Type: Law Bulletins
Date: 05/11/2020

PPP Eligibility Requirements Challenged in Bankruptcy Lawsuits

Several lawsuits have emerged in the last week involving the Small Business Administration’s Paycheck Protection Program (PPP). “The Paycheck Protection Program is a loan designed to provide a direct incentive for small businesses to keep their workers on the payroll.”1 The listed criteria for eligibility is very broad. Companies that have 500 employees or less, pay salaries or payroll taxes and were in operation on Feb. 15, 2020, are eligible to apply.2

However, for one group of plaintiffs, hope for economic relief during this pandemic was almost immediately quashed because of one fact: each had filed for Chapter 11 bankruptcy. And while Congress included nothing in the CARES Act “excluding companies in bankruptcy from receiving PPP loans, the SBA promulgated an application form requiring the applicant to state whether it is ‘presently involved in any bankruptcy.’”3 If “yes,” the application is automatically denied.

The SBA’s reasoning, according to an interim rule released on April 28, 2020—almost two weeks after the program began, is that “debtors in bankruptcy…present an unacceptably high risk of unauthorized use of funds or non-repayment of unforgiven loans.”4 The SBA administrator, Jovita Carranza, further justified the SBA’s position by stating, “the Bankruptcy Code does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy.”5 The SBA therefore concluded that entities in bankruptcy should not be eligible for the PPP.

That rationale, according to these plaintiffs, is arbitrary and capricious and in excess of the SBA’s authority in violation of 5 U.S.C. § 706. So far, one judge has disagreed and ruled in favor of the SBA.6 Judge Brendan Shannon of the U.S. District Court of Delaware stated, “that although he disagrees with the SBA’s decision to preclude bankruptcy debtors from receiving PPP money and is ‘dismayed at the consequences’ and harm that will be caused to Cosi by denying its bid for relief from the court, he would defer to a recent directive from the SBA as to how loan funds are to be disbursed.”7 Interestingly, he added that if Cosi files an emergency motion to dismiss its Chapter 11 case to seek the PPP funds and attempt to stabilize its financial plight, it should keep the court apprised of such action.8

Several other bankruptcy judges around the country have taken the opposite position and have granted both temporary and final relief for this group of plaintiffs.

In one case, Judge Michael Fagone of Bangor, Maine, focused on the application of 11 U.S.C. § 525(a), which bars the government from denying “a license, permit, charter, franchise or other similar grant, solely because the applicant has filed for bankruptcy.”9 In granting the plaintiff’s request for a temporary restraining order, he reasoned that while Section 525(a) does not apply to loans, “the CARES Act is a grant of aid necessitated by a public health crisis.”10 In other words, the PPP is not a loan; it’s a grant. And because it’s a grant, Section 525(a) precludes the SBA from denying the application based on bankruptcy status.

Other judges have gone further and called the SBA’s decision to discriminate against Chapter 11 debtors “completely frivolous.”11 Judge David Thuma of New Mexico, has issued one of the strongest opinions against the SBA thus far, finding its decision to exclude Chapter 11 debtors arbitrary and capricious for several reasons.12 One reason, he stated, is that “[w]hile a borrower’s bankruptcy status clearly is relevant for a normal loan program, the PPP is the opposite of that.”13 He went on to explain that:

“[The PPP] is not a loan program at all. It is a grant or support program. The statute’s eligibility requirements do not include creditworthiness. Quite the contrary, the CARES Act makes PPP money available regardless of financial distress. Financial distress is presumed. Given the effect of the lockdown, many, perhaps most, applicants would not be able to repay their PPP loans. They don’t have to, because the ‘loans’ are really grants. Repayment is not a significant part of the program. That is why Congress did not include creditworthiness as a requirement.”14

Judge Thuma also agreed the SBA had exceeded its authority issued by Congress when it independently decided to question applicants about bankruptcy status. “The CARES Act directly addresses the PPP eligibility requirements. It charged Defendant with issuing ‘regulations to carry out this title.’ Defendant had no authority under this charge to change the eligibility requirements. That, however, is exactly what it did.”16

Unlike other courts that have been presented with these same issues, Judge Thuma took swift action. He converted the archdiocese’s request for temporary relief into a trial on the merits and entered a “final judgment” against the SBA. In doing so, he awarded the plaintiff the $900,000 it had requested and added that if the SBA fails to make those funds available, the archdiocese may file an adversary proceeding for compensatory and punitive damages.17

Given this bold move by Judge Thuma, it remains to be seen whether the SBA will remove the question from the PPP application or whether further litigation will ensue around the country challenging the bankruptcy issue. As of now, the SBA’s April 28 Interim Rule has not been modified, amended or removed.

Please visit our COVID-19 Toolkit for all of Taft’s updates on the coronavirus.

1U.S. SMALL BUS. ASS’N, Paycheck Protection Program (May 7, 2020). 
3Bill Rochelle, Two More Judges Rule that Chapter 11 Debtors Are Eligible for PPP Loans, AM. BANKR. INST. (May 5, 2020).
4Business Loan Program Temporary Changes, 85 Fed. Reg. 23450 (Apr. 28, 2020) (to be codified at 13 C.F.R. 120-21); see also, In re Roman Catholic Church of the Archdiocese of Santa Fe, No. 18-13027 T11, 2020 WL 2096113, at *1 (Bankr. D.N.M. May 1, 2020).
6LAW 360, Cosi Loses Bid for Chapter 11 Relief to Seek SBA Virus Funds (April 30, 2020).
9In re Calais Reg’l Hosp., No. 19-10486, 2020 WL 2201947, at *1 (Bankr. D. Me. May 1, 2020).
11In re Hidalgo Cty. Emergency Serv. Found., No. 19-20497, 2020 WL 2029251, at *1 (Bankr. S.D. Tex. Apr. 25, 2020).
12In re Roman Catholic Church of the Archdiocese of Santa Fe, No. 18-13027 T11, 2020 WL 2096113.
13Id. at *6.
14Id. at *6-*7.
15Id. at *9-*11.
16Id. at *10-*11.
17Id. at *15.

Additional Resources

In This Article

You May Also Like