Debtors in Bankruptcy Seek Access to CARES Act Paycheck Protection Program Loans
- The U.S. Small Business Administration's (SBA) official form in effect since April 3, 2020, and its more recent interim final rules prohibit a debtor in bankruptcy that otherwise qualifies from being granted a loan under the Coronavirus Aid, Relief and Economic Security Act's (CARES Act) Paycheck Protection Program (PPP).
- In response, debtors in cases pending in bankruptcy courts around the country have commenced proceedings to enjoin the SBA and lenders working with it from preventing those debtors from benefiting from the PPP solely on the basis that they are in bankruptcy.
- While the landscape is still shifting, numerous courts have sided with the debtors' position, finding on at least a temporary basis that the SBA cannot bar a debtor in bankruptcy from benefiting from the PPP.
The U.S. Small Business Administration's (SBA) official form in effect since April 3, 2020, and its more recent interim final rules prohibit a debtor in bankruptcy that otherwise qualifies from being granted a loan under the Coronavirus Aid, Relief and Economic Security Act's (CARES Act) Paycheck Protection Program (PPP). In response, debtors in cases pending in bankruptcy courts around the country have commenced proceedings to enjoin the SBA and lenders working with it from preventing those debtors from benefiting from the PPP solely on the basis that they are in bankruptcy. While the landscape is still shifting, numerous courts have sided with the debtors' position, finding on at least a temporary basis that the SBA cannot bar a debtor in bankruptcy from benefiting from the PPP.
CARES Act PPP Loans
Section 1102 of the CARES Act establishes the PPP, a temporary program by which applicants can obtain unsecured loans in an amount up to the lesser of $10 million and 2.5 times an applicant's average monthly payroll (as determined pursuant to the CARES Act), to be used to fund payroll, mortgage interest, rent and utility costs. The PPP loans are a lifeline for struggling businesses, as all interest and principal payments on the loans are deferred for six months and borrowers do not pay fees for obtaining or prepaying the loans. The PPP loans also are forgivable in whole or in part if the borrower satisfies certain requirements, including that it maintain employment and wage levels, and payroll costs account for 75 percent of the forgiven principal amount.
The CARES Act grants to the SBA emergency rulemaking authority to administer and issue regulations concerning the PPP. To obtain a PPP loan, a borrower must apply with a participating lender using an application form created by the SBA, which guarantees the loan. Lenders do not perform any due diligence or other investigation with respect to the truthfulness of the borrower's application or its ability to repay the loan. They also are authorized to rely on the statements in a borrower's application in assessing whether the borrower qualifies for a PPP loan. The CARES Act states that PPP loans are available to, among other entities: 1) any business concern, 501(c)(3) nonprofit organization, veterans organization or tribal business concern as described in Section 31(b)(2)(C) of the Small Business Act (15 U.S.C. 657a(b)(2)(C)) that, a) qualifies as a small business concern under current SBA standards corresponding to its primary industry, b) meets both tests in SBA's "alternative-size standard" as of March 27, 2020, c) employs not more than 500 employees whose principal residence is in the United States or 2) a sole proprietorship, independent contractor or eligible self-employed individual (as defined in Section 7002(b) of the Families First Coronavirus Response Act (Public Law 116-127)).
There is nothing in the CARES Act that prohibits a debtor in bankruptcy from applying for or receiving a PPP loan, or otherwise limits the availability of PPP loans based on an applicant's status as a debtor or other party in interest in bankruptcy or to entities that have not directly or via an affiliate defaulted on a federally guaranteed loan. Nevertheless, the PPP loan application form issued by the SBA on or about April 2, 2020, asks if the applicant is "presently involved in any bankruptcy" or if the applicant, any owner of the applicant, or any business owned or controlled by any of them, ever obtained a direct or guaranteed loan from the SBA or any other federal agency that currently is delinquent or has defaulted in the last seven years and caused a loss to the government. If the answer to either of these questions is yes, the SBA's official form states that the loan will not be approved.
More recently, the SBA issued its interim final rule on the PPP effective April 28, 2020, which confirmed the prohibition on issuing PPP loans to debtors in bankruptcy as follows:
- If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the applicant or the owner of the applicant becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant's obligation to notify the lender and request cancellation of the application. Failure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes.
The April 28 interim final rule states the rationale for denying PPP loans to debtors in bankruptcy as follows:
- The administrator, in consultation with the Secretary, determined that providing PPP loans to debtors in bankruptcy would present an unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans. In addition, the Bankruptcy Code does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy. The Borrower Application Form for PPP loans (SBA Form 2483), which reflects this restriction in the form of a borrower certification, is a loan program requirement. Lenders may rely on an applicant's representation concerning the applicant's or an owner of the applicant's involvement in a bankruptcy proceeding.
