Source: https://blog.hfk.law/author/admin/
Timestamp: 2020-07-06 00:06:09
Document Index: 509123778

Matched Legal Cases: ['§ 18', '§ 3114', '§ 18', '§ 18', '§ 3104', '§ 18']

admin – HFK Law Blog
Good-Faith Determinations under the CARES Act Paycheck Protection Program*
The CARES Act Paycheck Protection Program requires that small-business applicants for loans make a good-faith certification that the uncertainty of current economic conditions makes the loan request necessary to support ongoing operations.
How do applicants determine “necessity,” and how do they ensure they make that determination in “good faith”?
Where can applicants turn for guidance?
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act).[1] In section 1102 of the CARES Act, Congress established the Paycheck Protection Program (PPP), which provides for hundreds of billions of dollars’ worth of loans under section 7(a) of the Small Business Act (SBA)[2] to borrowers who consist of, among others, eligible small businesses.
In applying for an SBA section 7(a) loan under the PPP (a PPP loan), eligible applicants must, among other requirements, be able to make a good-faith certification that the uncertainty of current economic conditions makes the PPP loan request “necessary” to support the ongoing operations of that eligible applicant (a “necessity” certification). However, further complicating the analysis, section 1102(I) of the CARES Act suspends the ordinary requirement that an applicant for a section 7(a) loan be unable to obtain “credit elsewhere”, which is defined in section 3(h) of the SBA[3] to mean the availability to obtain credit from nonfederal sources on reasonable terms and conditions, taking into consideration the prevailing rates and terms in the community in or near where the borrower transacts business, for similar purposes and periods of time. Unlike a borrower for a traditional section 7(a) loan, under the CARES Act, an applicant for a PPP loan is not required to certify that it is unable to obtain credit elsewhere. Instead, PPP loan applicants must consider alternate sources of liquidity in connection with their PPP loan application to assess whether the current economic uncertainty makes its PPP loan request necessary to support its ongoing operations.
On April 23, 2020, the SBA issued then-updated FAQs[4] (SBA FAQs) addressing the “necessity” certification in the PPP loan application but failing to provide any specific standard or quantitative metrics for defining the applicant’s need for the PPP loan. The SBA FAQs, however, did illustrate that:
applicants must make a reasonable, good-faith determination of need
applicants must assess their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business
applicants who receive a PPP loan should maintain records supporting their determination of need and be ready to demonstrate to a federal regulator the basis for having made their certification
Fortunately, for smaller borrowers—for these purposes, these are borrowers that, together with their affiliates, receive or have received PPP loans in an original, aggregate principal amount of less than $2 million (a Micro-Borrower)—the SBA, in consultation with the U.S. Department of the Treasury, just amended the SBA FAQs to include a safe harbor for Micro-Borrower’s making the “necessity” certification.[5] Under the new safe harbor, Micro-Borrowers will be deemed to have made the “necessity” certification in good faith.
As a consequence of the new safe harbor, the focus on the “necessity” certification has shifted to borrowers who, together with their affiliates, receive or have received PPP loans in an original, aggregate principal amount of $2 million or more (Significant Borrowers); borrowers unable to rely on the safe harbor described above for Micro-Borrowers. Best exemplifying this risk, especially for the larger borrower, is the first official action taken by the Select Subcommittee on the Coronavirus Crisis (the Subcommittee), which is a special investigatory subcommittee established by the U.S. House of Representatives under the House Oversight Committee empowered to oversee that the funds for the PPP loans are used effectively and not subjected to fraud or waste.
On May 8, 2020, the Subcommittee delivered letters to five large, public corporations demanding that they immediately return the PPP loan proceeds that they have received, funds that Congress had intended for small businesses struggling to survive during the coronavirus crisis.[6] These letters were sent to public companies with market capitalization of more than $25 million and 600 employees; PPP loan applicants that sought and received “small business” loans of $10 million or more. The Subcommittee instructed each of these companies to respond by May 11th as to whether they would return their PPP loan funds; otherwise, the Subcommittee gave them until May 15th to produce all documents and communications (1) between that borrower and the SBA and the Department of the Treasury relating to its PPP loan, and (2) between that borrower and any financial institution relating to its PPP loan, including all applications for a PPP loan. Thus, in its first official action, the Subcommittee sent a clear signal of the real risk that a borrower unable to rely on the Micro-Borrower safe harbor incurs in making the “necessity” certification. Where the Subcommittee will eventually draw the line on sending out similar demands to Significant Borrowers is anyone’s guess. Time, as always, will provide that answer.
What are Significant Borrowers to do in the interim? Unfortunately, the good-faith certification as to the necessity for the PPP loan by the applicant still leaves unanswered questions such as: “How do you define good faith?” “How do you truly determine whether the PPP loan is necessary?” “What law or rule governs these definitions?”
Many commentators have spoken critically about these issues and the ambiguity of these terms. For example, in discussing the process of applying for a PPP loan, Don McGahn, former White House counsel from 2017–18 and now a partner at a large, private law firm, opined in the Wall Street Journal on April 27, 2020,[7] that:
To get a loan, a business must certify that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
A lax standard, to be sure. But is anyone really going to question that there is “current economic uncertainty”? And that such uncertainty makes a loan request “necessary” to support operations? There is no statutory requirement that a company would go under but for the loan, or that it must, with any degree of certainty, prove need in a detailed way. Hotels and restaurants were given additional statutory leeway: a per location size standard. Regardless of what the goal-post movers now claim they intended, the Cares Act says what it says, and its loose language was sold as a feature, not a bug.
Thus, Mr. McGahn makes the case that every qualified business applying for a PPP loan is capable of making this “necessity” certification in good faith.
However, in the Wall Street Journal the following day,[8] Paul S. Atkins, a former Commissioner with the Securities and Exchange Commission and now CEO of Patomak Global Partners, stirred the pot further by cautioning businesses about taking federal money:
But borrower beware! Businesses with flexibility should seriously consider to what extent accepting the terms of federal loans or other support may be a Faustian bargain. The ultimate cost may dramatically outweigh the temporary gain.
Through the congressional oversight commission established under the Cares Act, the new Special Inspector General for Pandemic Recovery, and numerous other freshly funded inspectors general, the groundwork is already laid for aggressive investigation and review of which businesses received—and how they spent—federal emergency funds.
Thus, back to the question: if a Delaware corporation is applying for a PPP loan, would Delaware General Corporation Law determine whether that entity (and its board of directors) had acted in “good faith” in making its “necessity” certification for a PPP loan? Is not every decision of the board of directors of a Delaware corporation required to be taken in good faith? Remember, section 102(b)(7) of the Delaware General Corporation Law expressly provides that directors cannot be shielded from liability for actions not taken in good faith or breaches of the duty of loyalty.
Moreover, the duty of good faith under Delaware law falls under the protection of the business judgment rule. In Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 360–61 (1993) (citations omitted), the Delaware Supreme Court stated that:
The [business judgment] rule operates as both a procedural guide for litigants and a substantive rule of law. As a rule of evidence, it creates a ‘presumption that in making a business decision, the directors of a corporation acted on an informed basis [i.e., with due care], in good faith and in the honest belief that the action taken was in the best interest of the company.’ The presumption initially attaches to a director-approved transaction within a board’s conferred or apparent authority in the absence of any evidence of ‘fraud, bad faith, or self-dealing in the usual sense of personal profit or betterment.
. . . To rebut the [business judgment] rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty—good faith, loyalty or due care.
If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.
Thus, an applicant for a PPP loan could argue that its good-faith determination was subject to the business judgment rule, which protects directors from second guessing if they can demonstrate that they have fulfilled their fiduciary duties: the duty of loyalty and duty of care. If the board of directors can demonstrate its members made a good faith determination, then the directors should be protected by the business judgment rule. After all, the business judgment rule dictates that courts defer to decisions taken by the board of directors if the directors acted in good faith and in what they reasonably believed to be in the best interest of the corporation after the exercise of due care. The duty of loyalty, which means that a director must act in good faith and free from any conflict of interest, should not be an issue with respect to a PPP loan. The second component of the director’s fiduciary duty is the duty of care, which requires, first, that directors inform themselves of all material information reasonably available to them prior to making a business decision on behalf of the corporation; and then, after becoming appropriately informed, the directors must act with requisite care in the discharge of their duties. Although the duty of care can be in play with respect to a PPP loan, it is not relevant for determining whether a PPP loan applicant’s “necessity” certification was done in good faith. If that were the case, then the new federal-level Special Inspector General for Pandemic Recovery would, for example, be obliged to look at how each of the states have interpreted the term “good faith,” applying principles of state law (corporation, limited liability company, or limited partnership law, as applicable), in order to determine whether an applicant from that state who applied for a PPP loan satisfied its obligation to make a “necessity” certification in good faith. You know that will not be the case.
