Alert04.27.2020

Bankruptcy Court Overrides SBA’s Prohibition Against Extending PPP Loans to Companies in Bankruptcy

by Irve J. Goldman

The Paycheck Protection Program is a federal loan program that was brought into law on March 27, 2020, by the Coronavirus Aid, Relief, and Economic Security Act, known as the “CARES Act.”  It provides for SBA-backed loans to small businesses for up to 2.5 times their average monthly payroll, up to $10 million (“PPP Loans”).  PPP loans may be fully forgiven if the money is used for payroll and related expenses (subject to certain caps), rent, utilities, and interest on debts incurred before February 15, 2020.

Since the CARES Act was passed into law, the SBA has required participating lenders to use an SBA-created loan application that would disqualify any small business in bankruptcy from receiving a PPP Loan.  Nothing in the CARES Act itself, however, prohibits debtors in bankruptcy from receiving PPP Loans.

On April 24, 2020, the SBA formalized its rule against lending to companies in bankruptcy with its Interim Final Rule on the Paycheck Protection Programs, which provides, in relevant part, that:

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 at 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.       

Even prior to the issuance of the Interim Final Rule, several Chapter 11 debtors challenged the SBA-imposed ban against extending these types of loans to bankrupt companies on the ground that it exceeded the SBA’s statutory authority and was in violation of section 525(a) of the Bankruptcy Code.  That section prohibits a governmental unit from denying “a license, permit, charter, franchise, or other similar grant” to a debtor in bankruptcy (emphasis added). 

On April 25, 2020, that specific challenge to the ban was upheld by the United States Bankruptcy Court for the Southern District of Texas in In re Hidalgo County Emergency Service Foundation, Case No. 19-20497, which issued a Temporary Restraining Order (TRO) prohibiting the SBA and the lender from declining the debtor’s PPP Loan application because the debtor was in Chapter 11 (Adv. No. 20-2006 (ECF No. 18)).  A further hearing is scheduled on May 8, 2020, since a TRO simply requires a likelihood of success on the merits.  Other similar legal challenges are underway in Arizona and New Mexico.  See In re Blue Ice Inv., LLC, Case No. 2:20-bk-2208-DPC, Adv. No. 2:20-ap-00095 (Bankr. D. Ariz.); In re Roman Catholic Church of the Archdiocese of Sante Fe, Case No. 18-13027, Adv. No. 20-1026 (Bankr. D.N.M.).

Another legal strategy that has been employed by debtors who have been shut out of the PPP loan program has been to move to voluntarily dismiss their Chapter 11 cases, with the objective of getting the PPP loan and then potentially refiling.  It has been successful in at least one bankruptcy case so far. See In Advanced Power Technologies, LLC, Case No. 20-13304-PGH, ECF No. 60 (Bankr. S.D. Fla. Apr. 24, 2020).

The SBA’s position appears to be somewhat self-defeating or at least dubious.  This is because a company that receives a PPP Loan and then files Chapter 11 can potentially treat the loan as a purely unsecured debt that can be discharged, whereas if such a loan could be obtained by a Chapter 11 debtor, it would enjoy at least administrative priority treatment.  That means it would have to be paid in full by the debtor in order to successfully emerge from Chapter 11. 

Irve J. Goldman is a member of the Bankruptcy and Creditors Rights Practice at Pullman & Comley, LLC, and has been certified as a business bankruptcy specialist by the American Board of Certification since 1993.  He can be reached at igoldman@pullcom.com.

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