Month: May 2020

Joint Check Agreement Causes Big Trouble in Virginia

Many general contractors manage the risk of a subcontractor’s financial instability by issuing joint checks to the subcontractor and its suppliers on a project. These arrangements are usually governed by a separate agreement that sets forth the roles and rights of the parties, and limits the general contractor’s liability to sub-subcontractors and suppliers with whom the general contractor does not have a contract. A recent decision by the Virginia Supreme Court now calls into question this common practice. As a result, contractors need to review and modify their joint check agreements and procedures regarding communications with lower tier entities to limit the risk of effectively paying twice.

In the case of James G. Davis Construction Corp. v. FTJ, Inc., 2020 Va. LEXIS 42 (Va., May 14, 2020), Davis was a general contractor for a condominium project and subcontracted the drywall work to H&2 Drywall Contractors. H&2 purchased its drywall materials from FTJ, Inc. and entered into a joint check agreement with H&2 and Davis that contained terms similar to many joint check agreements that contractors use, including:

      • That any checks for materials would be made payable jointly to H&2 and FTJ;
      • That Davis will only make payments to the extent Davis actually owes money to H&2 on the project;
      • That the sole purpose of the agreement was to assist H&2 in making payment to FTJ; and
      • That nothing in the agreement creates any contractual relationship or equitable obligation between FTJ and Davis.

Predictably, H&2 ran into financial difficulties and was unable to complete its work on the project. Davis informed FTJ to stop shipping materials and then terminated H&2. Davis advised FTJ that its past due invoices were being processed, but Davis later refused to pay FTJ once Davis determined it had incurred costs beyond the remaining subcontract value to complete H&2’s scope of work. Davis relied on the language in its joint check agreement that it was not liable to FTJ because it did not owe H&2 anything further on the project.

The Virginia Supreme Court affirmed the trial court’s determination that Davis was liable to FTJ not by contract, but by the equitable theory of unjust enrichment. Even though the costs of completing the subcontract work exceeded its value, the court found that Davis had not paid for all of the drywall and was unjustly enriched by using it for the project. Prior to this case, courts in Virginia were not receptive to such claims and generally, the only relief available was through the express agreement between the parties (breach of contract), or enforcement of a validly filed mechanic’s lien or payment bond claim. This upsets the common assumption that a party is only liable for economic loss to those with whom it contracts.

Contractors commonly seek continued performance from suppliers when a subcontractor faces trouble to keep a project on track. This has now become a more complicated and risky process. Contractors should consult with a Vandeventer Black attorney now to revisit the terms of any joint check agreements and alter their processes for dealing with vendors with whom they do not have a contract. 

If you have questions about this article or need assistance with reviewing your contracts and subcontracts, please contact Jim or one of the other attorneys at the Construction and Government Contracts Practice Group.

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Payments Due Subcontractors and Suppliers in Virginia

Virginia’s law on the payment of subcontractors and suppliers just got some muscles. For years, Virginia had a statute that made it a crime for any contractor or subcontractor “with the intent to defraud” to retain or use funds for any purpose other than to pay persons performing labor or furnishing material on a project. This was a rarely known or used statute as Commonwealth Attorneys across the state had little time, knowledge or motivation to dig into the financing of a construction project to see if funds were properly used.  But because the Virginia Supreme Court ruled that the statute was criminal in nature, and Virginia does not treat construction funds as a trust for those performing the work or providing materials no private right of action existed to enforce the prohibition on using construction funds for purposes other than paying for the labor, equipment and materials benefiting the property.

However, effective July 1, 2020, Virginia code §43-13 is strengthened to now provide a private cause of action “for a party in contract” with the general contractor or subcontractor as appropriate for the moneys owed. Simply, the use of funds before paying all amounts due for labor and material creates the presumption of “intent to defraud.”  Subcontractors and suppliers now have a new arrow in their quiver to claim the contractor acted with an intent to defraud by using funds without payment the amount the subcontractor believes is due it on a project.

Additional changes to Virginia Code §43-13 will require almost every general contractor to modify their form subcontracts. Any provision in a contract or subcontract that permits the general contractor to offset or withhold funds due under one contract for alleged claims or damages due on another contract is now void as against public policy. The right of offset is a common tool used by contractors and specifically permitted on contracts that deal with the sale of goods. If a subcontractor is not performing on a project, then the general contractor now has less tools to enforce performance requirements.

Consult with the attorneys at Vandeventer Black LLP to develop your strategy to deal with the realities of Virginia’s new subcontracting laws. Modify your subcontracts and develop the processes you need to protect your business and keep it successful in these changing times.

Written by James R. Harvey, a partner a partner in Vandeventer Black’s Construction and Public Contracts Law Group.  If you have questions about this article or need assistance with reviewing your contracts and subcontracts, please contact Jim or one of the other attorneys at the Construction and Government Contracts Practice Group.

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Construction and Virginia’s New Wage Laws

Of the record number of new laws in Virginia, a trio of wage laws will arguably have the biggest impact on contractors changing the way the construction companies operate in Virginia. Virginia statutes on non-payment of wages, worker misclassification and wage theft all create new administrative penalties and private rights of actions that combine to create new risks to every contractor or supplier on a project. Contractors need to modify their subcontracts, purchase orders, lien release certifications, and subcontracting plans to protect against the increased liability they now face.

First, Virginia’s Wage Theft Law was significantly strengthened to provide both criminal and administrative penalties as well as new civil cause of action. Virginia Code §40.1-29 now provides that an employer who “willfully and with the intent to defraud” fails or refuses to pay wages is guilty of a misdemeanor if the amount is less than $10,000 and a felony if more than that amount. It also provides that the Commission of Labor and Industry may assess a civil penalty of $1,000 for each violation, considering the size of the business and gravity of the violation, plus attorney’s fees of 1/3 the amount of the award. Finally, a new civil action exists for individually, jointly or on behalf similarly situated employees that can result in an award of wages, plus 8% interest, plus attorney’s fees and costs. If the employer is found to have “knowingly” failed to pay, then the assessed damages are triple the wages due. No specific intent to defraud the employee is necessary to prove this “knowingly” element, instead, actual knowledge, acts in deliberate ignorance of the truth or falsity of information, or acts in reckless disregard to the truth or falsity of the information satisfy this requirement. This statute alone is likely to cause significant litigation across the state as it incentivizes legal actions on behalf of “similarly situated employees” against employers with the promise of an award of attorney’s fees.

Second, a series of new laws make clear that worker misclassification will be a new priority in Virginia. A presumption now exists that workers should be classified as employees unless an employer can demonstrate the worker is an independent contractor pursuant to IRS guidelines. Violations of worker misclassification laws result in debarment from public contracting in Virginia, a private cause of action to the worker, and can include attorney’s fees that can include a wage claim under §40.1-29 discussed above.  The worker is entitled to the benefits the employer provides its employees, which includes worker’s compensation insurance coverage, medical coverage or retirement benefits. The employer is prohibited from taking retaliatory action against the worker or anyone reporting the relationship.

Third, Virginia Code §11-4.6 now provides that for any construction contract entered after July 1, 2020, the general contractor and each subcontractor at any tier are “jointly and severally liable to pay any subcontractor’s employees” all wages due. The general contractor is now deemed to be the employer of all the subcontractors’ employees at all tiers on the project, and subject to all penalties, criminal and civil of an employer that fails to pay wages due. This is a dramatic departure from centuries of Virginia law that generally limited a company’s exposure to those with whom it directly employed and contracted.

The combination of these three laws can be devastating: if a drywall sub-subcontractor on a project hires 50 misclassified temporary or independent contractor workers to hang sheetrock on a project then the sub-subcontractor, subcontractor and general contractor may each be liable as the employer of all 50 for their wages, plus interest at 8% and attorney’s fees. It is not a stretch for a worker to then claim that the general contractor was on-site and knew or should have known the situation and acted in deliberate ignorance or reckless disregard of the truth and, therefore, should be liable for treble damages. Plus, each contractor could be liable for $50,000 in fines to the Department of Labor and Industry, and each faces the possibility of criminal charges.  

