Since the Payroll Protection Program (PPP) became law March 27, businesses who applied and obtained PPP loans, or considered applying for them, were given a roller coaster ride of uncertainty as to whether, and under what terms, the loans would be forgiven. First, PPP borrowers who had existing lines of credit with other lenders—not prohibited under PPP—were condemned by Congress and the Treasury Secretary and threatened with criminal investigation. Later, when it became apparent that the rigid requirements for loan forgiveness were unworkable for the businesses most in need, Congress passed legislation to loosen the requirements for PPP loan forgiveness. Still, the current political climate ensures that uncertainty over loan forgiveness will continue. For those borrowers who are denied meaningful loan forgiveness and must add short-term SBA debt to their balance sheets, there is an alternative to reduce the additional debt load: the Small Business Debtor Reorganization Act, Subchapter V to Chapter 11 of the Bankruptcy Code. Subchapter V became law last February.

It Will Be Difficult for Most Small Businesses to Meet PPP Loan Forgiveness Requirements

Businesses with 500 or fewer employees will have trouble making the PPP work for them because of the high standard the law set for the full amount of the loan to be forgiven. Under prior PPP law, businesses had to use 75% of the loan in eight weeks for employee payroll at pre-pandemic staffing levels. The June 5 amendments to the PPP law reduced the payroll requirement to 60% and extended, by 16 weeks, the time to spend the loan. Still, these and other requirements of the PPP make it difficult for small businesses to obtain complete loan forgiveness. Borrowers get only part of their PPP loan forgiven if they operate at reduced staffing levels and do not rehire or replace workers who were furloughed during the shutdown. By the time a distressed business receives the funds, its payroll, in all likelihood, will have already been reduced to keep the business alive. The forgiveness aspect of the loan won't work for businesses operating on a limited basis or not at all, or for businesses whose payroll costs are relatively low compared to inventory and supply expenses. And those businesses who received PPP loans before recent change in the PPP law will continue to be required to pay back the loan within two years. For most companies, this will mean adding a more short-term debt to their balance sheets at a time they can least afford it.

Help From the Small Business Debtor Reorganization Act

Small businesses, including sole proprietors, with debt of as much as $7.5 million are eligible for reorganization under Subchapter V of Chapter 11 if the petition is filed before March 27, 2021. Subchapter V makes it easier to get court approval of a reorganization plan by eliminating the requirement that at least one class of creditors "buy into" the plan by voting to accept it. Now, the business owner only needs the bankruptcy judge to approve the reorganization plan. Subchapter V also dropped the requirement for business owners to contribute cash or valuable property to the reorganization if the plan proposes to pay creditors only a portion of their unsecured debt. Instead, the plan must provide for the business to pay its disposable income to creditors over a three to five-year period. After the owners of the business are paid reasonable compensation for their work, the profits of the business are paid to its creditors.

How Subchapter V Can Ease the Burden of Unforgiven PPP Loans

If, at the end of its PPP journey, a borrower is told by SBA it will not qualify for a meaningful amount of PPP loan forgiveness, filing Subchapter V can be a way to "enhance" loan forgiveness. Since a PPP loan is unsecured debt, a court approved Subchapter V plan need only pay a portion of the loan to obtain a bankruptcy discharge for the debtor's business. While a business is in Subchapter V, a PPP loan lender will have little basis to block the debtor's use of the loan funds so long as the money is used to pay for payroll, employee benefits, interest on mortgage and other debt and utilities. And even if the SBA were to complain about its borrower's Chapter 11, it is doubtful the SBA would find a sympathetic ear in Bankruptcy Courts: The PPP is two months old and already, Bankruptcy judges in New Mexico and Texas have issued orders requiring the SBA to stop refusing to process PPP loan applications submitted by Chapter 11 businesses or slowing PPP loan approval.

Fewer businesses are applying for PPP loans because most business owners either realize the current rules for loan forgiveness do not fit their business or fear more election year changes to the PPP law will move the forgiveness "goal post" beyond the reach of most small businesses. Subchapter V provides an alternative for those who want to try to survive the current downturn with the help of government funding, but without adding substantial short-term SBA debt to the already difficult problems faced by businesses.

Thomas R. Lehman is a partner with Levine Kellogg Lehman Schneider + Grossman in Miami. He focuses on bankruptcy, insolvency, employment, insurance coverage and real estate disputes.