While traders may even see the CARES Act as a lifeline for his or her startup portfolio firms, there are specific traps to concentrate on.
Under the False Claims Act, the federal government can search each civil and felony penalties in opposition to firms acquiring funding below false pretenses. On prime of this, particular person whistleblowers (with their hungry plaintiffs’ attorneys) even have standing to sue on behalf of the government.
It’s not simply the businesses that get hold of funding that may be liable. Individuals, together with administrators, have the potential to change into liable, as effectively.
Stimulus funding necessities
Many widespread CARES Act funding packages — just like the PPP and EIDL packages — require an applicant firm to make eligibility certifications. For instance, the PPP loans require a certification that “the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient.” The SBA additional clarified that “Borrowers must . . . [take] 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.”
There has clearly been a spate of stories tales about well-resourced firms acquiring PPP funding (e.g. Ruth’s Chris, Shake Shack). But within the VC and startup group, purchasers are questioning whether or not a VC-backed startup actually “needs” the cash. This isn’t only a ethical query. Given the certification described above and the SBA’s current steering, it is a vital authorized query.
In comes the False Claims Act
What occurs if an organization makes false certifications to acquire CARES Act stimulus funding? The reply is discovered below the False Claims Act.
The False Claims Act offers for civil and felony legal responsibility for “knowingly” submitting a false declare to the federal authorities — together with a request for a authorities mortgage.
Merely submitting a false declare will not be sufficient. It should be “knowingly” false. But there needn’t be a particular intent to defraud.
False Claims Act legal responsibility arising from the CARES Act isn’t just a theoretical concern. The Department of Justice has already issued a press release asserting that will probably be prioritizing investigations of COVID-19 associated fraud. So, consideration and assets are being put into ferreting out CARES Act fraud.
The authorities isn’t the one one that may sue you for a false declare
It’s not solely the federal government that one wants to fret about. A member of the general public can stand within the authorities’s footwear and file a swimsuit below the False Claims Act. This is known as a qui tam motion.
Why would somebody deliver a qui tam declare below the False Claims Act? Because it may be value some huge cash. A non-public plaintiff in a qui tam motion could possibly maintain as much as 30% of the restoration within the lawsuit, plus an award of attorneys’ charges. The remainder of the restoration goes to the federal government.
The plaintiff’s bar has already began promoting for whistleblowers to come back ahead for the plain function of bringing a slew of qui tam actions below the CARES Act.
Why traders ought to care
The False Claims Act doesn’t restrict legal responsibility to simply the applicant firm. It can prolong to administrators in addition to traders.
And keep in mind — numerous startups are money poor. Investors, nevertheless, are sometimes not. Thus, VCs and different traders make enticing targets with massive pockets for plaintiffs’ legal professionals searching for to file qui tam actions.
Let’s give attention to two necessary facets of False Claims Act legal responsibility for VCs and different traders.
First, is the notion of “submitting” a false declare. You would possibly assume that given the potential legal responsibility an investor faces when a startup seeks CARES Act funding that one of the best factor to do is to insert your self within the course of. This may not have the specified outcome.
You will not be robotically liable below the False Claims Act simply because the corporate turns into liable. In truth, information of the corporate submitting a false declare isn’t even sufficient to impose private legal responsibility. Rather, the person will need to have taken some affirmative steps to trigger the corporate to submit the false declare.
This has totally different implications for VCs themselves vs. administrators who could also be appointed by a VC.
Investors will not be typically anticipated to have any function in deciding whether or not to hunt authorities funding. So, from a legal responsibility avoidance perspective, there’s a robust case to be made to remain out of it.
For investor administrators, it’s tougher to shut your eyes and let the corporate do what it desires to do. That can elevate fiduciary obligation considerations. But the job of a director is to verify the corporate has insurance policies and procedures in place for the officers to make choices on authorities funding, to not substitute one’s judgment for that of the corporate’s officers. Staying one step faraway from day-to-day choice making — the place a director ordinarily must be — is useful in avoiding legal responsibility, whereas nonetheless assembly fiduciary duties.
Second, there’s the information factor of a False Claims Act declare. The False Claims Act will not be a strict legal responsibility statute, nor does it search to punish negligence. To be liable, the federal government (or a non-public plaintiff within the authorities’s footwear) should present that the defendant acted “knowingly.”
As an investor director, you need to be sure to can show, at a minimal, that you’ve got acted fairly and in good religion. In that regard, documentation is all the time really helpful.
In addition, be sure to are consulting with authorized counsel in guaranteeing compliance with federal funding necessities. This is a very key when coping with dealing with potential False Claims Act litigation. Reliance on recommendation of counsel could be, in itself, a protection to a declare that you simply violated the False Claims Act offered you made a full disclosure of the info to your counsel.
Did your portfolio firm already take a mortgage it’s not entitled to?
For many traders, this steering could also be seen as coming too late — their portfolio firms already obtained stimulus loans when maybe they weren’t actually eligible. Thankfully, the SBA has offered an answer.
Any firm that has acquired a PPP mortgage can return the mortgage in full by May 7, 2020. This secure harbor will enable firms to keep away from legal responsibility for having obtained a mortgage once they had been probably ineligible.
Mital Makadia and David Siegel are companions at Grellas Shah LLP, the place they counsel tech startups and traders typically company, enterprise financing, M&A, and different transactional issues.