PPP Lawsuits Allege Banks Favored Larger Customers, A Second Round Of Funding Likely

In pleading their case, the plaintiffs draw on SBA data, arguing that it implies that banks “front-loaded” larger loans early in the PPP funding process.  There is some logic behind their argument, though readers should take caution that the plaintiffs will ultimately need more than statistical inferences to prevail. The SBA data that the plaintiffs cite indicates, for example, that as of April 13, 2020, banks had processed some 3,273 loans that were greater than $5 million, making up roughly .32% of the total number of loans as of that date.  SBA data also indicates that as of April 13, 2020, banks had processed some 725,058 loans in amounts under $150,000, making up approximately 70% of total loans as of that date.

The plaintiffs compare this data against SBA data taken just 3 days later, as the PPP funds ran out.  That data indicates that the rate of loans above $5 million had tapered off during the closing days, decreasing in terms of their relative share of the total number of loans.  On the other hand, the rate of loans in amounts less than $150,000 grew, nearly doubling in only 3 days and increasing in terms of their relative share of the total number of loans.  This, the plaintiffs argue, “demonstrates” (implies, however, is probably a more accurate verb) that banks front-loaded, or prioritized, larger loans early in the process, and only after getting those loans in the door did they then turn to processing small loans.  This follows, they argue, because one would expect a consistent mix among the types of loans over time if the banks had treated the loans equally and had not given priority to larger loans early in the process.  It is a pretty clever argument.  (Notably, though, the SBA’s application timing and rules for smaller borrowers, which are covered in-depth in “Why The SBA’s New Self-Employed PPP Guidance Got It Wrong,” may also have had an impact on the mix over time.)

The plaintiffs allege that the bank stood to receive a larger origination fee for larger loans.  This is, in fact, generally true under the CARES Act.  The Act provided for origination fees that were tied to a percentage of the amount of the loan and could increase with larger loans.

Indeed, it seems that the Act created a potentially perverse incentive—if the goal was to favor businesses on the smaller side of the scale.  By rewarding financial institutions for making larger loans, the Act structurally incentivized banks to favor larger borrowers.  That, of course, does not necessarily mean that they actually did.  It should also be noted that larger loans may require greater time and cost to a bank to process.  But it stands to reason that Congress could, if it wanted, change this incentive as it seeks to roll out a second round of funding.  The current bill, however, does not do so.

Notably, financial institutions had another potential incentive to favor bigger borrowers that is not getting attention or raised in the suit: Banks had greater risk exposure to larger borrowers, in whom they had made more significant investments. Banks stand to be hurt more if those borrowers default, and thus had a greater incentive to ensure that those borrowers were propped up during this time with government-backed PPP funds.  In other words, there was a natural underlying incentive to protect their existing “assets”—that is, their investments in borrowers—by enhancing the larger borrower’s ability to repay existing loans.  The plaintiffs have not raised this dynamic in their suit.  Yet it may be particularly relevant if banks owed fiduciary duties to borrowers or applicants, as the allegations, if true, would indicate self-interested transactions, which can run afoul of a fiduciary’s duties.  Generally, however, banks are not considered fiduciaries to their borrowers.  Nonetheless, courts have at times imposed limited fiduciary duties on banks where special circumstances or special relationships exist.  I am unaware of any existing PPP lawsuit that has used this strategy to date.

The Wells Fargo lawsuit is one of a handful of related suits that have also been filed against Bank of America, JP Morgan Chase, and U.S. Bank.  Expect to see more suits arise out of the PPP loan initiative.

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