In response, businesses that otherwise purport to qualify for a PPP loan aside from the bankruptcy restriction are taking various steps to address their exclusion from the PPP process. For example, Florida restaurant operator TooJay's Management LLC and its affiliate (collectively TooJay's), waited to file chapter 11 petitions until after receiving the proceeds of a PPP loan, thereby skirting the letter of the SBA's requirement that a debtor return any PPP loan proceeds received post-petition in relation to a pre-petition application.1 Other entities with pending cases have filed motions to dismiss their pending chapter 11 cases so that they could apply for a PPP Loan.2 Dismissal of a pending case is risky for a debtor that ultimately may need the protection of the automatic stay and other benefits of bankruptcy, as the debtor may not be able to refile for a period after the first case was dismissed.3
Businesses in Pending Bankruptcy Cases Seek Recourse
Other businesses in pending bankruptcy cases have commenced litigation against the SBA in the bankruptcy court or the district court in which their bankruptcy cases are pending. Those debtors have sought temporary restraining orders and injunctive relief prohibiting lenders and the SBA from denying their applications solely on the ground that they are a debtor in a bankruptcy case, and requiring the SBA to reserve sufficient funds to make the requested PPP loan to the debtor in the event that debtor prevails on the merits and otherwise qualifies for the loan.
The debtors that have commenced litigation have made two main arguments. First, they have argued that the SBA did not have authority to prohibit debtors (much less any person "involved in a bankruptcy") from applying for or obtaining a PPP loan, given that no such prohibition is stated in the relevant sections of the CARES Act and, taken at face value, the prohibition would exclude not just a debtor, but any creditor, lessor, lender or other party in interest that has filed a proof of claim or notice of appearance in another party's bankruptcy case from obtaining a PPP loan. Given that the purpose of the CARES Act is to provide support to small businesses and keep them operating, they argue that this prohibition simply makes no sense.
Second, debtors have argued that the SBA's actions violate section 525(a) of title 11 of the U.S. Code, 11 U.S.C. § 101, et seq. (Bankruptcy Code). As relevant here, section 525(a) states that a governmental unit:
- ... may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise or other similar grant to, condition such a grant to, discriminate with respect to such a grant against, deny employment to, terminate the employment of, or discriminate with respect to employment against a person that is or has been a debtor under this title ... or another person with whom such bankrupt or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title ..., has been insolvent before the commencement of the case under this title, or during the case but before the debtor is granted a discharge, or has not paid a debt that is dischargeable in the case under this title ...
See 11 U.S.C. § 525(a). While the PPP is on its face a loan program, the loans are being made available on an unsecured basis to any applicant that purports to fulfil the criteria. The loans are forgivable, and, as noted above, lending banks are specifically authorized to rely on the applications without performing any diligence or underwriting investigation of the borrower. As such, debtors have argued that the PPP is more in the nature of a grant of support by the government at a time of acute need – not a situation where the government is acting as a commercial actor and lending money based on a borrower's ability to repay. Thus, the debtors claim that the SBA's denial of PPP loans to a person solely because it is a debtor is improper discrimination prohibited by section 525(a).
In response, the SBA has argued, inter alia, that bankruptcy courts do not have subject matter jurisdiction or constitutional authority to rule on the claims concerning access to PPP loans asserted by debtors, that the Anti-Injunction Act, 15 U.S.C. § 634(b)(1), prohibits the court from entering a temporary restraining order or other injunctive relief against the SBA, and that neither section 525(a) nor any other provision of the Bankruptcy Code prohibits a governmental unit from denying a loan to or refusing to guarantee a loan on behalf of a debtor.
The arguments for and against the entry of injunctive relief have met with varied success. On April 24, 2020, the Bankruptcy Court for the Western District of Texas was the first to enter an order on behalf of a debtor, in that case Hidalgo County Emergency Service Foundation. The order temporarily restrains the SBA and any lender acting in concert with it from rejecting an application by Hidalgo based on the "presently involved in any bankruptcy" requirement and ordering that the PPP application be considered with those words stricken from the form. In so ruling, the Texas bankruptcy court found that it had jurisdiction and constitutional authority to rule on Hidalgo's application. It further found that the PPP is more in the nature of a governmental grant in this time of economic crisis and not a true "loan," given that neither the CARES Act nor the SBA required any proof of creditworthiness, the provision of collateral or even any diligence that the information submitted in an application was correct. As such, it found that there was a likelihood that Hidalgo could show that the requirement that a PPP applicant not be "presently involved in a bankruptcy" violates section 525(a). While the Texas bankruptcy court acknowledged that it had concerns about the effect of the Anti-Injunction Act, it ultimately found that the act did not apply in circumstances where the SBA's actions violate section 525(a). As such, it entered the requested temporary restraining order against the SBA and any lender acting with it, and set a further hearing in the case for May 8, 2020.4
In addition to the temporary restraining order entered by the Texas bankruptcy court in Hidalgo, the U.S. Bankruptcy Courts for the Districts of Vermont and Maine have entered similar orders temporarily restraining the SBA and other entities acting in concert with the SBA from refusing to grant or guarantee a PPP loan solely on the grounds that the relevant debtor is a debtor in a bankruptcy case. The courts are requiring that the SBA reserve sufficient funds to honor a PPP loan application in the event that the debtor ultimately is successful and setting follow-up hearings. Also, the court found that PPP loans are more akin to an aid grant than a loan, so the debtor had demonstrated a likelihood that it would be able to show that the SBA's refusal to make such loans available to a debtor in bankruptcy would violate section 525(a).5 Hearings are scheduled to take place during the coming two weeks in cases seeking similar relief brought by debtors the Diocese of Rochester and the Diocese of Buffalo N.Y., which filed a joint complaint in the U.S. District Court for the Western District of New York; Starplex Corp., which filed an adversary proceeding in the U.S. Bankruptcy Court for the District of Arizona; and Organic Power LLC, which filed an adversary proceeding in the U.S. Bankruptcy Court for the District of Puerto Rico.