The CARES Act is not governed by notions of corporate law because section 7(a) loans involve a federal statutory duty or obligation, which is outside the purview of the Delaware General Corporation Law. The CARES Act is federal law and unfortunately does not include definitions of “necessary,” “necessity,” or “good faith.” So, what are applicants for PPP loans of $2 million or more to do? A good first step is to determine whether there are any SBA rules and interpretations regarding section 7(a) loans that offer guidance in construing these terms.
One SBA publication does in fact shed light on the definition of “good faith”—publication SBA SOP 50 57 from the Office of Capital Access, Small Business Administration, dated March 1, 2013, titled “7(a) Loan Servicing and Liquidation.” Item 16 on page 12 of publication SBA SOP 50 57 provides the following definition of “good faith”:
Good Faith, whether capitalized or not, means the absence of any intention to seek an unfair advantage or to defraud another party; i.e., an honest and sincere intention to fulfill one’s obligations in the conduct or transaction concerned.
Thus, the SBA itself defines “good faith” to include “an honest and sincere intention” and an “absence of any intention to defraud . . . [or to] seek an unfair advantage.” These are helpful standards that businesses can utilize to reduce risks associated with any lack of good faith in applying for a PPP loan.
Also helpful to PPP loan applicants are a question and a comment buried inside a PPP loan guide prepared by the U.S. Senate Committee on Small Business and Entrepreneurship titled, “The Small Business Owner’s Guide to the CARES Act” (the SBA Guide. Taken together, they illustrate the purpose and intent of the CARES Act (italics added):
[Do you need c]apital to cover the cost of retaining employees?
The SBA Guide therefore makes clear that the primary aim of the PPP is to protect workers and help maintain their jobs; thus, applicants interested in protecting their workers and maintaining their payrolls should apply for a PPP loan, in good faith, especially during this unprecedented time.
Facts and circumstances are paramount. Each business applying for a PPP loan should carefully consider and reasonably document its determinations and considerations of issues such as:
whether it is subject to any risk of losing employees because of the economic uncertainty caused by the COVID-19 pandemic
whether the PPP loan may help the applicant maintain its payroll during this emergency
whether alternative sources of liquidity are available
the terms of any alternative source of liquidity, including repayment terms, if any
the likelihood and timing of closing on those alternative sources of liquidity
whether any additional preference overhang might be created by such alternative sources of liquidity
the dilutive effect upon existing owners of pursuing alternative sources of liquidity
So, rather than “borrower beware,” we say, “Significant Borrowers, don’t worry, just act in good faith and be sure to document your determinations!”
Mark Hobson is a partner in the San Francisco, CA, Jackson, WY, and Miami, FL offices of Halloran Farkas + Kittila LLP, where his practice includes domestic and international mergers and acquisitions, venture capital and private equity funds, corporate governance, private placements of securities, joint ventures, asset-based lending, technology transfer arrangements, cross-border deals, and various other business transactions. For more information on the firm, go to HFK.law.
[1] The full text of the CARES Act can be found at this link: https://www.govinfo.gov/content/pkg/BILLS-116hr748enr/pdf/BILLS-116hr748enr.pdf.
[2] Section 7(a) of the Small Business Act can be found at this link: https://www.sba.gov/sites/default/files/Small%20Business%20Act_0.pdf
[3] See https://www.sba.gov/sites/default/files/Small%20Business%20Act_0.pdf.
[4] full text of the updated the Paycheck Protection Program Loans – Frequently Asked Questions (FAQ) can be found at this link: https://www.sba.gov/sites/default/files/2020-05/Paycheck-Protection-Program-Frequently-Asked-Questions_05%2013%2020.pdf.
[5] See question 46 of the Paycheck Protection Program Loans – Frequently Asked Questions (FAQ), dated May 13, 2020.
[6] See https://oversight.house.gov/news/press-releases/in-first-official-action-house-coronavirus-panel-demands-that-large-public.
[7] Opinion piece in the Wall Street Journal, dated April 27, 2020, by Don McGahn, titled “The Cares Act Game Begins”, posted at this link: https://www.wsj.com/articles/the-cares-act-blame-game-begins-11588026158.
[8] Opinion piece in the Wall Street Journal, dated April 28, 2020, by Paul S. Atkins, titled “Borrower Beware: Cares Loans Carry a Steep Cost”, posted at this link: https://www.wsj.com/articles/borrower-beware-cares-loans-carry-a-steep-cost-11588113575.
Acting Manager of LLC Subject to Personal Jurisdiction in Delaware: Case Law Precedents “Not Persuasive”*
Managers of Delaware limited liability companies can be compelled to appear in Delaware courts if they are either formally named as managers under an LLC’s operating agreement (“formal managers”) or if they “participate[] materially in the management of the limited liability company” (“acting managers”). Under Section 18-109(a) of the Delaware LLC Act, serving as either a formal manager or an acting manager constitutes consent to service of process in a lawsuit and with it the exercise of personal jurisdiction by the Delaware courts. 6 Del. C. § 18-109(a).
LLCs can be either “member-managed,” where the vote of holders of a majority of the membership interests governs, or “manager-managed,” where the LLC agreement provides for a formal manager. In Metro Storage International LLC v. Harron, 2019 Del. Ch. LEXIS 272 (Del. Ch. July 19, 2019), the defendant, Harron, served as the acting manager of two Delaware LLCs. Although the LLCs were manager-managed, Harron was not the formal manager of either one. Based on the fact that Harron did manage the day-to-day operations of the two LLCs, Vice Chancellor J. Travis Laster of the Delaware Court of Chancery found that Harron participated materially in their management and thus satisfied the plain language of the statute.
Harron argued, however, that to be an acting manager under the statute, a person must occupy a “control or decision-making role” and that any time an LLC agreement vests authority in a formal manager, another person cannot have a control or decision-making role and the LLC therefore cannot also have an acting manager. He also argued that a person who participates in management of an LLC as an agent for another cannot be an acting manager. The Court rejected those arguments.
The “Control Overlay” Argument
The Court referred to the first argument as the “control overlay” argument based on cases in which Delaware courts “added a layer to the material-participation test by holding that persons are not amenable to service as acting managers unless they occupy a ‘control or decision-making role.’” In the first such case, Florida R & D Fund Investors, LLC v. Florida BOCA/Deerfield R & D Investors, LLC, 2013 Del. Ch. LEXIS 216 (Del. Ch. Aug. 30, 2013), the Court of Chancery “mentioned the phrase ‘control or decision-making role’ once, in passing, without citing authority to support the formulation, and without providing any reason for departing from the statutory material-participation test.” The Court in Metro Storage found that “Later decisions have followed its language without testing the foundation’s footings.”
In the second case, Wakley Ltd. v. Ensotran, LLC, 2014 U.S. Dist. LEXIS 34918 (D. Del. Mar. 18, 2014), the United States District Court for the District of Delaware, following Florida R & D, “made the control overlay more onerous by interpreting a ‘control or decision-making role’ as requiring that the person named as a defendant be ‘effectively running [the entity’s] entire business.’” The District Court “elevated the control overlay from a passing phrase to an operative test, while further elevating the necessary level of involvement to require ‘effectively running [the LLC’s] entire business.’”
The Court in Metro Storage found that a more recent opinion of the Delaware Supreme Court, Hazout v. Tsang Mun Ting, 134 A.3d 274 (Del. 2016), “requires abandoning” the control overlay. Hazout addressed the analogous consent-to-service statute for directors and officers of Delaware corporations, 10 Del. C. § 3114. That statute provides for personal jurisdiction in two kinds of cases: (i) “all civil actions or proceedings brought in this State, by or on behalf of, or against such corporation, in which such officer is a necessary or proper party,” and (ii) “any action or proceeding against such officer for violation of a duty in such capacity.”
But in Hana Ranch, Inc. v. Lent, 424 A.2d 28 (Del. Ch. 1980), the Court of Chancery held that Section 3114 applied only to “claims asserting that the defendant had breached duties owed to the corporation or its stockholders,” abrogating the “necessary or proper party” portion of the statute. Hana Ranch was followed for 36 years, until the Delaware Supreme Court rejected it in Hazout, finding “it is our obligation to give effect to the plain language of statutes to the extent we can do so without offending any supervening constitutional limits.” The Delaware Supreme Court thus restored the Delaware courts’ full range of personal jurisdiction over corporate officers and directors in keeping with the plain language of the statute.
In Metro Storage, the Court of Chancery found that the same reasoning should apply to the consent statute for managers of LLCs; the control overlay violates the plain language of 6 Del. C. § 18-109(a), which provides for jurisdiction over persons who participate materially in the management of a Delaware LLC—the statute is not limited by its terms to persons in a control or decision-making role.
The “Formal Manager Designation” Argument
Next, Harron argued “that a defendant cannot serve as an acting manager if the operative LLC agreement contains a formal manager designation.” In Fisk Ventures, LLC v. Segal, 2008 Del. Ch. LEXIS 158 (Del. Ch. May 7, 2008), the defendant, Fisk Johnson, was a major investor who had the right to appoint two members to the LLC’s “Board of Member Representatives.” The plaintiff, Segal, argued that Johnson was an acting manager because he “(i) controlled his board appointees and (ii) participated in the management of [the LLC] through broad veto rights.” The Court of Chancery in Fisk Ventures rejected the first part of the argument, finding that Johnson did not materially participate in management.