What can a contractor do to guard against these dire consequences? No answer is perfect nor fit every circumstance, but contractors should consider the following actions

    1. Revise your subcontract indemnity provisions to attempt to shift the risk of wage non-payment to the entity responsible for the hiring. This is of limited value if the subcontractor has little assets to satisfy an indemnity obligation;
    2. Require payment and performance bonds of subcontractors. Bonds can be useful protection, but many subcontractors cannot meet surety financial strength requirements and they increase the cost of the project;
    3. Adopt and enforce subcontract requirements that limit the ability to sub-subcontract work without the approval of the general contractor, and then vet the ability of those contractors to pay wages that may become due. Such provisions are too often ignored and can increase the burden on the general contractor to vet the capacity of remote sub-subcontractors to pay their employees;
    4. Require the use of certified payrolls by every contractor providing labor on the project. This will likely be a requirement of every public project with the Commonwealth starting in May 2021, as well as localities opting to apply Virginia’s new prevailing wage law. Certified payrolls, required on projects using federal funds, identify the persons, hours and amount paid every individual working on a project during a pay period and is signed under penalty of perjury.  It makes sense for general contractors to institute procedures now on all projects to require monthly data, certified under oath, on the hours worked and amount paid for every worker on the project to track the payment of labor on the project each month, protect against enhanced treble liability for an alleged reckless disregard of the truth on a project, and prepare for the widespread use of certified payrolls beginning in 2021. While not perfect, they at least allow a contractor to track who should have been paid on a project and, if reviewed monthly for accuracy, guard against huge problems arising late in the project of allegations of months of unpaid labor;
    5. Modify the standard lien release language to specifically address the liabilities associated with wage claims and worker misclassification claims;
    6. Strengthen the certifications in lien releases to even impose personal liability for false statements made in these submissions. This is generally difficult to achieve as Virginia courts are not receptive to any attempt to turn a contract requirement into an action for fraud;
    7. Contractors could require proof of payment of employees and the ability to audit or sample employment and payment records of subcontractors working on a project to verify compliance; and
    8. Contractors can increase the use of joint check or the use of alternate security during the project. Public projects limit the retainage that a general contractor can hold to 5% of the subcontract value, but no limit exists on the requirement of alternate security such as a line of credit or other collateral.

These changes will dramatically increase the administrative burden on general and subcontractors managing lower tier workers. Logically, this added administrative cost could result in lower margins for contractors or higher prices for construction work in Virginia. The alternative, however, is an unacceptable amount of risk for any business that could be subject to unending lawsuits, administrative assessments and even criminal penalties.

Consult with the attorneys at Vandeventer Black LLP to develop your strategy to deal with the realities of Virginia’s new wage laws. Modify your subcontracts and develop the processes you need to protect your business and keep it successful in these changing times.

Written by James R. Harvey, a partner a partner in Vandeventer Black’s Construction and Public Contracts Law Group.  If you have questions about this article or need assistance with reviewing your contracts and subcontracts, please contact Jim or one of the other attorneys at the Construction and Government Contracts Practice Group.

CDC Issues Additional Guidance for Businesses on Reopening

Following the nationwide rush to reopen, the Centers for Disease Control (CDC) has issued decision trees for businesses to follow in deciding when to reopen and a brochure with detailed guidance for reducing the risk of infection in the workplace. Much of the information in these new CDC publications is similar to what the CDC has been advising for weeks—encourage proper hygiene, require social distancing, clean touch surfaces, and send home sick workers—but the decision trees and brochure tailor the guidance to specific industries and offers more details and examples for employers looking to reopen.

The CDC released the six decision-tree guides on May 14. These decision trees direct businesses to evaluate state and local orders, health and safety plans, and to provide ongoing monitoring before reopening. There are separate decision trees for schools, child care providers, camps, restaurants and bars, mass transit, and a more general decision tree for other workplaces.

