SPECIAL REPORT: PPP Eligibility for Bankruptcy Debtors

The CARES Act enacted the Paycheck Protection Program (“PPP”), a “loan” program administered by the Small Business Administration (“SBA”). Under the PPP, loans will be fully forgiven if at least 75% of the loan amount is spent on payroll. The balance of the loan may be used to pay mortgage interest, rent, and utilities. Other conditions also apply and should be taken into account and are not the subject of this update.

The text of the CARES Act does not exclude companies in bankruptcy from receiving PPP loans. However, the SBA promulgated rules making the approval of any PPP loan contingent on the borrower not being “presently involved in any bankruptcy.” The application states if an applicant answers in the affirmative that “the loan will not be approved.”

Debtors in bankruptcy throughout the United States have started challenging the SBA’s rules by filing lawsuits in bankruptcy courts. Courts are currently split as to whether the SBA can bar debtors from obtaining PPP loans and the degree of relief from the SBA rules that debtors are afforded in bankruptcy court.

Hidalgo County Emergency Service Foundation (“Hidalgo”) filed a lawsuit against the SBA after Hidalgo’s bank rejected its request for a $2.6 million PPP loan because Hidalgo is a debtor in a bankruptcy proceeding. Hidalgo sought a restraining order (i) striking any references to bankruptcy from the PPP loan application; (ii) barring lenders from excluding debtors from PPP loan funds; and (iii) declaring the exclusion of bankruptcy debtors as unlawful discrimination. Hidalgo argued the SBA exceeded its authority by imposing a bankruptcy prohibition because the CARES Act does not contain such an exclusion, which is an unlawful discrimination under Section 525 of the Bankruptcy Code, 11 U.S. Code Section 525, which is intended to prevent discriminatory treatment of a person who is or was  bankrupt or a debtor under the Bankruptcy Code and states, in relevant part, 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 … a person that is or has been a debtor under [the Bankruptcy Code] … solely because such bankrupt or debtor is or has been a debtor under [the Bankruptcy Code].”

The South District of Texas Bankruptcy Court ruled in favor of Hidalgo and entered a temporary restraining order permitting it to resubmit its PPP loan application to any lender with the phrase “presently involved in any bankruptcy” stricken from the application. The temporary restraining order directs the lender and the SBA to consider Hidalgo’s application on its merits without any consideration of the bankruptcy filing. The Court found that the SBA does not have any authority under the CARES Act to impose a bankruptcy exclusion. The Bankruptcy Court also found that the SBA’s bankruptcy exclusion violates Section 525 because it impermissibly discriminates against bankruptcy debtors.

Similarly to the holding in Hidalgo, the Maine Bankruptcy Court entered a temporary restraining order barring the SBA from denying a PPP loan application because the applicant is a bankruptcy debtor. The Court required the SBA to hold back funds to make a “loan” if the debtor is later found to be eligible.

Thus far, the most favorable outcome for debtors was decided by the New Mexico Bankruptcy Court. In In re Roman Catholic Church of the Archdiocese of Santa Fe, the Court found that the SBA’s exclusion of bankruptcy debtors from the PPP violated Section 525(a) of the Bankruptcy Code. The Court also found it to be arbitrary and capricious under Section 706(2)(A) of the Administrative Procedure Act, 5 U.S. Code Section 706, which in part instructs courts reviewing regulations of an agency to invalidate those regulations found to be “arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law.”

In reaching its decision, the Court held that the PPP is not a loan program under which an applicant’s creditworthiness would be relevant. The Court found the PPP to be more like a grant, and stated that:

While a borrower’s bankruptcy status clearly is relevant for a normal loan program, the PPP is the opposite of that.  It is not a loan program at all.  It is a grant or support program. The statute’s eligibility requirements do not include creditworthiness.  Quite the contrary, the CARES Act makes PPP money available regardless of financial distress.  Financial distress is presumed.  Given the effect of the lockdown, many, perhaps most, applicants would not be able to repay their PPP loans.  They don’t have to, because the “loans” are really grants.  Repayment is not a significant part of the program.  That is why Congress did not include creditworthiness as a requirement.

Moreover, the Court found the SBA’s decision to exclude bankruptcy debtors from the PPP is arbitrary and capricious. “Given the obvious purpose of the PPP, it was arbitrary and capricious for Defendant to engraft a creditworthiness test where none belonged.” In agreement with Hidalgo, the Court found a violation of Section 525(a) of the Bankruptcy Code, but took it further in holding that if the SBA precluded the debtor from obtaining the $900,000 it requested, the debtor could file an adversary proceeding for compensatory and, if appropriate, punitive damages.

In contrast to Texas, Maine, and New Mexico, the Bankruptcy Court for the District of Delaware reached a different outcome. Cosi Inc. (“Cosi”) was also denied a PPP loan due to the SBA’s bankruptcy exclusion. Cosi filed suit against the SBA seeking an order enjoining the SBA from disqualifying Cosi from receiving PPP funds. Cosi and the SBA made similar arguments to those made in the aforementioned cases. Although the Delaware Bankruptcy Court disagreed with the SBA’s rules barring debtors from receiving PPP loan, it denied Cosi’s request for relief and found that it did not have the authority to enjoin the SBA from enforcing its rules.

Conclusion

Although the second round of funding for PPP loans has not yet been exhausted, bankruptcy debtors will need to act quickly to decide what strategy to employ in order to secure a PPP loan while cases continue to progress through the bankruptcy courts.

CONTACT

Robert D. Tepper, Esquire
rtepper@satclaw.com
mobile: (312) 303-3116

John W. Campbell, Jr., Esquire
jcampbell@satclaw.com
Mobile: (312) 391-3126

Websites:
https://satclaw.com/
https://www.satcsolutions.com/