Client Alert: PPP Affiliation Pitfalls: How Employee Headcount Errors Can Lead To False Claims Act Troubles For Business Owners
Date: November 6, 2025
This article explains how the First Draw and Second Draw PPP Loan rules changed between draws, and how incorrect size determinations based on affiliation can become a pitfall for small business owners who certified eligibility regarding the number of employees. This article then explains the basic PPP rules, the current investigatory landscape, and what small business owners can do if the government initiates an investigation into their PPP loans.
- Affiliation Rules: First Draw and Second Draw PPP Loans
The Small Business Administration administered the PPP and implemented previously established rules for evaluating the size of a small business to determine eligibility. Part of the evaluation involved examining a business’s relationships with other entities or individuals, known under the law as its “affiliates” or “affiliation.” The affiliation rules have historically applied to SBA loans and were also applied to First Draw and Second Draw PPP loans.
If a small business’s stock was owned by a parent company, was controlled by managers who manage other entities, was under an agreement to merge, or was related to other entities by family-based ownership, the small business may be affiliated with the other entities. The result being that the small business was larger in size with more employees than when viewed in isolation. Although there was some initial ambiguity about how the affiliation rules applied to the PPP, the SBA and Treasury guidance eventually set forth basic guidelines discussed below.
For First Draw PPP Loans, certain nonprofits, veterans’ organizations, tribal concerns, self-employed individuals, sole proprietorships, and independent contractors were eligible if they had 500 or fewer employees. The employee count included all full-time and part-time employees, as well as all employees across all domestic and foreign affiliates. There was a limited exception to the 500-employee cap for businesses in the Accommodations and Food Services sector.
The rules for Second Draw PPP Loans were largely the same, but reduced the cap to 300 employees. Second Draw applicants must have received a First Draw PPP Loan and show a 25% reduction in gross receipts in comparable quarters in 2019 and 2020. Notably, Congress imposed new restrictions for Second Draw PPP Loans concerning Chinese origin, ownership, or control. Any business created, organized, or with significant operations in China was disqualified. Domestic entities also could not obtain a Second Draw PPP Loan if a Chinese company owned 20% or more of the economic interest directly or indirectly, or if a Chinese resident was a member of the applicant’s board of directors.
If a small business’s stock was owned by a parent company, was controlled by managers who manage other entities, was under an agreement to merge, or was related to other entities by family-based ownership, the small business may be affiliated with the other entities. The result being that the small business was larger in size with more employees than when viewed in isolation. Although there was some initial ambiguity about how the affiliation rules applied to the PPP, the SBA and Treasury guidance eventually set forth basic guidelines discussed below.
For First Draw PPP Loans, certain nonprofits, veterans’ organizations, tribal concerns, self-employed individuals, sole proprietorships, and independent contractors were eligible if they had 500 or fewer employees. The employee count included all full-time and part-time employees, as well as all employees across all domestic and foreign affiliates. There was a limited exception to the 500-employee cap for businesses in the Accommodations and Food Services sector.
The rules for Second Draw PPP Loans were largely the same, but reduced the cap to 300 employees. Second Draw applicants must have received a First Draw PPP Loan and show a 25% reduction in gross receipts in comparable quarters in 2019 and 2020. Notably, Congress imposed new restrictions for Second Draw PPP Loans concerning Chinese origin, ownership, or control. Any business created, organized, or with significant operations in China was disqualified. Domestic entities also could not obtain a Second Draw PPP Loan if a Chinese company owned 20% or more of the economic interest directly or indirectly, or if a Chinese resident was a member of the applicant’s board of directors.
- Consequences for misstating PPP eligibility, and the False Claims Act
When applying for a First Draw or Second Draw PPP Loan, businesses were required to attest to eligibility, necessity, and the accuracy of supporting information, including employee limits with all applicable affiliates. Now that the government is reviewing COVID-era relief programs and PPP Loans in particular, small business owners may find their PPP Loans under scrutiny. Small business owners should be aware that a false certification of eligibility on a PPP Loan application, even if unintentional, can trigger consequences beyond mere repayment.
The government has been seeking to reclaim falsely obtained PPP Loans through the False Claims Act and related civil investigations. The FCA imposes liability for knowingly submitting or causing the submission of false or fraudulent claims for payment, or for making materially false statements to avoid repaying money to the government. A false certification on a PPP Loan or forgiveness application could lead to an FCA investigation. Notably, the FCA’s knowledge standard includes deliberate ignorance and reckless disregard, meaning that willful blindness or careless review of employee headcount can establish FCA liability. Small business owners who may have accidentally failed to include all affiliate employees, even if it is an honest mistake, could find themselves under an FCA investigation.
The economic fallout from a successful government suit under the FCA can be severe. The FCA allows civil penalties ranging from approximately $14,000 to $28,000 per proven false statement. More damaging, however, is the possibility of multiplied damages based on the funds that were wrongfully obtained. Under the FCA, the government can seek treble damages up to three times the amount of the PPP Loan itself. This combination of penalties and treble damages could be enough to sink any small business. But early cooperation and strategizing can lead to resolution or an end to the FCA investigation before a suit begins.
The government has been seeking to reclaim falsely obtained PPP Loans through the False Claims Act and related civil investigations. The FCA imposes liability for knowingly submitting or causing the submission of false or fraudulent claims for payment, or for making materially false statements to avoid repaying money to the government. A false certification on a PPP Loan or forgiveness application could lead to an FCA investigation. Notably, the FCA’s knowledge standard includes deliberate ignorance and reckless disregard, meaning that willful blindness or careless review of employee headcount can establish FCA liability. Small business owners who may have accidentally failed to include all affiliate employees, even if it is an honest mistake, could find themselves under an FCA investigation.
The economic fallout from a successful government suit under the FCA can be severe. The FCA allows civil penalties ranging from approximately $14,000 to $28,000 per proven false statement. More damaging, however, is the possibility of multiplied damages based on the funds that were wrongfully obtained. Under the FCA, the government can seek treble damages up to three times the amount of the PPP Loan itself. This combination of penalties and treble damages could be enough to sink any small business. But early cooperation and strategizing can lead to resolution or an end to the FCA investigation before a suit begins.
- Civil Investigative Demands and what you can do next
Government investigations into PPP loans often begin as civil matters, typically when the local U.S. Attorney’s Office sends a Civil Investigative Demand to the business owner. A CID is a pre-suit administrative request used in most FCA investigations. It allows the government to compel production of documents, written responses, and sworn testimony from the business owner or relevant parties without first filing a case or seeking a judge’s approval. Responding to a CID is not voluntary. Failure to respond will often force the government to seek a federal court order to force compliance.
Receiving a CID can be alarming, but it should be viewed as an opportunity to resolve issues early. Business owners should communicate with the government attorney, attempt to narrow the scope of the investigation, and seek extensions to respond as necessary. For many, the CID process is the first and best chance to resolve the case before litigation.
If you have received a CID or an inquiry regarding your PPP Loans, it is imperative to consult an attorney to explain your options. The attorneys with Whiteford are ready to help you work with the government to develop a plan for resolution, or ideally, a complete end of the investigation without litigation.
Receiving a CID can be alarming, but it should be viewed as an opportunity to resolve issues early. Business owners should communicate with the government attorney, attempt to narrow the scope of the investigation, and seek extensions to respond as necessary. For many, the CID process is the first and best chance to resolve the case before litigation.
If you have received a CID or an inquiry regarding your PPP Loans, it is imperative to consult an attorney to explain your options. The attorneys with Whiteford are ready to help you work with the government to develop a plan for resolution, or ideally, a complete end of the investigation without litigation.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.