A few days later, the CDC followed up with a 60-page brochure, Activities and Initiatives Supporting the COVID-19 Response and the President’s Plan for Opening America Up Again, addressing contact tracing, surveillance, and infection control and providing guidance and criteria for government officials in implementing a phased reopening. Appendix F is geared toward businesses, offering “a menu of safety measures, from which establishments may choose those that make sense for them in the context of their operations and local community” and government directives. Like the decision trees, Appendix F includes specific guidance for child care providers, schools, camps, mass transit, and restaurants and bars. It also includes guidance for employers with “workers at high risk,”i.e., those over age 65 or with underlying medical conditions. The CDC encourages workers at high risk to self-identify and employers to avoid unnecessary medical inquiries. When a worker does self-identify, the CDC advises that employers “take particular care to reduce [their] risk of exposure” while complying with the Americans with Disabilities Act (ADA) and the Age Discrimination in Employment Act (ADEA).

These competing obligations can be difficult for businesses to balance. If your business needs assistance in understanding worker protections and ADA and ADEA compliance or other issues in reopening, Vandeventer Black LLP’s labor and employment law team is available to assist.


Virginia Enacts New Whistleblower Law for Private Employers

Effective July 1, 2020, private employers in Virginia will have a number of new legal obligations and potential liabilities. One of these new laws is Virginia Code § 40.1-27.3, the Fraud and Abuse Whistleblower Protection Act. This new law creates several new protections for employees involved in reporting suspicious, questionable, or unlawful employer activity. The law specifically prohibits retaliation by the employer against whistleblower employees.  Retaliation includes discharging, disciplining, threatening, discriminating against, penalizing, or otherwise taking adverse action against the employee. Under the new law, employers may not retaliate against any employees who:

  • report in good faith any suspected violations of federal or state law to supervisors, governmental bodies, or law enforcement officials;
  • refuse to engage in a criminal act that would subject the employee to criminal liability;
  • refuse to follow an employer’s order if that action would violate any federal or state law, and the employee informs the employer that he or she is refusing to comply for that reason;
  • are requested by a governmental body or law-enforcement official to participate in a government investigation, hearing, or inquiry; or
  • provide information to or testify before any governmental body or law-enforcement official conducting an investigation, hearing, or inquiry into any alleged violation by the employer of federal or state law or regulation.

This language is very broad and creates potential pitfalls for employers.  However, it is noteworthy that the new law includes three specific exceptions.  The law does not protect employees from retaliation for taking any of the following actions: (1) disclosing employer data that is protected by law or any legal privilege; (2) knowingly making statements or disclosures that are false or are made in reckless disregard for the truth; or (3) making disclosures that would violate federal or state law or diminish or impair the rights of any person to the confidentiality protections provided by the common law.

An employee alleging a violation of this new Fraud and Abuse Whistleblower Protection Act has an immediate right to file suit in court. The suit must be brought within one year. Notably, in contrast to federal anti-retaliation laws, the employee is not obligated to exhaust administrative remedies. Among the various types of relief available to the employee are lost wages, lost benefits, and other remuneration with interest.  Courts may also award the employee injunctive relief or reinstatement to a prior or equivalent position, and even reasonable attorney’s fees. The statute does not expressly authorize punitive damages.  

Based on the sheer breadth of this new whistleblower law, employers should anticipate an increased need for internal investigations of employee complaints, as well as greater scrutiny of any decisions affecting employees that might be perceived as retaliatory. The Vandeventer Black Labor & Employment team is available to assist employers in navigating these unprecedented changes to Virginia’s legal landscape.

U.S. Department of Labor Expands Overtime Exemption for Commission-Based Employees of Retail or Service Establishments

On May 18, 2020, the Wage and Hour Division of the U.S. Department of Labor (DOL) announced a new final rule to govern the determination of whether an employer qualifies as a “retail or service” establishment for purposes of applying an overtime exemption to commission-based employees.

