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Law360 (May 7, 2020, 5:46 PM EDT )
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| Shane Ramsey |
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| John Baxter |
The loans may also be used for payment of interest on mortgages, rent and utilities. The PPP loans are capped at $10 million for each small business. The Small Business Administration, or SBA, administers the PPP with support from the U.S. Department of the Treasury.
The PPP application includes a bankruptcy barrier notably absent from the CARES Act.
The CARES Act is notably silent on the issue of whether PPP loans are available to companies that are currently under active bankruptcy protection. Despite this silence, the PPP application requires the applicant to state whether they are presently involved in active bankruptcy.
If the applicant answers "yes" to this question, the application will be automatically denied. Because the application includes a bankruptcy restriction absent from the provisions of the CARES Act, debtors whose applications have been denied on this ground have taken to the bankruptcy courts to resolve this inconsistency.
Hidalgo paves the way for debtors to seek loans despite the language of the application.
The first court to hear and rule on the issue was the U.S. Bankruptcy Court for the Southern District of Texas in the case In re: Hidalgo County Emergency Service Foundation.[1]
In Hidalgo, U.S. Bankruptcy Judge David Jones entered a temporary restraining order, or TRO, on April 25 enjoining the SBA from denying the debtor's PPP application on the sole basis that the debtor was in bankruptcy.
The primary justification for the Hidalgo court's ruling was two-fold: (1) that the debtor was likely to succeed in its claim that the SBA had exceeded its statutory authority by including a bankruptcy-specific bar that was not included in the CARES Act; and (2) that the debtor was likely to succeed on its claim that allowing lenders to deny a PPP loan application solely on the grounds of the debtor's bankruptcy case would violate section 525(a) of the Bankruptcy Code.
Section 525(a) provides that "a governmental unit may not deny, revoke, suspend or refuse to renew a license, permit, charter, franchise or other similar grant to ... a person that is or has been a debtor under this title or a bankrupt or debtor under the Bankruptcy Act ... solely because such bankrupt or debtor is or has been a debtor under this title or ... the Bankruptcy Act."
At the hearing in Hidalgo, Judge Jones made clear that he was not buying the SBA's argument that the issuance of PPP loans to debtors would result in a situation where it was highly unlikely that the funds issued would either be used for an improper purpose or otherwise unlikely to be repaid.
Judge Jones noted that this argument was "so out of context in this program that it's a frivolous argument." This was so, according to Judge Jones, because the PPP program was not a "loan program," but a "support program." As such, the argument that extending the loans to debtors would result in a position where they were unlikely to be repaid was inapposite to the purpose behind the enactment of the PPP.
The SBA enacted a new interim final rule that could limit further debtor requests.
On April 24, one day prior to the Hidalgo decision, the SBA released a new interim final rule that expressly included a section providing that debtors in bankruptcy could not be eligible for PPP loans. This rule expressly incorporated the SBA's argument in Hidalgo that "providing PPP loans to debtors in bankruptcy would present an unacceptably high risk of an unauthorized use of funds or nonrepayment of unforgiven loans." This interim final order was published and, thus, effective as of April 28.
In addition to the interim final rule, the SBA also enacted a separate interim final rule that caps the total amount of PPP loans for affiliated entities at $20 million. Under this rule, companies that are directly or indirectly majority-owned by a common parent are limited to the aggregate $20 million cap — equal to two full $10 million PPP loans.
The combination of these two rules adds additional layers to future PPP litigation in bankruptcy courts. Despite the Hidalgo court's clear admonition of the high risk of nonrepayment argument, the SBA has now incorporated that rationale into a rule that, on its face, bars the availability of PPP loans to debtors.
In addition, the aggregate cap on affiliates' loans will reduce the availability of PPP loans to debtors in consolidated cases, even where they are able to get past the initial hurdle of the new rule barring debtors from PPP loans altogether.
Bankruptcy courts are not uniformly following the SBA's guidance.
Since the entry of both the Hidalgo decision and the new interim final rule, courts are split as to how to treat the debtors' requests for TROs regarding PPP loans. At least one court — critically for bankruptcy practitioners, the U.S. Bankruptcy Court for the District of Delaware — has rejected the Hidalgo precedent in deference for the SBA's new interim final order.
In In re: Cosi Inc.,[2] U.S. Bankruptcy Judge Brendan Shannon denied the debtor's request for a TRO, stating that although he was dismayed at the potential negative consequences of the SBA's refusal to grant debtors access to PPP funds, he was nevertheless going to defer to the SBA as to how the loans were to be disbursed.
Conversely, a number of courts are continuing to impose TROs despite the new interim final rule. For example, in In re: Calais Regional Hospital, U.S. Bankruptcy Judge Michael Fagone of the U.S. Bankruptcy Court for the District of Maine entered a TRO similar to the Hidalgo TRO on May 1.
The Calais court focused primarily on the Section 525(a) analysis, noting that although loans are not traditionally covered by the section, the PPP loans under the CARES Act could qualify as an "other similar grant" of aid sufficient to fall within the confines of the statute. Accordingly, the Calais court allowed the Debtor to seek PPP loans despite the interim final order being in place.
Similarly, in In re: Springfield Hospital Inc., U.S. Bankruptcy Judge Colleen Brown of the U.S. Bankruptcy Court for the District of Vermont entered a TRO on May 4 based on her conclusion that the SBA was likely in violation of Section 525(a) because the PPP constitutes a "grant of economic aid in response to the pandemic."
Debtors' counsel must remain vigilant on these issues.
Given the dynamic and fluid nature of this situation, debtors' counsel for small businesses should keep an ear to the ground on this issue to ensure that they are providing their clients with the best advice possible in this ever-changing landscape. It appears that as more and more cases are resolved, a trend may emerge either in favor of or against the allowance of PPP loans to debtors.
It appears that at the moment, the debtors are coming out ahead more than behind, but now that at least one court — the District of Delaware no less — has given deference to the SBA, there is still no consensus.
Shane Ramsey is a partner and vice chair of the bankruptcy and financial restructuring practice group at Nelson Mullins Riley & Scarborough LLP.
John Baxter is an associate at the firm.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] In re: Hidalgo County Emergency Service Foundation, Case No. 19-20497.
[2] In re: Cosi Inc. (Case No. 20-10417).
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