By contrast, the U.S. Bankruptcy Court for the District of Delaware denied a similar application for a temporary restraining order filed by debtor Cosi Inc. The Delaware court indicated that while it disagreed with the SBA's decision to exclude debtors, it would not tell the SBA how to administer the PPP.6 The U.S. Bankruptcy Court for the Western District of Kentucky likewise denied an application by debtor Village East Inc. to compel its lender to turn over PPP loan proceeds that the debtor had applied and received approval for immediately before it filed its bankruptcy petition, but which had not yet been disbursed as of the petition date.7
Even in the cases in which courts have granted a temporary restraining order, the debtors must still show that they otherwise are qualified to receive a PPP loan and establish their cases on a preliminary and final basis before they receive any funding. They also must find a bank willing to cooperate with them in submitting an application for a PPP loan on behalf of a debtor.8 In addition, it remains unclear if the SBA will continue to oppose these proceedings or will alter its position in the face of continued criticism by courts, including by at least one court, the Bankruptcy Court for the District of Delaware, that ultimately determined not to overrule the SBA's position. The SBA also may simply be able to run out the clock on new cases given that there has only been a limited amount of financing authorized by Congress for the PPP to date.
Holland and Knight's Bankruptcy, Restructuring and Creditors' Rights Group is working closely with the firm's COVID-19 Response Team to keep clients apprised of developments in this rapidly changing program. Our team is here to assist you in responding and addressing any concerns.
1 See In re TooJay's LLC, Chapter 11 Case No. 20-14792 (Bankr. S.D. Fla.), Declaration of Edward Maxwell Piet in Support of the Debtors' Chapter 11 Petitions and First Day Motions, dated April 30, 2020 at 14 [dkt. #12].
2 See, e.g., In re Capital Restaurant Group, LLC, chapter 11 case No. 19-65910 (Bankr. N.D. Ga.), Order Dismissing Chapter 11 Case with Prejudice dated April 28, 2020 [dkt. #192]; In re Advanced Power Technologies, LLC, chapter 11 case no. 20-13304 (Bankr. S.D. Fla.), Order Granting Debtor's Emergency Motion to Voluntarily Dismiss Case Without Prejudice and Shortening Notice Period, dated April 24, 2020 [dkt. # 60].
3 See In re Capital Restaurant Group, LLC, chapter 11 case No. 19-65910 (Bankr. N.D. Ga.), Order Dismissing Chapter 11 Case with Prejudice dated April 28, 2020 [dkt. #192] (Court dismissed case with prejudice and ordered that debtor could not refile for a period of one year following the dismissal).
4 See Hidalgo County Emergency Service Foundation v. Jovita Carranza, Adversary Pro. No. 20-02006 (Bankr. W.D. Tx.), Transcript of April 24, 2020, Hearing.
5 See Penobscott Valley Hospital v. Jovita Carranza (In re Penobscott Valley Hospital), Adv. Pro. No. 20-1005 (Bankr. D. Me.), Temporary Restraining Order dated May 1, 2020 [dkt. #18]; Calais Regional Hospital v. Jovita Carranza (In re Calais Regional Hospital), Adv. Pro. No. 20-1006, (Bankr. D. Me.), Temporary Restraining Order dated May 1, 2020 [dkt. # 21]; Springfield Hospital, Inc. v. Jovita Carranza (In re Springfield Hospital, Inc.), Adv. Pro. No. 20-01003 (Bankr. D. Vt.), Order Granting Plaintiff's Emergency Motion For Temporary Restraining Order and Setting Status Conference on the Plaintiff's Request For a Preliminary Injunction, dated May 4, 2020 [dkt. # 19].
6 See Law360, "Bankrupt Cosi Loses Bid To Seek Small-Business Virus Funds," dated April 30, 2020.
7 In re Village East, Inc., Chapter 11 Case No. 20-31144 (Bankr. W.D. Ky.), Order dated April 22, 2020 [dkt. # 31].
8 For example, debtor Hidalgo issued a press release indicating that it has not been able to locate a bank that will submit an application for a PPP loan to the SBA on Hidalgo's behalf, notwithstanding the Texas bankruptcy court's order.
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