Section 7(i) of the Fair Labor Standards Act (“FLSA”) provides an overtime exemption specifically for certain employees paid commissions by retail establishment employers.  To qualify for the overtime exemption, (1) the employee must be employed by a “retail or service” establishment; (2)  he or she must earn a wage of at least one and one-half times the minimum wage (currently $7.25)”;[1] and (3) for a representative period, more than half the employee’s compensation must be comprised of commissions.

The new rule eliminates two partial lists of establishments that the DOL categorized as either completely lacking any “retail concept” or as potentially or presumptively possessing some “retail concept.” The DOL issued these two lists in 1961 as part of informal guidance from the agency for interpreting and applying the Section 7(i) overtime exemption. For the past fifty-plus years, these two lists served to categorically deny the exemption to several businesses while creating confusing litigation scenarios for the courts.  The decision to withdraw these lists opens the door for several employers to assert that they have a retail concept and qualify for overtime exemptions for their commission-based employees, assuming these employers meet the definition of retail concept and the other exemption criteria.

Among the many employers who may now attempt to qualify for the Section 7(i) exemption under the new final rule are banks, employment agencies, laundries, plumbing companies, roofing companies, security dealers, travel agencies, and tax preparers. Going forward, all employers seeking to take advantage of the Section 7(i) exemption will be subject to the same legal test of whether they have a retail concept and qualify as a retail or service establishment.

The new final rule became effective immediately upon the DOL’s announcement.  If you are curious as to whether certain commission-based employees in your organization may qualify for this overtime exemption, contact the Vandeventer Black Labor & Employment team to discuss the matter.


[1] Virginia’s minimum wage will increase to $9.50/hour on May 1, 2021.  For more information on this and several other coming employment law changes in Virginia, review our article.

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Virginia’s Mechanic’s Lien Plus Statute: Making those in higher tiers personally liable separate from and regardless of mechanic’s lien rights

Within Virginia’s mechanic’s lien article is a little known, and little used, mechanism providing for personal liability of higher tiers separate from that article’s mechanic’s lien rights. The title is “How owner or general contractor made personally liable to subcontractor, laborer or materialman.” It is actually a very simple process; and all it takes is two steps to effectuate.

Step One: If you have furnished labor or material to a general contractor or a subcontractor (per the Article, “subcontractor” includes all contractors, laborers, mechanics, and persons furnishing materials, who do not contract with the owner but with the general contractor) you, first, need to send a “preliminary notice” in writing to the owner or his agent or the general contractor, that “states the nature and character of [your] contract and the probable amount of [your] claim.” That is it. The statute provides no other details as to when the notice is required or other specifics about the notice. Although the presumed intention is that this “preliminary notice” is required before labor or materials are furnished, the statute does not expressly include such a requirement.

Step Two: Additionally, “after the work is done or material furnished” but “before the expiration of thirty days from the time the subject building or structure is completed or the work thereon otherwise terminated,” you then are required to provide a “second notice” that states:

    1. a correct account, verified by affidavit, of your actual claim against the general contractor or subcontract, for work done or materials furnished;
    2. the actual claim against the general contractor or subcontractor for your work done or materials furnished; and
    3. the amount due.

Both notices must be either: a) served using Virginia’s service of process methods; or b) mailed by registered or certified mail and received by the owner or general contractor upon whom personal liability is sought to be imposed; with a return receipt showing delivery being “prima facie” (legal speak for being accepted as correct until proven otherwise) of receipt. While any “bona fide agreement” for deductions for failure or refusal of the general contractor to comply with his contract shall be binding on the claimant seeking personal liability, that is an affirmative defense to the 43-11 notice and must be proven by the owner.

Like mechanic’s lien defenses, more generally, however, the lower tier claim at the time of the second notice cannot exceed the amount for which the next higher tier is liable to the tier above. In other words, if no further payment is due to the general contractor from the owner, that effectively “cuts off” the owner’s liability to the claimant; and, similarly, if no further payment is due to the first tier subcontractor from the general contractor, that cuts off the liability to the subcontractor’s lower tier supplier or laborer. So, while not quite the equivalent of a “notice of claim of lien against funds” as some jurisdictions provide (like North Carolina) because of such defenses; the Virginia Code § 43-11 notice statute provides both practical, and legal, basis for lower tier laborer and supplier claims against owners and general contractors – – separate from Virginia’s mechanic’s lien processes.

