Partner
McCarter & English
A recent bankruptcy court decision surprisingly reversed two earlier temporary restraining orders enjoining the Small Business Administration from enforcing its rule that a debtor in bankruptcy cannot qualify for a Paycheck Protection Program loan, and some courts have permitted end runs around the bankruptcy exclusion, empowering debtors to take advantage of those loopholes.
The SBA’s Bankruptcy Exclusion
program designed to help small businesses pay their employees during the COVID-19 pandemic. The PPP is 100% guaranteed under Section 7(a) of the Small Business Act. As with other 7(a) loans, the SBA made the approval of a PPP loan expressly contingent on the borrower not being “presently involved in any bankruptcy,” even though that requirement is not imposed by the CARES Act. Furthermore, and perhaps more importantly, unlike other 7(a) loans, PPP loans are to be completely forgiven if their proceeds are used to pay employees and permitted operating expenses. Indeed, the PPP was enacted in the belief
that more than a majority of the principal amount of these loans, initially $350 billion, would be forgiven and thereby repaid by the SBA.
Attorney
McCarter & English
Courts across the country are split on the enforceability of the PPP bankruptcy exclusion, with some ruling for debtors and others for the SBA. However, until recently, no court had reversed a prior ruling in favor of a debtor.
The debtors in Penobscot and Calais sought relief from the bankruptcy exclusion. Each of them had been denied access to PPP loan funds on account of their pending bankruptcies and alleged that the denial of their loan applications violated: 1) Section 525(a) of the bankruptcy code because the PPP is a “grant” program as opposed to a loan program, and in administering the grant, the SBA impermissibly discriminated against bankruptcy debtors; and 2) the Administrative Procedures Act (APA) because the SBA exceeded its rulemaking authority when it promulgated the bankruptcy exclusion.
For example, In re United States of America Rugby Football Union Ltd., the debtor rugby association was allowed to keep the PPP funds it had allegedly applied for prior to its bankruptcy filing — although the timing of the application was disputed by the SBA — and which had been funded while the debtor was in bankruptcy. The Bankruptcy Court for the District of Delaware ruled in favor of the debtor notwithstanding the factual dispute regarding the timing of the loan application and, by implication, the veracity of the debtor’s representations therein.
Uncertainty Reigns
Until there is greater certainty, if any comes at all, lenders should process PPP loan applications in accordance with the SBA’s rules governing eligibility, including the bankruptcy exclusion. Failure to follow the SBA’s rules may put a lender at risk of losing the SBA’s 100% guarantee, resulting in expensive litigation. In any event, lenders must be prepared to field questions from borrowers and to deal with the ambiguities of the PPP. •
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See Springfield Hosp., Inc. v. Carranza and USA Gymnastics v. U.S. Small Bus. Admin.
– By Howard M. Berkower (Partner, McCarter & English) and Franklin Barbosa Jr. (Attorney, McCarter & English)
