Alerts

Important Lessons from the DOJ's First Civil Action for CARES Act Loan Fraud

Alerts / January 25, 2021

On January 12, 2021, the Department of Justice (the “DOJ”) settled its first civil action for alleged fraud against the Paycheck Protection Program (the “PPP”) – the primary lending program under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act for small businesses negatively impacted by the COVID-19 pandemic. Prosecutors in the Eastern District of California brought civil claims under the False Claims Act (the “FCA”) and the Financial Institution Reform, Recovery, and Enforcement Act (“FIRREA”) against a company and its CEO, alleging that they falsely claimed that the company was not in bankruptcy in order to qualify for a PPP loan. The FCA creates civil liability for a person who knowingly (including recklessly or with deliberate ignorance) defrauds a federally funded program by submitting false claims for money.[1] FIRREA allows the government to impose civil penalties for violations of enumerated federal criminal statutes, including those that affect federally insured financial institutions.[2] Damages and fines under these federal statutes can be substantial, including treble damages under the FCA.[3]

It was only a matter of time. The government relied heavily on FCA and FIRREA actions in the aftermath of prior national emergencies. While the government had only brought criminal actions for alleged CARES Act loan fraud thus far, government officials have long hinted that civil actions would be on the horizon. For example, in June 2020, Ethan Davis, the former acting assistant attorney general of the DOJ’s Civil Division, warned that civil tools such as the FCA will be deployed “against those who commit fraud related to the various COVID-19 stimulus programs, like the Paycheck Protection Program and the Main Street Credit Facility.”[4]

In the DOJ’s action, SlideBelts Inc., an online fashion accessories company, and its CEO, Brigham Taylor, agreed to pay $100,000 in damages and penalties to resolve allegations of fraud rooted in allegedly false certifications made on PPP loan applications to three separate banks.[5] According to the government, on April 3, 2020, while a debtor in bankruptcy, SlideBelts submitted an application for a PPP loan of approximately $300,000 with a bank (“Lender 1”). On April 10, SlideBelts submitted an application with another bank (“Lender 2”) for a PPP loan of $350,000. On their loan applications with both lenders, Taylor and SlideBelts falsely represented that SlideBelts was not in bankruptcy. On April 14, Lender 1 rejected SlideBelts’ application because it had independent knowledge of the bankruptcy. Just hours after this rejection, SlideBelts filed a loan application with a third bank (“Lender 3”), again certifying that it was not subject to a bankruptcy proceeding.[6]

The government further alleged that while SlideBelts’ application with Lender 3 was pending, Lender 2 approved its loan application for $350,000. One day after receiving the loan payout, SlideBelts informed Lender 2 that it “may not have filled out [the bankruptcy question] correctly. . . .” Instead of immediately returning the funds, SlideBelts filed a motion with its bankruptcy court to retroactively approve the PPP loan, without disclosing to the court that it obtained the loan by making a false statement regarding its bankruptcy status with the lender. The Small Business Administration (the “SBA”) opposed the motion and requested that the court order SlideBelts to return the loan. SlideBelts then moved the bankruptcy court to dismiss its bankruptcy case so it could refile and apply for a PPP loan in the period during which the case would be dismissed. During the hearing on SlideBelts’ motion, the SBA reiterated its demand that SlideBelts return the PPP loan immediately. The bankruptcy court dismissed the case, but on July 8, 2020, SlideBelts returned the loan to Lender 2.[7] Even though SlideBelts returned the funds, the DOJ pursued a civil fraud action.

This first civil action by the government for alleged CARES Act loan fraud provides several important lessons for borrowers and prospective borrowers who may be considering utilizing the recently reopened PPP under the Economic Aid Act:

  • Thus far, the DOJ’s criminal actions for alleged CARES Act loan fraud have centered on egregious conduct, such as borrowers identifying fake companies, fake employees, and fake payrolls on loan applications; submitting loan applications under stolen identities; and using loan proceeds for personal luxury expenses. As time passes, we expect the DOJ to bring a wider array of cases against borrowers for violations that may not be so egregious and to utilize civil statutes with lower burdens of proof to bring many of these actions. The SlideBelts case might indicate a beginning of this trend. While the government alleges that SlideBelts lied about its bankruptcy status on its loan applications, there are no allegations that SlideBelts was a fake company, falsified its employee count or payroll information on its loan applications, or used loan proceeds for personal expenses.
     
  • To the contrary, SlideBelts returned the PPP funds, but only after multiple requests by the SBA and two and a half months after it obtained the loan. The government’s focus on the timing of SlideBelts’ return of the PPP funds suggests that companies should review all previously filed or prospective loan applications for inaccuracies; and if an error or misstatement is found such that the business would otherwise be ineligible for the PPP loan, the company should return the loan promptly. The outcome in the SlideBelts matter might have been different had the company returned the PPP funds promptly after it told Lender 2 that it made a mistake on its loan application.
     
  • The government will seek substantial damages and penalties under the FCA and FIRREA, even in a case involving a relatively small loan amount. While SlideBelts and Taylor settled with the government for $100,000, the government contended that they were liable to the U.S. for damages and penalties totaling $4,196,992.[8]
     
  • Finally, an increase in the government’s use of the FCA and FIRREA to bring loan fraud cases will inevitably lead to increased whistleblower reports and actions under these statutes. The qui tam provisions of the FCA permit suits by private persons “for the person and for the United States Government.” These suits are then investigated by the DOJ, and the whistleblower can obtain 15 percent to 30 percent of any recovery, whether or not the DOJ decides to join the suit.[9] Under FIRREA, whistleblowers can file with the Attorney General a declaration of a violation giving rise to prospective FIRREA claims and obtain a share of any government recovery up to $1.6 million.[10] In order to mitigate the risk and impact of any whistleblower qui tam actions or reports to the government, companies should diligently investigate any allegations of CARES Act loan abuse and promptly remediate any identified misconduct, including returning any funds improperly obtained.

Authorship Credit: Christina O. Gotsis, George A. Stamboulidis and Patrick T. Campbell


[1] 31 U.S.C. § 3729.
[2] 12 U.S.C. § 1833a.
[3] 31 U.S.C. § 3729(a)(1)(G).
[4] Ethan P. Davis, Speech to the Institute for Legal Reform, U.S. Chamber of Commerce (June 26, 2020), available at https://www.justice.gov/civil/speech/principal-deputy-assistant-attorney-general-ethan-p-davis-delivers-remarks-false-claims.
[5] Settlement Agreement, DOJ (Jan. 12, 2021), available at https://www.justice.gov/usao-edca/press-release/file/1352931/download.
[6] Id. at ¶1.
[7] Id.
[8] Id. at ¶11.
[9] 31 U.S.C. § 3730(d).
[10] 12 U.S.C. § 1833a(b).

Baker & Hostetler LLP publications are intended to inform our clients and other friends of the firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience.