junio 26 2020

Continued Uncertainty Regarding Whether Companies in Bankruptcy Are Eligible for PPP Loans Under the US CARES Act

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As discussed in earlier posts,1 substantial uncertainty exists over whether companies in bankruptcy are eligible to pursue funding pursuant to the SBA’s Paycheck Protection Program, or PPP, which was established by the CARES Act to support small businesses by offering SBA-guaranteed loans on advantageous terms. Litigation has ensued, with jilted companies looking to restructure in bankruptcy challenging the SBA’s ability to block their loan requests. Recent decisions in certain of those actions have, to date, yielded a mixed bag, leading to increasing uncertainty in some jurisdictions and much-needed (if bleak) clarity in others. Of particular note, the Fifth Circuit Court of Appeals recently came down in favor of the SBA’s position likely strengthening the SBA’s stance in other cases.

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Brief Recap Regarding the PPP and the SBA Bankruptcy Restriction

The CARES Act does not expressly provide that companies in bankruptcy are ineligible to receive PPP loans; instead, the CARES Act is silent on the issue. Nonetheless, the SBA has sought to prohibit bankrupt debtors from accessing PPP funding by (i) requiring participating lenders to use an SBA-sponsored loan application that, on its face, disqualifies businesses already in bankruptcy, and (ii) issuing administrative guidance—in the form of an interim final rule—expressly providing that companies in bankruptcy are ineligible to participate in the PPP (the “Interim Final Rule”).2 Following codification of the SBA’s bankruptcy restriction vis-à-vis the Interim Final Rule, businesses that otherwise would have been eligible for PPP loans (but for the Interim Final Rule) have turned to bankruptcy courts for clarity in their pursuit of potentially entity-saving PPP funds.

These businesses have sought various forms of relief in connection with their eligibility-related challenges against the SBA, including, but not limited to, (i) injunctive relief, such as temporary restraining orders and preliminary or permanent injunctions, to enjoin the SBA from denying PPP loan applications on the sole basis of the applicant’s pending bankruptcy cases,3 (ii) authority to incur unsecured postpetition financing in connection with a PPP loan,4 and (iii) standing to pursue an adversary action (or a civil action separate and apart from an underlying bankruptcy case) against the SBA for compensatory damages resulting from the delay and inaccessibility to limited funds, as applicable, caused by the SBA’s application denial pursuant to the bankruptcy restriction.5 In adjudicating such challenges, bankruptcy courts have not taken consistent approaches and, thus, have rendered inconsistent decisions supported by differing rationale with respect to the same eligibility-related issues. As discussed in greater detail in earlier posts,6 two bankruptcy cases pending in two of the nation’s busiest and most prominent bankruptcy courts offer a dynamic illustration of this inconsistency.

On the one hand, the U.S. Bankruptcy Court for the Southern District of Texas—which was the first bankruptcy court to address the eligibility issue in Hidalgo Cnty. Emergency Serv. Found. v. Carranza (In re Hidalgo Cnty. Emergency Serv. Found.), Case No. 19-20497, Adv. P No. 20-2006 (Bankr. S.D. Tex. 2020) (“Hidalgo I”)—entered a preliminary injunction enjoining the SBA from denying the debtor’s PPP application after ruling that the SBA cannot deny access to PPP loans on the sole basis of the debtor’s status in bankruptcy. In so ruling, Chief U.S. Bankruptcy Judge David Jones reasoned that, because the PPP is not a traditional “loan program” but a “support program” enacted to provide essential credit to qualifying small businesses, the public interest would be better served by allowing bankrupt companies, such as the health care service provider in Hidalgo, to access PPP loans.7 On the other hand, the U.S. Bankruptcy Court for the District of Delaware in Cosi, Inc., et al. v. U.S. Small Business Administration, et al. (In re Cosi, Inc., et al.), Case No. 20-10417, Adv. P. No. 20-50591 (Bankr. D. Del. Apr. 30, 2020), denied the debtors’ request for entry of a temporary restraining order in deference to the SBA’s rule-making authority, reasoning that the plain meaning of the Interim Final Rule prohibited bankrupt debtors from accessing PPP funding and, more notably, that the Bankruptcy Court did “not have the statutory power to enjoin” the SBA.8

Recent Developments

Shortly after the U.S. Bankruptcy Court for the Southern District of Texas sided with the debtor in Hidalgo I, the SBA appealed to the U.S. District Court for the Southern District of Texas, which then stayed the preliminary injunction and certified the case for direct appeal to the U.S. Court of Appeals for the Fifth Circuit. The Fifth Circuit granted the request for a direct appeal and, on June 22, 2020, vacated the bankruptcy court’s preliminary injunction.9 According to the Fifth Circuit, the bankruptcy court exceeded its authority when it ordered the SBA to process the debtor’s PPP loan application without considering the debtor’s pending bankruptcy because applicable circuit precedent expressly and absolutelyprohibits all injunctive relief directed at the SBA. Specifically, the Fifth Circuit’s opinion in Hidalgo II provides, in pertinent part, that:

The issue at hand is not the validity or wisdom of the PPP regulations and related statutes, but the ability of a court to enjoin the [SBA], whether in regard to the PPP or any other circumstance. Because, under well-established Fifth Circuit law, the bankruptcy court exceeded its authority when it issued an injunction against the SBA [sic], we VACATE its preliminary injunction.

Hidalgo II, at *2. In addition, the Fifth Circuit expressly rejected the debtor’s request to make an exception to the Fifth Circuit’s “absolute prohibition” in light of the extreme facts and highly-compressed time frame presented by the COVID-19 pandemic, the debtor’s bankruptcy, and the potential exhaustion of available PPP funds.

