Howard M. Berkower
Partner
McCarter & English, LLP
Franklin Barbosa Jr.
Attorney
McCarter & English, LLP

The Small Business Administration recently published new guidance declaring Chapter 11 debtors with confirmed plans eligible for Paycheck Protection Program loans. The new guidance creates an exception to the SBA’s blanket rule that any entity “presently involved” in bankruptcy is not eligible for PPP funds.

The PPP and the Bankruptcy Exclusion

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) created the PPP under Section 7(a) of the Small Business Act, which authorizes the SBA to guarantee loans to qualified small businesses with the goal of helping them keep their employees working during the COVID-19 pandemic. While the CARES Act eliminated the traditional Section 7(a) loan requirement that a business demonstrate it was unable to obtain credit from commercial sources in favor of a good-faith representation that “the current economic uncertainty makes the PPP loan request necessary to support its ongoing operations” absent statutory direction to the contrary, the SBA treated the PPP like any other 7(a) loan by requiring an applicant to not be “presently involved in any bankruptcy.” Many lenders adhered to the bankruptcy exclusion and denied PPP loans to bankruptcy debtors.

Debtors across the country challenged the bankruptcy exclusion and filed lawsuits against the SBA seeking to prevent its enforcement. In response to those actions, the SBA aggressively defended its authority to issue the exclusion and extolled the alleged public policy virtues of precluding bankruptcy debtors from the benefits of PPP funding. The outcomes of the lawsuits varied significantly. Some courts declined to enforce the exclusion because they found that either the SBA exceeded its rulemaking authority or the exclusion violated the anti-discrimination provisions of 11 U.S.C. § 525. Meanwhile, other courts sided with the SBA and multiple courts allowed debtors to take advantage of certain loopholes affecting the exclusion, such as by permitting debtors to voluntarily dismiss their cases in order to apply for PPP funding and then reopen the previously dismissed case. (See our related alert here.)

Debtors initially thought they had obtained a victory when the Consolidated Appropriations Act of 2021 (CAA) was signed into law on Dec. 27, 2020. The CAA sought (1) to amend the Bankruptcy Code to permit certain debtors — those filing under Subchapter V, Chapter 12 and Chapter 13 — to obtain PPP funds and (2) to protect lenders by treating unforgiven PPP loans as super-priority administrative expense claims under sections 364(c)(1) and 503(b) of the Bankruptcy Code. However, these provisions were contingent on the SBA providing a written determination to the Office of the U.S. Trustee that bankruptcy debtors are eligible for PPP loans. The SBA never made such a determination.

The SBA’s Updated Guidance

Although the SBA still maintains that debtors “presently involved” in bankruptcy proceedings are not eligible for PPP loans, the SBA has now narrowed the scope of the bankruptcy exclusion. Specifically, on April 6, the SBA published question 67 of its “frequently asked questions,” which asks when an entity is “no longer considered to be ‘presently involved in any bankruptcy’ for PPP loan eligibility purposes.” The SBA’s answer to that question, in relevant part, is as follows:

 [. . .] If an applicant or owner has filed a Chapter 11, 12 or 13 bankruptcy petition, the applicant or owner is considered to be “presently involved in any bankruptcy” for PPP eligibility purposes until the bankruptcy court has entered an order confirming the plan in the case. [. . .] The . . . order confirming the plan . . . must be entered before the date of the PPP loan application.

Thus, if a Chapter 11 debtor can achieve plan confirmation, it may apply for a PPP loan. While Chapter 11 debtors have cause to celebrate the SBA’s new guidance, they have a relatively short period of time within which to accomplish confirmation and apply for PPP funds. The application deadline is May 31 and that window may close even sooner if the program runs out of money.

Chapter 11 Debtors Will Be Off to the Races

Given the approaching PPP application deadline, current Chapter 11 debtors in need of PPP funds may seek to accelerate a prompt, consensual confirmation of their Chapter 11 plans. Chapter 11 debtors that have already filed their plans and have imminent confirmation hearing dates may pacify any potential objecting creditors to swiftly confirm their plan and submit a timely PPP loan application. For many Chapter 11 debtors, the SBA’s guidance comes too late, however. Chapter 11 debtors that have not yet filed a plan, have confirmation hearings scheduled after May 31 (the date on which the PPP application window closes, assuming it does not run out of funds) or expect protracted confirmation hearings will not be able to avail themselves of the expanded PPP loan eligibility.

Howard M. Berkower is a partner in the New York office of McCarter & English and a member of the firm’s corporate practice. He can be reached at hberkower@mccarter.com

Franklin Barbosa, Jr., an attorney in the Newark, NJ, office of McCarter, assists clients with a range of bankruptcy and commercial litigation matters. He can be reached at fbarbosa@mccarter.com.