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On Friday, April 24, 2020, President Trump signed into law the Paycheck Protection Program and Health Care Enhancement Act (PPP Enhancement Act), one of a series of coronavirus-rated relief bills. The law provides supplemental funding for the Paycheck Protection Program and Economic Injury Disaster Loans, originally authorized under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as well as billions in funding for hospitals and coronavirus testing.

Under the CARES Act, Congress initially allocated $349 billion in forgivable loans for small businesses through the Paycheck Protection Program (PPP), which was replenished with an additional $310 billion in funding under the PPP Enhancement Act. Under the PPP, loans of up to $10 million used to cover certain eligible expenses (e.g., payroll, rent, utilities) may be forgiven. PPP loans have favorable terms, including (1) no collateral or personal guarantees are required; (2) the loans mature in two years; (3) interest rate is 1%; and (4) the loans may be fully forgiven.

The PPP loans are administered by banks through the Small Business Administration (SBA). The PPP application form requires a borrower to certify that it is "not presently involved in a bankruptcy." On April 15, 2020, the SBA published in the Code of Federal Regulations an "interim final rule" implementing the PPP (the First Interim Rule). Neither the CARES Act itself, nor the First Interim Rule, said anything about bankruptcy debtors being ineligible for PPP loans. Then, on April 28, 2020, the SBA issued another interim final rule (the Second Interim Rule). The Second Interim Rule purports to disqualify bankruptcy debtors from the PPP by stating: "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 restriction against allowing PPP loans to be made to companies in pending bankruptcy proceedings has led to a number of debtors challenging whether the SBA has the authority to restrict debtor borrowers from being able to participate under this program. The main challenges that debtors have raised in connection with their ability to qualify for and receive PPP loans include: (1) there is nothing in the CARES Act itself that provides that a borrower must certify that it is not presently involved in a bankruptcy; (2) SBA's prohibition against bankruptcy debtors is arbitrary and capricious, in violation of 5 U.S.C. §706(2)(A)—which governs judicial review of government agencies actions, findings and conclusions; and (3) the SBA's insertion of a bankruptcy-related exclusion to eligibility for a PPP loan is unlawful discrimination under 11 U.S.C. §525(a).

Section 525(a) of the Bankruptcy Code states in relevant part: "… a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to, condition such a grant to, discriminate with respect to such a grant against … a person that is or has been a debtor under this title … solely because such bankrupt or debtor is or has been a debtor under this title …" 11 U.S.C. §525(a). Courts apply §525 (a) to prohibit discriminatory acts by governmental units against debtors, including those involving government contracts, student loan applications, public housing, insurance, public mortgage financing, utility service, building permits, employment termination, and agricultural subsidies. See generally Rees v. Employment Security Commission of Wyoming (In re Rees), 61 B.R. 114, 120 (Bankr. D. Utah 1986)(collecting cases). While the PPP program is initially set up as a loan, debtors argue that, in reality, it's a grant for businesses and §525(a)'s antidiscrimination provisions apply.

Numerous debtors have sought injunctive relief to force the SBA to approve PPP loans to companies presently in a bankruptcy proceeding. In those cases, the SBA has generally argued that it was delegated broad authority to implement its lending programs—and the bankruptcy exclusion it implemented for PPP loans falls within this authority. The SBA argues that its Administrator is explicitly empowered to "make such rules and regulations as [she] deems necessary to carry out the authority vested in [her]," and in addition to "take any and all actions … [that] [she] determines … are necessary or desirable in making … loans." 15 U.S.C. §634(b)(6), (7). The SBA notes that the CARES Act did not limit this authority, but rather, gave the SBA Administrator authority to issue new regulations and rules to implement the PPP without complying with typical notice and comment requirements. CARES Act §1114. Further, the SBA contends that the CARES Act left intact the existing requirement that loans "be of such sound value or so secured as reasonably to assure repayment." 15 U.S.C. §636(a)(6). With respect to arguments about the SBA position being unlawfully discriminatory, the SBA argues that by its plain language, the prohibition in §525(a) does not apply to lending or loan guarantees.

Many courts seem sympathetic to debtor company arguments, and have been ruling in favor of debtors and against the SBA. See e.g., Roman Catholic Church of the Archdiocese of Santa Fe v. United States of America Small Business Administration, Adv. No. 20-1026 t (Bankr. D. N.M. May 1, 2020), ECF No. 15 (Opinion finding that the SBA's "inexplicable and highhanded decision to rewrite the PPP's eligibility requirements in this way was arbitrary and capricious, beyond its statutory authority, and in violation of 11 U.S.C. §525(a). By a separate final judgment, the court will grant plaintiff the relief it requests. If defendant's actions result in Plaintiff not obtaining the $900,000 it requested, Plaintiff may file an adversary proceeding for compensatory and, if appropriate, punitive damages."); Hidalgo County Emergency Service Foundation v. Jovita Carranza, In Her Capacity As Administrator For The U.S. Small Business Administration, Adv. No. 20-2006 (Bankr. S.D. Tex. May 8, 2020), ECF No. 33 (Preliminary Injunction finding that debtor showed a substantial likelihood of success on the merits that the SBA acted in a manner that is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law," 5 U.S.C. §706(2)(A); "in excess of statutory jurisdiction, authority, or limitations, or short of statutory right," 5 U.S.C. §706(2)(C), and in violation of 11 U.S.C. §525(a) and, among other things, restrained the SBA and lenders from making or conditioning the approval of any PPP loan to the debtor contingent on the debtor not being presently involved in a bankruptcy).

Conversely, other courts have deferred to the SBA's decision making authority and denied relief to debtors. See, e.g., Cosi v. The U.S. Small Business Administration, and Jovita Corranza, as Administrator of the U.S. Small Business Administration, Adv. Pro. No. 20-50591 (BLS) (Bankr. D. Del. May 14, 2020), ECF No. 18 (order denying debtor's motion for temporary restraining order). Other debtors have sought and obtained approval to dismiss their pending bankruptcy proceedings in order to be eligible to obtain a PPP loan. See, e.g., In re Capital Restaurant Group, Case No. 19-65910-WLH (Bankr. N.D. Ga. April 28, 2020), ECF No. 192 (order dismissing Chapter 11 case with prejudice and barring debtor from filing a new Chapter 11 case for one year). At least one debtor dismissed their bankruptcy case, obtained a PPP loan, and then successfully moved to reinstate their bankruptcy case with the PPP loan proceeds. In re Advanced Power Technologies, Case No. 20-13304-PGH (Bankr. S.D. Fla. May 12, 2020), ECF No. 67 (order granting motion to reconsider dismissal order and reinstate Chapter 11 case).  

While people can rationally debate the public policy issues concerning whether debtors should or should not be eligible to receive a PPP loan, the haphazard way in which these important issues are being decided is unfortunate. It does not seem logical or appropriate to force a debtor entity to go through the time and expense of dismissing its pending bankruptcy proceeding, only to obtain a PPP loan and then immediately reinstate its case. Similarly, a company appears permitted to file for bankruptcy after receipt of a PPP loan. As PPP loans are unsecured loans, the government will have a general unsecured claim against a debtor company that files for bankruptcy. So, it also does not seem rational to preclude a company that is in a bankruptcy proceeding from obtaining a PPP loan, while at the same time, allowing companies to obtain a PPP loan and then file for bankruptcy. More thorough guidelines from the outset would have helped avoid some of these issues which are bound to play out in the appellate courts for the foreseeable future.

Brett Moore is a principal of Porzio, Bromberg & Newman and a member of the firm's bankruptcy and financial restructuring department.