One of the economic lifelines provided to struggling businesses by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) is the Paycheck Protection Program (“PPP”).1 Under the PPP, qualifying businesses can obtain up to $10 million in forgivable loans, which can be used on payroll expenses and, potentially, certain payments of mortgages, rents, and utilities. Although the CARES Act does not expressly exclude businesses in chapter 11 bankruptcy proceedings, the U.S. Small Business Administration (“SBA”), which administers the PPP, has determined that chapter 11 debtors do not qualify for PPP loans, given the “unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans.”2 Several chapter 11 debtors have taken issue with the SBA’s determination and sought bankruptcy court orders enjoining the SBA from disqualifying them under the program. So far, bankruptcy courts have taken varying approaches to the issue.
A recent decision out of the U.S. Bankruptcy Court for the Southern District of Texas3 sounded the opening bell for the debate. There, Hidalgo County Emergency Services Foundation, a provider of crucial emergency medical transportation, had been continuing to operate as a debtor in possession since filing for bankruptcy last year. Quickly approaching the end of the runway in terms of meeting its payroll obligations, the debtor filed an adversary complaint against the SBA, seeking a temporary restraining order regarding its disqualification from the PPP. After finding that the government had provided no legitimate authority for excluding bankrupt companies from the program, the bankruptcy court temporarily restrained the SBA from “mak[ing] or condition[ing] the approval of any PPP loan guaranty to the Debtor contingent on the Debtor or any owner of the Debtor not being presently involved in any bankruptcy.” Notably, the bankruptcy court issued its decision prior to the latest rules promulgated by the SBA and, as such, it examined only the exclusionary language from the PPP application itself. Although the bankruptcy court found that it had a duty to combat bankruptcy discrimination, it stopped short of finding that it had authority to direct the SBA to affirmatively issue a PPP loan.
In the wake of this decision, numerous companies have sought similar relief from bankruptcy courts. However, some courts—like the U.S. Bankruptcy Court for the District of Delaware—have been unwilling to adopt the Hidalgo court’s approach (though these courts have also had the benefit of the SBA’s explicit guidance). In In re Cosi Inc.,4 the debtor—a restaurant and catering chain—sought to bar the SBA from disqualifying it from the PPP. In response to the debtor’s motion, the government relied on decisions from the Fourth and Fifth Circuits to argue that courts have no jurisdiction to award injunctive relief against the SBA. Ultimately, although the bankruptcy court sympathized with the debtor’s plight and even theorized that the SBA’s interpretation may run counter to Congressional intent, it agreed with the government, which made an appearance through the Department of Justice’s Commercial Litigation Branch, and found that it must defer to the SBA’s directive.
Thereafter, on May 1, the U.S. Bankruptcy Court for the District of Maine, in In re Calais Regional Hospital,5 added to the changing landscape by finding that the issuance of a temporary restraining order against the SBA was authorized under the Bankruptcy Code, as well as relevant non-bankruptcy law provisions, which the First Circuit has interpreted as permitting injunctive relief against the SBA. The bankruptcy court found such relief was warranted because it was carefully tailored not to interfere with the SBA’s internal operations, as opposed to the product of those internal operations. Other bankruptcy courts, such as the U.S. Bankruptcy Court for the District of Vermont,6 have taken similar requests under advisement in recent days and are expected to issue rulings this week that will continue to shape the debate.
As the effects of COVID-19 continue to ripple through the business community, many distressed entities will be required to consider this issue when implementing a restructuring strategy. Seward & Kissel LLP will continue to monitor the relevant decisional law closely.
Seward & Kissel has established a COVID-19 Resource Center on our web site to access all relevant alerts that we distribute.
2 The applicable SBA interim final rule states: “If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan.” The rule also requires that “if an applicant files for bankruptcy after submitting its application, but prior to receiving funds “it is the applicant’s obligation to notify the lender and request cancellation of the application.” Notably, SBA’s directive does not address the effect of a chapter 11 bankruptcy on a business that has already applied for and received funds under the program. As such, some struggling companies are waiting to commence bankruptcy proceedings until after receiving PPP funds, while others are seeking voluntary dismissal of their bankruptcy cases in order to apprise themselves of PPP funds.
3 In re Hidalgo County Emergency Service Foundation, Case No. 19-20497 (DRJ) (Bankr. S.D. Tex. Apr. 22, 2020).
4 In re Cosi, Inc., Case No. 20-10417 (BLS) (Bankr. Del. Apr. 30, 2020).
5 In re Calais Regional Hospital, Case No. 20-01006 (MAF) (Bankr. D. Me. May 1, 2020).
6 In re Springfield Hospital, Inc., Case No. 20-01003 (CAB) (Bankr. D. Vt. May 1, 2020).