

The risks are numerous, including liability claims by lenders under state law, potential exposure to the False Claims Act (FCA), risks of anti-money laundering violations money (AML), the Bank Secrecy Act (BSA), whistleblowers, and investigations by the DOJ or other government agencies. , to name a few. What should financial service providers do about their exposure to PPPs?

The CARES Act is (so far) not a full shield

In March 2020, Congress passed the CARES (Coronavirus Aid, Relief, and Economic Security) Act to provide emergency financial support to millions of Americans suffering from the economic effects caused by the COVID-19 pandemic. The Paycheck Protection Program was a nearly $1 trillion business loan bailout administered by the U.S. Small Business Administration (SBA), and it allowed entities to apply for low-cost private loans. interest rate to pay their payroll and certain other costs. These loans have been promoted as being subject to full forgiveness if they are SBA compliant. If canceled, PPP loans are repaid by the government. If not forgiven, the loans must be repaid to the lenders.

PPP regulations allowed lenders to rely on “borrower’s documents and certificates”.[s].” This concession encouraged lenders to start approving PPP loans and processing them quickly. However, the SBA regulations also required lenders to conduct a “good faith review” of PPP loan applications and did not relieve them of their obligations under other laws, such as the BSA.

SBA rules provide that lenders are to be “held harmless” if borrowers fail to meet PPP program criteria and will not be subject to any enforcement action or sanction related to the granting of the PPP program. loan or cancellation of the PPP loan if the lender (1) “acts in good faith with respect to making or canceling the PPP loan” and (2) “satisfies all other federal, state, local and other requirements applicable legal or regulatory requirements”.

So, lenders have received partial immunity under the CARES Act, but how far that extends remains to be seen. The CARES Act did not establish a private right of action against banks. Profiles Inc. v. Bank of America Corp.., No. 1:20-cv-00894, ECF No. 17 (D. Md., filed April 13, 2020). This case is currently on appeal. Taking an alternative legal route, class action plaintiffs have now turned to state law claim theories to sue lenders – such as negligence, fraud, breach of contract, and unfair acts or practices or misleading (UDAP).

The Cabbage Dispute in the NDGA

That lawsuit, filed in late March 2022, alleges that Kabbage failed to properly handle borrowers’ PPP loan forgiveness requests. See Carr v. Kabbage, Inc., Case No. 1:22-cv-01249 (ND Ga.). Apparently, Kabbage did not process the requests within the time required by federal regulations that required customers to sign modified forms and required customers to provide unnecessary documents. The lawsuit argues that Kabbage should have participated in the SBA’s loan cancellation portal, and it alleges that Kabbage improperly attempted to collect loans that should have been cancelled.

The lawsuit seeks to certify a nationwide class of Kabbage borrowers. In damages, he is seeking to restore Kabbage for all of his PPP loan origination fees. Kabbage filed a motion to dismiss, which was advised, but no decision was rendered.

PNC litigation in NDIL

US Cargo Direct, Inc. v. PNC Bank, NA, Case 1:22-cv-03925 (ND. Ill. July 28, 2022). This case was filed in the Northern District of Illinois on July 28, 2022. A trucking and logistics company that used self-employed truck drivers received a PPP loan from PNC on April 14, 2020, in the amount of $1,524,000 and used the proceeds to pay its contractors. PNC had approached US Cargo in March 2020, to apply for a PPP loan since it was an existing bank customer and a known entity. The bank told US Cargo that it would confirm the eligible amount of the PPP loan and the bank had US Cargo’s tax returns and Forms 1099. The bank had approved the PPP loan within 24 hours of submission.

When US Cargo applied to PNC’s remission portal on July 28, 2021, PNC first notified US Cargo that only $53,017 of the PPP loan was eligible for remission and requested payment of the balance of 1 $470,983. Apparently, the PNC’s loan application procedures for PPP loans as of April 14, 2020 had not been updated to reflect the SBA’s interim final rule dated April 6, 2020, which stated that payments that PPP loan recipients could make to independent contractors would not be considered payments to employees and therefore would not be eligible for the forgiveness.

PNC was sued for five claims: (1) breach of contract; (2) unjust enrichment; (3) breach of fiduciary duty; (4) negligent misrepresentation; and (5) promissory estoppel. The case is pending and no response has yet been filed.

BOA Litigation in Maryland

On August 23, 2022, Bank of America (BOA) was sued by a putative nationwide class of PPP borrowers under North Carolina law — since that’s where BOA is headquartered and choice of the law in all BOA promissory notes signed by PPP clients.

Apparently the bank made many loans that wrongly included 1099 worker wages as part of the formula and then discovered the errors [and the BOA legal department wrote a memo detailing that the bank had to deny submissions of forgiveness requests to the SBA or else face False Claims Act liabilities]. Rather than directing borrowers to the SBA Forgiveness Portal, the bank controlled its own portal and flatly refused to allow borrowers to even apply for forgiveness if their submissions/loans included 1099 workers or used loan proceeds to pay 1099 workers. The result was a large amount of unforgiven loans.

1099 workers are usually independent contractors hired by companies when repairers are needed. 1099 workers are not included in the company’s payroll. The complaint says the expenses of these workers could not be used to calculate a company’s loan eligibility under the PPP, but the BOA did so anyway. The specific allegation is that “BOA asked small business owners to include this salary in their loan applications to calculate their maximum loan eligibility and then included these 1099 worker expenses when obtaining loans for these amounts.” The complaint further states “To their surprise, the plaintiffs and class members found themselves responsible for repaying the portions of their loans that they used to pay their 1099 workers. the payments to 1099 workers were not eligible for plaintiffs and that the group would not have applied for and taken out a loan, reduced the amount of the loan they applied for, and/or allocated their loan funds differently. The plaintiffs cite that BOA was the second largest PPP lender and earned fees on those loans of more than $345 million.

The case is pending and no response has yet been filed. Modern Perfection LLC et al. against Bank of America NAfile number 1:22-cv-02103in the USA District Court for the District of Maryland.

Analytical imperatives

Lender negligence includes conduct that fails to meet the standard of due care with respect to an obligation owed to the prospective borrower, which causes immediate harm. This may include failure to process a loan application with reasonable care. See, First Federal Savings & Loan Ass’n v. Caudle, 425 So. 2d 1050 (Alabama 1982). What is reasonable caution in the context of the torrent of loan applications processed in the first few weeks of a PPP loan? This is the question which must be examined by the courts.

The 1099-worker-ineligibility for loan application amounts [or for the use of proceeds] is a vulnerable area for lenders of all types and sizes. The issues are many:

  1. How many mistakes were made with these 1099 inclusions?
  2. Were the errors detected by the lender, and if so, when, in what amounts and how?
  3. Have lenders ever denied forgiveness to PPP borrowers based on 1099 defaults in the process?
  4. Did some 1099 infractions slip through and get forgiveness and the lender was aware of the error?
  5. Have whistleblowers raised the issue with the lenders – claiming the lender knowingly processed PPP loan forgiveness applications for businesses with 1099 smears included, and could the FCA be held liable by the lender?
  6. Did the lender engage in an analysis of the PPP loan portfolio to look for errors in the processing of 1099 workers?
  7. Has the lender suspended all document destruction policies and practices for the 10-year period applicable to FCA cases?
  8. Has the lender consulted and considered all available information, particularly where a review has revealed inconsistencies. For example, when a PPP loan was issued to an existing bank customer, would the tax returns show 1099 workers? Was this information inconsistent with the borrower documentation provided on the PPP loan application?

Fortunately for lenders, the government has a heavy burden to prove FCA violations. Liability under the FCA requires proof of some level of knowledge of the fraud. The United States Supreme Court has ruled that this scientific requirement must be strictly enforced. Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S.Ct. 1989 (2016).

But, the government is investigating, and it has a long time to look back for any culpability. If a lender’s response to government inquiries suggests compliance deficiencies, or if the documentation provided suggests that the lender did not act in good faith in making the loan, or in cancellation of the PPP loan, the government may open a broader investigation into the conduct of the lender.

Given the increase in litigation and/or enforcement that PPP lenders are likely to face in the months and years to come, lenders would be well advised to take proactive steps to ensure that their portfolios of PPP loans were reviewed for compliance.


Federal banking agencies
CFPB Guide to Adverse Action Notices for PPPs
OCC Guidelines on PPP Loan Documentation
Federal Reserve PPP Liquidity Facility

PPP rules and guidelines

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