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Confusion in Bankruptcy Courts Regarding Debtor Eligibility for PPP Loans

June 23, 2020
Bankruptcy Advisory

Business Law Advisory GraphicThe Small Business Administration's (SBA) rules and regulations concerning the eligibility of businesses for Paycheck Protection Program (PPP) loans when the business is involved in bankruptcy have recently been a source of substantial uncertainty, with the nationwide split of authority in bankruptcy courts. While these cases deal with a very small minority of PPP recipients and are a relative novelty in that regard, these decisions could foretell future issues for companies who have received PPP loans but are later forced to file Chapter 11, specifically regarding their eligibility for loan forgiveness.

The SBA is enabled with emergency rulemaking authority to adopt rules and regulations to manage application and qualifications for PPP loans under the CARES Act. Pursuant to this authority, the SBA publishes Interim Final Rules (IFR). The SBA's April 28, 2020 IFR expressly disqualified applicants who are debtors in a bankruptcy proceeding at any time between the date of application and when the loan is disbursed.[1] Several companies in bankruptcy proceedings, whose loans have been denied, have challenged the SBA's rulemaking authority in this regard, leading to a nationwide split on this issue in bankruptcy courts.

Specifically, these courts have rendered opinions to decide whether the SBA can impose a policy disqualifying a business in bankruptcy proceedings from participating in the PPP and whether the SBA violates other laws for doing so.[2] More than a dozen cases have been decided in the last two months, with the recent decisions highlighting the confusion that bankruptcy courts face in discerning the intent of Congress and the purpose of the CARES Act.

In decisions amounting to a majority of court decisions to date, bankruptcy courts have ruled in favor of the debtor on the merits or a request for injunctive relief.[3] One decision in favor of the debtor, with detailed analysis, has been rendered in the In re Gateway Radiology Consultants, P.A. bankruptcy case. In that case, the bankruptcy court concluded that excluding Chapter 11 debtors conflicts with the intent of Congress and the purpose of the CARES Act. The bankruptcy court determined that collectability was not a criterion for a qualification which Congress intended to focus on and rejected the SBA's argument that debtors had a higher risk of misusing PPP funds for non-covered expenses.[4]

On the other hand, in a minority stance are bankruptcy courts that have found that the IFR is not in violation of the CARES Act, and that the SBA has not exceeded its statutory authority under the APA. Some of these courts point to the extreme urgency with which the CARES Act was enacted, which they say necessitated clarifying rulemaking, as well as the historical broad authority granted by Congress to the SBA which allows for such rulemaking in areas where the CARES Act is silent.[5]

Given the large number of PPP recipients and the potential for a dramatic increase in the number of companies forced to file for bankruptcy protection in the near future, the ultimate resolution of this issue may have significant implications for the future. Varnum will continue to follow the current case split, as well as their possible implications for other debtors that may have received a PPP loan pre-filing and will seek to have the loans forgiven as part of the Chapter 11 process.

[1] See Interim Final Rule, 13 C.F.R. Parts 120-21, Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility (RIN 3245-AH37), at p. 8-9.
[2] The laws invoked are under the Administrative Procedures Act (the "APA") 5 U.S.C. § 706(2)(C), APA 5 U.S.C. § 706(2)(A), and under the Bankruptcy Code's antidiscrimination provision, 11 U.S.C. § 525.
[3] In re Skefos, No. 19-29718-L, 2020 WL 2893413 (Bankr. W.D. Tenn. June 2, 2020) (order granting the Debtor's motion for PI); In re Gateway Radiology Consultants, P.A., No. 8:19-BK-04971-MGW, 2020 WL 3048197 (Bankr. M.D. Fla. June 8, 2020) (enjoining the SBA from disqualifying the Debtor and finding that the decision-making of the SBA was not reasoned); Diocese of Rochester v U.S. Small Bus. Admin., No. 6:20-CV-06243 EAW, 2020 WL 3071603 (W.D.N.Y. June 10, 2020).
[4] In re Gateway Radiology Consultants, P.A., No. 8:19-BK-04971-MGW, 2020 WL 3048197, at *15-17.
[5] Schuessler v United States Small Bus. Admin., No. AP 20-02065-BHL, 2020 WL 2621186 (Bankr. E.D. Wis. May 22, 2020) (denying declaratory and injunctive relief and dismissing the complaints in three consolidated Chapter 12 cases); In re iThrive Health, LLC, Adv. Pro. No. 20-00151 (Bankr. D. Md. June 8, 2020) (finding Debtor would not prevail on the merits and denying preliminary injunction; but granting Debtor's motion to dismiss the bankruptcy without disclosing if Debtor intends to move to reinstate the bankruptcy after PPP funding is approved as contemplated by Debtors in Arizona and S.D. Florida); In re Henry Anesthesia Assoc., 2020 WL 3002124 (Bankr. N.D. Ga. June 4, 2020).

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