The Court in Fisk Ventures also rejected the second part of the argument. The company’s LLC agreement provided that the members of the LLC “shall conduct, direct and exercise full control over all activities of the company through their representatives of the board.” The Court concluded that “the designation of the board as the formal manager precluded Johnson from qualifying as an acting manager.” The Court in Metro Storage found that, because the material participation test was not met in Fisk Ventures, “[t]he reference to the formal manager designation in the… LLC agreement did not add anything to the analysis.”
In support of the formal manager designation argument, Harron cited three cases, Wakley Ltd. v. Ensotran, LLC, 2014 U.S. Dist. LEXIS 34918 (D. Del. Mar. 18, 2014) (discussed above), In re Dissolution of Arctic Ease, 2016 Del. Ch. LEXIS 185 (Del. Ch. Dec. 9, 2016), and CelestialRX Investments, LLC v. Krivulka, 2019 Del. Ch. LEXIS 102 (Del. Ch. Mar. 27, 2019). The Court found that those cases were “not persuasive precedents.” In Wakley, the District Court found that although a defendant had “broad authority,” “her power was ‘subject to the decisions and instructions of the board.” The Court concluded that the defendant “is not a ‘manager’ under § 18-109(a)(ii) because she did not participate materially in the management of [the LLC].” The Court in Metro Storage found that “This brief reference does not appear to have played a meaningful role in the court’s analysis.”
In Arctic Ease, the LLC’s managing member argued that the Court of Chancery had personal jurisdiction over an investor because the investor participated materially in management. The Court found that because the LLC had a managing member who was empowered by the LLC agreement to manage the company, the investor “could not have served in the type of ‘control or decision-making role’ necessary to satisfy the control overlay.”
Similarly, in CelestialRX, the Court of Chancery found that a former board member “could not have participated materially in management because he no longer occupied a control or decision-making role.”
The Court in Metro Storage found that in all three cases the factual allegations did not support jurisdiction under the plain-language test, and that they all “reached outcomes for which the formal manager designation was unnecessary.” The Court also found that the formal manager designation argument derived from the control overlay argument that it had already rejected and that it originated from a misreading of case law. The Court concluded “Because LLCs have flexible governance structures and often operate with a relatively high degree of informality, the broader formulation enables Delaware courts to exercise personal jurisdiction over key individuals who take action on behalf of the entity.”
The “Agency Shield” Argument
Harron’s third and final argument was that “if a person participates materially in the management of an LLC while acting as an agent, then the person’s actions as agent cannot support a finding of material participation because the agent is acting on behalf of his principal.” In Wakley, the Court stated that the plaintiff failed to convince the Court that the defendants “were not acting at the direction of, and as representatives for” the investor who appointed them. The Court in Metro Storage rejected this “agency shield” argument, finding that it was a version of the “fiduciary shield” doctrine, “which holds that when an officer or other agent for an entity engages in acts within a jurisdiction in an official capacity, the agent is not subject to jurisdiction based on official acts, but only for acts committed in a personal capacity.”
The Court found that “Scholars have thoroughly critiqued the fiduciary shield and argued for its rejection,” that it conflicts with the Delaware long-arm statute, 10 Del. C. § 3104(c)(1), which authorizes service of process on a person who engages in forum-directed activity “in person or through an agent,” and the common-law agency theory of jurisdiction, which allows the exercise of jurisdiction over a non-resident principal by attributing the jurisdictional contacts of the agent to the principal.
The Court thus rejected the agency shield argument, and concluded that Section 18-109(a)(ii) can be used to serve a person with process “even if the person acted as an agent of the LLC or its formal manager.”
By rejecting Harron’s arguments and hewing to the plain language of the LLC Act, the Court of Chancery confirmed the full range of jurisdiction of Delaware courts over acting managers of Delaware LLCs in keeping with the statute. Acting managers of Delaware LLCs and their counsel should be aware that any person who participates materially in the management of a Delaware LLC can be haled into a Delaware court in any case “involving or relating to the business of the limited liability company or a violation by the manager . . . of a duty to the limited liability company or any member of the limited liability company….” 6 Del. C. § 18-109(a).
* This blog post is a reprint of an article to be published in the August 2019 edition of the newsletter of the ABA Business Section’s Middle Market and Small Business Committee.