Emergency Relief – Bankruptcy Courts Grant Debtors Relief in Fight Against SBA’s Refusal to Provide PPP Loans

Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, qualifying businesses may seek up to $10 million under the Paycheck Protection Program (PPP) for funding payroll and business expenses. The US Small Business Administration (SBA) guarantees the loans, and the full principal amount of the loans and any accrued interest may qualify for loan forgiveness. For many businesses, PPP loans have served as a lifeline during the COVID-19 pandemic.

However, in an Interim Final Rule issued by the SBA on April 24, 2020, the SBA stated that businesses involved in bankruptcy proceedings are not eligible to receive PPP loans, because providing PPP loans to bankrupt businesses “would present an unacceptably high risk of an unauthorized use of funds or non-payment of unforgiven loans.”[1]  Specifically, the Interim Final Rule states that if an applicant, or the owner of an applicant, for a PPP loan is a debtor in a bankruptcy proceeding, either when its application is submitted or at any time before the PPP loan is disbursed, that applicant is ineligible to receive the PPP loan. The Interim Final Rule does not address a bankruptcy filing by a company that has already received a PPP loan.

Several businesses in Chapter 11 bankruptcy have now sought court orders determining that the SBA’s rule against making PPP loans to companies in bankruptcy is arbitrary and capricious, exceeded the SBA’s statutory authority, and violates the Bankruptcy Code’s anti-discrimination provisions. In two recent cases, these businesses were successful.

On May 1, 2020, the United States Bankruptcy Court for the District of New Mexico granted debtor Roman Catholic Church of the Archdiocese of Santa Fe a preliminary injunction against the SBA.[2]  The church filed an application for a $900,000 PPP loan on April 20, 2020, having previously filed a petition for relief under Chapter 11 of the Bankruptcy Code on December 3, 2018. On April 28, 2020, the church filed a motion for approval of the PPP loan as post-petition financing under section 364 of the Bankruptcy Code. At this time, the SBA made a final determination that the church was ineligible for a PPP loan because it is a debtor in a pending bankruptcy proceeding. The church then filed for a preliminary injunction against the SBA. In granting the preliminary injunction, the bankruptcy court remarked that “[w]ith only the flimsiest of justifications Defendant [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. Defendant [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).”[3]  The bankruptcy court went on to invite the church to pursue an adversary proceeding against the SBA if it did not receive its PPP loan—including pursuing punitive damages.

Similarly, on May 4, 2020, the Bankruptcy Court for the District of Vermont granted an emergency temporary restraining order in favor of debtor Springfield Hospital, Inc.[4]  At the outset, the bankruptcy court addressed, and cast aside, the SBA’s threshold sovereign immunity argument. The bankruptcy court concluded that it is authorized to enter “carefully tailored injunctive relief” against the SBA, despite its status as a governmental entity. The bankruptcy court then turned to the hospital’s substantive argument—that the SBA’s Interim Final Rule impermissibly discriminates against bankrupt businesses in violation of section 525 of the Bankruptcy Code. Like the bankruptcy court in In re Roman Catholic Church of the Archdiocese of Santa Fe, the court agreed that the PPP loan program falls within the purview of section 525, and that the SBA’s rule was thus impermissibly discriminatory against the hospital. However, the bankruptcy court narrowly tailored its ruling to this particular circumstance, avoiding a sweeping ruling that the Interim Final Rule generally is unenforceable. The bankruptcy court couched its narrow ruling, in part, on the critical role the hospital plays on the front lines of the COVID-19 pandemic and the public interest in granting the hospital access to PPP loan funds to continue its operations.

Other companies in Chapter 11 bankruptcy recently have sued the SBA seeking similar determinations, including Hidalgo County Emergency Service Foundation, Asteria Education Inc., Calais Regional Hospital in Maine, and restaurant chain Cosi Inc. in Delaware. The bankruptcy court overseeing Hidalgo’s case also sided with the company and entered a temporary restraining order permitting it to resubmit its PPP loan application with the phrase “presently involved in any bankruptcy” stricken from the application, and directing the lender and the SBA to consider the application on its merits.[5] 

There is no indication yet that the SBA will modify its Interim Final Rule in response to these decisions, but these recent decisions are a positive development for many small businesses that have already filed Chapter 11 bankruptcy. As bankruptcy courts continue to rule on this issue nationwide, lenders and debtors alike can look forward to additional clarity with respect to eligibility requirements for PPP loans and access to these critical funds.

[1] Interim Final Rule, ¶ 4.

[2] See Roman Catholic Church of the Archdiocese of Santa Fe v. United States of America Small Business Administration (In re Roman Catholic Church of the Archdiocese of Santa Fe), Adv. No. 20-1026 (Bankr. D. New Mexico, May 1, 2020) [Docket No. 15].

[3] Id.

[4] See Springfield Hospital, Inc. v. Jovita Carranza, in her capacity as Administrator for the U.S. Small Business Administration (In re Springfield Hospital, Inc.), Adv. No. 20-01003 (Bankr. D. N.H. May 4, 2020) [Docket No. 20].

[5] See Hidalgo County Emergency Service Foundation v. Jovita Carranza, in her capacity as Administrator for the United States Small Business Administration (In re Hidalgo County Emergency Service Foundation), Adv. No. 20-02006 (Bankr. S.D. Tex. April 25, 2020) [Docket No. 18].