Accordingly, it appears that bankruptcy courts in the Fifth Circuit are now charged with changing course and adopting the rationale initially set forth by the U.S. Bankruptcy Court for the District of Delaware in Cosi. Further, as it concerns small business debtors with bankruptcy cases pending in the Fifth Circuit, the viability of any challenge against the SBA’s bankruptcy restriction is now bleak—at least with respect to challenges seeking any form of injunctive relief against the SBA.

Conclusion

While Hidalgo II is binding on all bankruptcy courts in the Fifth Circuit, it remains to be seen whether its holding will have lasting ramifications elsewhere, as many adversary proceedings and other similar actions across the county remain pending and ripe for adjudication. In fact, since the Hidalgo II was handed down on June 22, several additional debtors have commenced new adversary proceedings seeking similar injunctive relief against the SBA.10

If the past few months are any indication, small business debtors in need of life-saving capital likely will go to great lengths in their pursuit of PPP funds. Indeed, it has been reported that counsel to the debtor in Hidalgo has no plans on quitting any time soon, as the company is reportedly considering requesting an en banc review of the Fifth Circuit’s ruling in Hidalgo II and is also preparing to head back to bankruptcy court for a trial on the merits.


1 See Paycheck Protection Program Loans and DIP Financing (Apr. 30, 2020); see also Are Companies in Bankruptcy Eligible for PPP Loans under the US Cares Act? (May 15, 2020).

2 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), effective April 24, 2020. 

3 See, e.g., Hidalgo Cnty. Emergency Serv. Found. v. Carranza (In re Hidalgo Cnty. Emergency Serv. Found.), Case No. 19-20497, Adv. P No. 20-2006 (Bankr. S.D. Tex. 2020); Roman Catholic Church of the Archdiocese of Santa Fe v. U.S. Small Business Administration, et al. (In re Roman Catholic Church of the Archdiocese of Santa Fe), Case No. 18-13027, Adv. P. No. 20-01026 (Bankr. D. N.M. 2020); Calais Reg’l Hosp. v. Carranza (In re Calais Reg’l Hosp.), Case No. 19-10486, Adv. P. No. 20-1006 (Bankr. D. Me. 2020); Penobscot Valley Hosp. v. Carranza (In re Penobscot Valley Hosp.), Case No. 19-10034, Adv. P. No. 20-1005 (Bankr. D. Me. 2020); Springfield Hosp., Inc. v. Carranza (In re Springfield Hosp., Inc.), Case No. 19-10283, Adv. P. No. 20-01003 (Bankr. D. Vt. 2020); Cosi, Inc., et al. v. U.S. Small Business Administration, et al. (In re Cosi, Inc., et al.), Case No. 20-10417, Adv. P. No. 20-50591 (Bankr. D. Del. 2020); Starplex Corp., et al. v. Carranza (In re Blue Ice Inv., et al.), Case No. 20-02208, Adv. P. No. 20-00095 (Bankr. D. Ariz. 2020); Organic Power LLC v. U.S. Small Business Administration, et al. (In re Organic Power LLC), Case No. 19-01789, Adv. P. No. 20-00055 (Bankr. D. P.R. 2020). 

4 See, e.g., In re Elemental Processing, LLC, Case No. 20-50640 (Bankr. E.D. Ky. 2020); In re TooJay’s Mgmt., LLC, Case No. 20-14792 (Bankr. S.D. Fla. 2020).

5 See, e.g., The Diocese of Rochester, et al. v. U.S. Small Business Administration, et al., Case No. 20-06243 (W.D.N.Y. 2020). 

6 See supra note 1 and accompanying links.

7 Many other bankruptcy courts imposed similar restrictions against the SBA on similar grounds. See, e.g., In re Calais Reg’l Hosp., Case No. 19-10486, Adv. P. No. 20-1006 (Bankr. D. Me. May 1, 2020); In re Penobscot Valley Hosp., Case No. 19-10034, Adv. P. No. 20-1005 (Bankr. D. Me. May 1, 2020); In re Springfield Hosp., Inc., Case No. 19-10283, Adv. P. No. 20-01003 (Bankr. D. Vt. May 4, 2020); In re Roman Catholic Church of the Archdiocese of Santa Fe, Case No. 18-13027, Adv. P. No. 20-01026 (Bankr. D. N.M. May 1, 2020).

8 Likewise, many other bankruptcy courts have issued decisions based on similar reasoning. See, e.g., Asteria Educ., Inc., v. Carranza (In re Asteria Educ., Inc.), Case No. 20-50169, Adv. P. No. 20-05024 (Bankr. W.D. Tex. Apr. 21, 2020); Schuessler, et al. v. U.S. Small Business Administration, et al. (In re Schuessler, et al.), Case No. 20-02065-BHL, 2020 WL 2621186 (Bankr. E.D. Wis. May 22, 2020).

9 See generally In re Hidalgo Cnty. Emergency Serv. Found., Case No. 20-40368, 2020 WL 3411190 (5th Cir. June 22, 2020) (“Hidalgo II”). 

10 See, e.g., USA Gymnastics v. U.S. Small Business Administration, et al. (In re USA Gymnastics), Case No. 18-09108, Adv. P. No. 20-50055 (Bankr. S.D. Ind. 2020); iThrive Health, LLC v. Carranza (In re iThrive Health, LLC), Case No. 19-25413, Adv. P. No. 20-00151 (Bankr. D. Md. 2020); Aspen Landscaping Contracting, Inc. v. U.S. Small Business Administration, et al. (In re Aspen Landscaping Contracting, Inc.), Case No. 19-31885, Adv. P. No. 20-01277 (Bankr. D. N.J. 2020); Henry Anesthesia Associates, LLC v. Carranza (In re Henry Anesthesia Associates, LLC), Case No. 19-64159, Adv. P. No. 20-06084 (Bankr. D. Ga. 2020).

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