For more information about this or other construction law matters, please contact the author or any of the other attorneys with the Vandeventer Black Construction and Government Contracts Practice Group.

Additional guidance from the SBA on “available liquidity” element of certifications for PPP Loans – Safe Harbor extended to May 18, 2020.

Since the passage of the CARES Act and the SBA completing the first round of PP Loans, companies have been dealing with an ever changing set of guidelines interpreting the eligibility requirements for a PPP Loan and the eventual forgiveness of the Loan.  Unfortunately, no clear guidance is yet available.

On April 23, 2020, the Treasury Department issued its Question 31 to its Frequently Asked Questions guidance on the CARES Act, which states:

    1. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and 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. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.  Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith. [Emphasis added]

The Treasury Department further emphasized the “adequate sources of liquidity” issue on April 28 and 29 when it published Questions 37 and 39, as follows:

    1. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: See response to FAQ #31.

    1. Question: Will SBA review individual PPP loan files?

Answer: Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. Additional guidance implementing this procedure will be forthcoming.

This guidance abruptly focused the attention on the certification given by each borrower that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” and that the certification must be made “in good faith, taking into account their current business activity and 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” [Emphasis added].

The fear has been that the borrower’s decision to seek a PPP Loan, the rationale for making the certification and whether the certification was made in good faith will be judged in retrospect.    Are businesses and their owners required to evaluate their own wealth, liquidity positions, and borrowing capacity before making the certification when seeking a PPP Loan?  The CARES Act suspends the normal requirement that a borrower be unable to obtain credit elsewhere.  Thus, it appears that availability of funds on a line of credit loan or the ability to obtain a loan from a lender, are not the equivalent of having access to other sources of liquidity.  Further confusing is the caveat that available liquidity not be “significantly detrimental to the business.” Does that mean “significantly detrimental” to the current business owners in terms of dilution or the like, or does this important phrase instead mean just what it says — such alternative available liquidity is not “significantly detrimental to the business” the company?  

On May 13, 2020 the Treasury Department provided some additional guidance that will be a relief to all of the businesses that received a PPP Loan of less than $2 million and provides some comfort to borrowers with larger PPP Loans.  The new guidance states, “Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith” [Emphasis added].  The guidance also recognized that borrowers with loans greater than $2 million can still have an adequate basis for making the required good-faith certification, based on their individual circumstances, but will remain subject to review by SBA for compliance with program requirements.  If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. But the guidance does provide that if the borrower repays the loan after receiving notification from SBA, the SBA will not pursue administrative enforcement or referrals to other agencies.

Thus, we do expect that public companies, large private companies, portfolio companies of private equity funds and any other company that may be presumed to have “adequate sources of liquidity to support operations”  and received a PPP Loan in an amount exceeding $2 million, will receive increased government scrutiny relating to the certification.  But should the SBA determine that the borrower is not eligible for loan forgiveness, the borrower can repay the PPP Loan and have the protection of SBA assurance of no further action.

To satisfy the requirement imposed by this guidance, companies that have received a PPP Loan or are considering applying for a PPP Loan in excess of $2 million must determine whether the company has access to liquidity to support operations and, if it does, whether such access would have been significantly detrimental to the business.   If the answer to either of these inquiries is negative, then the company should compile all documents, correspondence, minutes, e-mail messages, research and notes that it relied upon in coming to such conclusion and that otherwise support the “good faith” obligation in making the necessary certification. The evidence amassed by the company should include information about advice sought from outside sources, including attorneys and CPAs.  This evidence will be critical in the event the PPP Loan obtained by the company is audited by the government.

