PPP loan investigations and D&O insurance coverage: 4 things businesses need to know
Bonnie Hoffman, shareholder, Hangley Aronchick Segal Pudlin & Schiller
In the months after the onset of COVID-19, businesses of all sizes faced an uncertain future. In response to this unprecedented global crisis—and concerns about economic instability under lockdown—Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act on March 27, 2020. A fundamental part of that act was the Paycheck Protection Program, or PPP, a low-interest loan backed by the Small Business Association (SBA) that would help businesses keep their workers employed despite the challenges presented by the coronavirus.
In a rush to support business owners during the crisis, the SBA gave out $669 billion in loans during the first two rounds of the PPP program and more than $800 billion in loans as of May 31, 2021. And while most PPP recipients used their loans to stay afloat and support their workforce, some business owners took advantage of the crisis to use that money inappropriately. To uncover the malicious behavior of those bad actors, the Department of Justice (DOJ) is now looking more closely at the ways business owners used their PPP funds.
The SBA gave out $669 billion in loans during the first two rounds of the PPP program and more than $800 billion in loans as of May 31, 2021.
Unfortunately, even business owners who did everything by the book may come under scrutiny as the DOJ digs deeper into PPP loan fraud. In this article, we’ll take a closer look at PPP loan investigations and share four things business owners need to know about their insurance coverage should they come under investigation.
The rush to help businesses reeling from the effects of the pandemic led to an implementation of a program with lowered guardrails, according to the inspector general of the SBA. Of the more than $1 trillion distributed part of the PPP and Economic Injury Disaster Loans (EIDL), an estimated 5 percent of transactions were fraudulent, motivating the DOJ to launch a campaign of PPP loan investigations.
Of the more than $1 trillion distributed part of the PPP and Economic Injury Disaster Loans (EIDL), an estimated 5 percent of transactions were fraudulent.
As of March 2021, the DOJ has brought charges against 474 individuals for fraudulent schemes related to the COVID-19 pandemic. Some examples of fraud found thus far include individual business owners who inflated payroll expenses and serial fraudsters who purchased shell companies to apply for multiple loans. The DOJ also uncovered fraud from organized criminal networks that submitted identical loan applications under the names of different companies. Some of these fraudsters were particularly egregious—like one Texas man who fabricated tax filings and bank statements and then used his more than $25 million in PPP loans to purchase multiple houses and a fleet of luxury cars.
The upsurge in PPP loan investigations can feel concerning to business owners who fear that a misfiled form or accidental error will bring the DOJ to their doorstep. And in fact, some businesses may come under scrutiny simply because of the type or the size of the loan they received, even if they used their funds appropriately. In these instances, business owners frequently look to their directors and officers (D&O) insurance policy for support—but it doesn’t necessarily provide coverage in fraud-related government investigations. Read on to learn four reasons why.
Many D&O policies include coverage for pre-claim inquiries, but only when an executive is asked to produce documents or appear for an investigative interview. However, if the DOJ investigates your business, it will likely file charges against the company, not a single executive. As such, coverage may be limited or nonexistent depending on whether the policy language provides coverage for the entity or is limited to individual D&Os.
Government investigations are different than criminal or civil cases and may not be covered by D&O insurance. Some policies may provide limited coverage for certain investigations, depending on the language. But whether PPP loans and related investigations are covered will depend on the circumstances of the investigation and the D&O policy language.
In some cases, an investigation may progress to a formal civil or criminal proceeding. In that case, defendants may have questions about whether D&O policies will cover any fines or penalties the insured may be ordered to pay. But the definition of “loss” under most D&O insurance policies often expressly excludes fines and penalties. Similarly, most policies exclude restitution, or the return of funds that a recipient was not entitled to receive. Because of this, D&O coverage will likely not pay out for these claims.
Finally, virtually every D&O policy has a fraud-exclusion policy. That being said, merely alleging fraudulent activity does not immediately trigger the fraud exclusion. In most policies, for the exclusion to apply, there must be proof of fraudulent conduct (i.e., a final adjudication that the conduct occurred). Because of that, business owners may still be protected in instances of alleged fraud, depending on the specific language in their policy.
It’s been a trying year for business owners—and unfortunately, the malicious behavior of a few fraudsters may add further complications. While a PPP loan investigation is still unlikely for most businesses, having a solid understanding of what is covered under your D&O insurance policy can help you prepare.
As an experienced partner in management liability insurance, we offer a suite of solutions to help protect directors, officers, managers, and business entities. Learn more about our D&O liability coverage.
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