By Rick Archer

Law360 (June 11, 2020, 4:22 PM EDT ) A New York federal judge has rejected a pair of Roman Catholic dioceses' challenge to a U.S. Small Business Administration rule barring coronavirus relief loans to bankrupt businesses, saying the agency was within its rights to deny them $2.8 million in loans.

On Wednesday, U.S. District Judge Elizabeth Wolford rejected the arguments by the bankrupt Catholic dioceses of Buffalo and Rochester, New York, that the SBA had no legal grounds for its rule denying Paycheck Protection Program loans to organizations in Chapter 11, saying the agency is under a legal requirement to make sure its loans are likely to be repaid.

The PPP, created under March's coronavirus relief package, is an SBA-administered program that offers loans of up to $10 million from third-party lenders to firms with 500 or fewer employees to cover their costs while they are shuttered by local COVID-19 shutdown orders.

In April, the SBA issued a rule that companies in bankruptcy are ineligible for the program.

In their court papers, the dioceses said they applied for more than $2.8 million in loans — arguing that with their churches closed by state order, donations by parishioners were down by more than 90% — but were denied on the grounds that they were in Chapter 11.

The Rochester diocese entered Chapter 11 in September and the Buffalo diocese in February. Both were facing multiple lawsuits alleging sexual abuse by clergy.

The dioceses filed suit against the SBA in April, arguing that the coronavirus relief package does not authorize the SBA to deny PPP participation to bankrupt organizations that meet the number of employees requirement and does mention bankruptcy in its list of participation conditions.

The dioceses noted in their filings that in April, a Michigan judge had issued a preliminary injunction ordering the SBA to give a PPP loan to a strip club, saying the relief package authorizes participation for "any" business and that the club was likely to prevail in its argument that the agency had exceeded its authority when it implemented a rule barring businesses of a "prurient sexual nature" from the program.

However, Judge Wolford said the relief legislation, known as the CARES Act, acknowledges the existence of criteria beyond the size requirement by expressly waiving them, and that the SBA is under a separate statutory requirement to ensure its small business loans are of "sound value."

"The court will not presume that simply by using the phrase 'any business' concern in one part of the CARES Act, Congress meant to implicitly eliminate the long-standing statutory requirements for Section 7(a) loans," Judge Wolford said.

The diocese had also argued the bankruptcy code bars government agencies from using bankruptcy to deny a "license, permit, charter, franchise, or other similar grant," but Judge Wolford said the PPP is a loan program, not a grant.

"It is also true that Congress provided for loan forgiveness if the funds are used in certain ways, but the loan forgiveness is just that — it is a loan forgiveness," the judge said.

Counsel for the dioceses and representatives of the SBA did not immediately respond to requests for comment.

The dioceses are represented by Stephen A. Donato, Charles J. Sullivan and Brian Butler of Bond Schoeneck & King PLLC.

The SBA is represented by Ruth A. Harvey, Margaret Newell and Kevin P. VanLandingham of the U.S. Department of Justice, Commercial Litigation Branch.

The case is Diocese of Rochester et al. v. U.S. Small Business Administration, case number 6:20-cv-06243, in the U.S. District Court for the Western District of New York.

--Editing by Nicole Bleier.

For a reprint of this article, please contact reprints@law360.com.