Those borrowers that determine, in light of the SBA’s recent guidance, that they had adequate sources of liquidity at the time of application and that accessing such sources would not have been significantly detrimental to the business can return the loan proceeds in full by May 18, 2020[1] and the company will “be deemed by SBA to have made the required certification in good faith.” The same holds for any company that determines that due to the affiliation rules it was not eligible to receive a PPP Loan.  This safe harbor was established to ensure prompt repayment of PPP Loan proceeds that were obtained “based on a misunderstanding or misapplication of the required certification standard.” Furthermore, it binds the SBA.


[1] Initially the SBA set May 7, 2020 as the deadline, but the deadline was extended to May 14 and now to May 18.

COVID-19: New IRS Relief Allows Health Plan and Flexible Spending Account Election Changes

On May 12, 2020, the IRS issued guidance (IRS Notice 2020-19) to allow temporary changes to section 125 cafeteria plans.  These plans allow participants to pay their portion of health insurance premiums and contribute to health care flexible spending accounts and dependent care assistance spending accounts (FSAs) on a pre-tax basis.  In return for the tax-favored treatment, the IRS imposes strict prohibitions on a participant’s ability to make changes once the plan year begins after open enrollment.  Participants must estimate expenses they anticipate for the following year and make their elections accordingly. 

COVID-19 has greatly impacted many individuals’ health care and dependent care expenses, causing them to have over- or under-estimated expenses; for example, contributions to a heath FSA for anticipated elective surgery that is the shut-down, higher unanticipated child care expenses due to school and summer camp closings, etc.   Most plans have a $500 carryover, but, if not, participants lose any unused balance at year-end.

The IRS guidance is intended to address unanticipated changes in expenses because of the COVID-19 pandemic, and it increases the $500 permitted carryover amount for health FSAs to $550 for 2020, with a direction to the Secretary of the Treasury to issue further guidance to  increase the carryover.

Specifically, IRS Notice 2020-29 allows plan participants to make the following changes for the remainder of 2020:

  1. Make mid-year election changes for health coverage, allowing them to respond to changes in needs as a result of COVID-19.  This includes changing from one plan option to another or switching coverage levels (single, family, employee + spouse, etc.).
  2. Make a new election for employer coverage if they initially declined coverage.
  3. Revoke an election, make a new election, or increase or decrease an existing election under health and dependent care FSAs.

Employers have discretion to allow all or any of these changes.  They are not mandatory. For employers that allow them, plan amendments are not required until the end of 2021.  Employers should contact their health plan administrative service providers to add these features and notify participants of the new options.

Please contact Vandeventer Black LLP if you have any questions or would like additional information on these issues.

Please visit our specialized Coronavirus Legal Services page:

Certifications made on application for a PPP Loan – Safe Harbor deadline extended to May 14, 2020.

Since the passage of the CARES Act and the SBA completing the first round of PP Loans, companies have been dealing with an ever changing set of guidelines interpreting the eligibility requirements for a PPP Loan and the eventual forgiveness of the Loan.  Unfortunately, no clear guidance is yet available.

On April 23, 2020, the Treasury Department issued its Question 31 to its Frequently Asked Questions guidance on the CARES Act, which states:

      1. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and 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. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.  Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith. [Emphasis added]

The Treasury Department further emphasized the “adequate sources of liquidity” issue on April 28 and 29 when it published Questions 37 and 39, as follows:

      1. Question: Do businesses owned by private companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: See response to FAQ #31.

      1. Question: Will SBA review individual PPP loan files?

Answer: Yes. In FAQ #31, SBA reminded all borrowers of an important certification required to obtain a PPP loan. To further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. Additional guidance implementing this procedure will be forthcoming.

This guidance abruptly focused the attention on the certification given by each borrower that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant” and that the certification must be made “in good faith, taking into account their current business activity and 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” [Emphasis added].

The fear has been that the borrower’s decision to seek a PPP Loan, the rationale for making the certification and whether the certification was made in good faith will be judged in retrospect.  Are businesses and their owners required to evaluate their own wealth, liquidity positions, and borrowing capacity before making the certification when seeking a PPP Loan?  The CARES Act suspends the normal requirement that a borrower be unable to obtain credit elsewhere.  Thus, it appears that availability of funds on a line of credit loan or the ability to obtain a loan from a lender, are not the equivalent of having access to other sources of liquidity.  Further confusing is the caveat that available liquidity not be “significantly detrimental to the business.” Does that mean “significantly detrimental” to the current business owners in terms of dilution or the like, or does this important phrase instead mean just what it says — such alternative available liquidity is not “significantly detrimental to the business” the company?  

