The Paycheck Protection Program (PPP) is one of two business loan programs created under the Coronavirus Aid, Relief and Economic Security (CARES) Act to assist companies by extending potentially forgivable credit to small business employers. The PPP is designed to help cover employee-related expenses and help employers avoid layoffs. The prospect of forgivable debt, coupled with relatively favorable terms, have put PPP loans in high demand and many businesses, including some which had already sought chapter 11 bankruptcy protection, have sought PPP loans.
The CARES Act contains no bar to the granting of PPP loans to bankrupt companies. That said, section 7(a)(6) of the Small Business Act requires qualifying small business loans to be “of such sound value or so secured as reasonably to ensure repayment.” As a result, the U.S. Small Business Administration (SBA) took the initial position that a PPP loan must meet the same requirements, and a loan cannot meet this standard if the borrower is a debtor in a bankruptcy case.
The SBA further crystalized its position in updated Interim Final Rules, which confirmed that the SBA would deny PPP applications where the borrower or its owners are or become a debtor in a bankruptcy proceeding prior to funding. The SBA reasoned that bankruptcy presents an “unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans.” And in issuing its Interim Final Rules, the SBA asserted reliance upon the Bankruptcy Code’s policy against compelling an entity to make a loan or financial accommodation in bankruptcy.
In response, many troubled companies and nonproﬁts in pending chapter 11 cases—from rural hospitals and emergency health services, to Catholic dioceses, to sandwich shops—have filed lawsuits in courts across the U.S. seeking access to PPP loans. These companies, joined by legal experts and some members of Congress, rely on the language of the CARES Act itself to argue that businesses in chapter 11 should not be rendered ineligible for the emergency funding.
While the results have not been unanimous, several companies on the front lines of the pandemic response have recently won significant victories in bankruptcy court. Bankrupt debtors including Texas-based ambulance company Hidalgo County EMS (HCESF) (In re Hidalgo County Emergency Service Foundation, Adv. No. 20-02006 (Bankr. S.D. Tex.)), Calais Regional Hospital located in Maine (In re Calais Regional Hospital, Adv. No. 20-1006 (Bankr. D. Me.)), Penobscot Valley Hospital also in Maine (In re Penobscot Valley Hospital, Adv. No. 20- 1005 (Bankr. D. Me.)), and Springﬁeld Hospital in Vermont (In re Springfield Hospital, Inc., Adv. No. 20-1003 (Bankr. D. Vt.), have temporarily restrained the SBA from barring them from the PPP loan program because of their status as bankrupt debtors. Together, these four entities have sought a combined $10 million in PPP loans
The Trend of Recent Decisions Appears to Favor Debtors Against the SBA.
Blazing the trail, on April 24, the Chief Bankruptcy Judge sitting in Houston, Texas granted HCESF’s request for a temporary restraining order (TRO) against the SBA. HCESF sought entry of a TRO (which, by definition, is extraordinary relief for any court to grant) after its application was rejected due to HCESF’s status as a bankrupt debtor.
HCESF is the largest ambulance service in South Texas and employs about 250 people. The company ﬁled for chapter 11 protection in October 2019 after falling behind on debt and tax payments. HCESF was readying its plan to exit chapter 11 when Covid-19 hit the area, causing its call volumes to drop about 30%. The bankruptcy court ordered HCESF’s lender to disregard HCESF’s chapter 11 ﬁling when considering its PPP application and forcefully criticized the SBA for the position taken in its Interim Final Rules, opining that it “see[s] no authority anywhere for including those words [“presently involved in any bankruptcy”] …. It serves no purpose … [and] this can’t be what Congress intended.”
The court went on to explain that PPP loans, with favorable terms and potential loan forgiveness, are akin to a money grant which can’t be denied because of an applicant’s bankruptcy under section 525(a) of the Bankruptcy Code. Section 525(a) of the Bankruptcy Code provides, in pertinent part: “[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 this title … solely because such bankrupt or debtor is or has been a debtor under this title ….”
Similar TROs were entered on May 1 in favor of Penobscot Valley Hospital and Calais Regional Hospital in the United States Bankruptcy Court for the District of Maine. Both hospitals had been denied access to PPP loans because of their bankruptcy filings, and both debtors filed lawsuits requesting immediate relief as part of their Chapter 11 bankruptcy proceedings. The court there found that the SBA likely violated section 525(a) of the Bankruptcy Code by systematically denying PPP applications based only on a borrower’s bankruptcy. Additionally, on May 4, 2020, the bankruptcy court for the District of Vermont issued a TRO in favor of Springfield Hospital on similar grounds. In each of these cases, there are further status hearings set in May.
The Bankruptcy Court for the District of New Mexico went further—not only granting a preliminary injunction against the SBA in favor of the Archdiocese of Santa Fe, but also entering judgment against the SBA in the amount of the requested $900,000 in PPP loan funds. (In re Roman Catholic Church of the Archdiocese of Santa Fe, Adv. No. 20-1026 (Bankr. D.N.M.)). The court there opined: “[w]ith only the flimsiest of justifications [the SBA] took one of many underwriting criteria from its ‘normal’ loan programs (bankruptcy status of the borrower), changed it to an eligibility condition, and then applied it to an emergency grant program where it clearly had no place. [The SBA’s] inexplicable and highhanded decision to rewrite the PPP’s eligibility requirements in this way was arbitrary and capricious, beyond its statutory authority, and in violation of 11 U.S.C. § 525(a).”
Some Recent Decisions Have Gone Against Debtors and In Favor of the SBA.
Importantly, the TROs described above only apply to those debtors’ loan applications, and have no broader controlling effect on any other courts, or even on other cases in those same courts. In fact, the Boston-based restaurant chain Così Inc., which filed for bankruptcy protection on February 25, 2020, lost its own motion for a TRO on April 30. (In re Cosi, Inc., Adv. No. 20-50591 (Bankr. D. Del)). In the Così case, the court cited the Texas court’s decision above in denying Cosi’s motion. While noting that it disagreed with the SBA’s decision and was dismayed at the harm it would cause, the court concluded that it lacked the authority to enter a temporary restraining order.
What Comes Next?
The future of this fight remains unwritten. Some decisions have given hope to debtors, while others have denied the same relief. It remains to be seen whether the SBA will hold fast—or even be permitted to hold fast—to its position, or if it might craft yet more “final interim” rules to cement its policy against debtor eligibility for PPP loans.
And what will happen once PPP money runs out? Given current economic conditions, we expect these programs to continue to be important and effective government responses to the financial distress affecting all businesses.
As always, you should seek competent business restructuring counsel if you are interested in learning more about the PPP loan program, even if your company is (or soon could be) in bankruptcy.
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