On May 13, 2020 the Treasury Department provided some additional guidance that will be a relief to all of the businesses that received a PPP Loan of less than $2 million and provides some comfort to borrowers with larger PPP Loans.  The new guidance states, “Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith” [Emphasis added].  The guidance also recognized that borrowers with loans greater than $2 million can still have an adequate basis for making the required good-faith certification, based on their individual circumstances, but will remain subject to review by SBA for compliance with program requirements.  If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, the SBA will not pursue administrative enforcement or referrals to other agencies.

Thus, we do expect that public companies, large private companies, portfolio companies of private equity funds and any other company that may be presumed to have “adequate sources of liquidity to support operations”  and received a PPP Loan in an amount exceeding $2 million, will receive increased government scrutiny relating to the certification.

To satisfy the requirement imposed by this guidance, companies that have received a PPP Loan or are considering applying for a PPP Loan in excess of $2 million must determine whether the company has access to liquidity to support operations and, if it does, whether such access would have been significantly detrimental to the business.   If the answer to either of these inquiries is negative, then the company should compile all documents, correspondence, minutes, e-mail messages, research and notes that it relied upon in coming to such conclusion and that otherwise support the “good faith” obligation in making the necessary certification. The evidence amassed by the company should include information about advice sought from outside sources, including attorneys and CPAs.  This evidence will be critical in the event the PPP Loan obtained by the company is audited by the government.

In addition to the question of necessity for the PPP loan and alternate sources of liquidity, companies must ensure that they considered the affiliation rules (unless otherwise waived) in deciding whether to apply for or retain a PPP Loan.

Affiliate status for purposes of determining the number of employees of a business concern for PPP Loans generally works as follows:  Businesses are affiliates of each other when one controls or has the power to control the other, or a third party or parties control or have the power to control both.  There are four general bases of affiliation that the SBA will consider when determining the size of an applicant: (1) affiliation based on ownership; (2) affiliation arising under stock options, convertible securities, and agreements to merge; (3) affiliation based on management; and (4) affiliation based on identity of interest.  It does not matter whether control is exercised, so long as the power to control exists.  For determining affiliation based on ownership, a concern is an affiliate of an individual, concern, or entity that owns or has the power to control more than 50 percent of the concern’s voting equity.  The SBA will, however, deem a minority owner to be in control, if that individual or entity has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.  The Treasury Department has specified that where the minority owner waives or relinquishes these rights, it will no longer be an affiliate of the business.

There are two SBA-related affiliation rules — rules set forth in 13 C.F.R. § 121.103 (Section 103) and rules set forth in 13 C.F.R. § 121.301 (Section 301).  The CARES Act exempted certain business concerns seeking PPP Loans from the affiliation rules under the Section 103 rules, but did not address the affiliation rules under Section 301. In the Interim Final Rule published by the SBA on April 3, 2020, the SBA clarified that it is the Section 301 rules that govern affiliation for the PPP loan program and consistent with the limited waiver of the Section 103 affiliation rules would also make that waiver applicable for the Section 301 affiliation rules.

Those borrowers with PPP Loans in excess of $2 million that determine, in light of the SBA’s recent guidance, that they had adequate sources of liquidity at the time of application and that accessing such sources would not have been significantly detrimental to the business can return the loan proceeds in full by May 14, 2020, and the company will “be deemed by SBA to have made the required certification in good faith.” The same holds for any company that determines that due to the affiliation rules it was not eligible to receive a PPP Loan.  This safe harbor was established to ensure prompt repayment of PPP Loan proceeds that were obtained “based on a misunderstanding or misapplication of the required certification standard.” Furthermore, it binds the SBA.

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