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The nearly $350 billion loan program made available to small businesses by the Coronavirus Aid, Relief, and Economic Security (CARES) Act was tapped out in less than two weeks. In response to this overwhelming demand, on Friday, April 24, 2020, an additional $320 billion was funded into the loan program, and the second round of applications for small businesses requesting these loans will open on Monday, April 27, 2020. However, one uncertainty looms for many statutorily eligible small businesses ahead of their second shot at obtaining a loan: how will their bankruptcy affect their loan application.

This question may be answered soon. Yesterday (April 24, 2020), the Bankruptcy Court for the Southern District of Texas granted a temporary restraining order (TRO) preventing, for now, the Small Business Administration (SBA) from denying loans to one applicant on the basis of the applicant’s pending bankruptcy. Next Wednesday (April 29, 2020), the District Court for the Western District of New York will also consider this same issue.

The Paycheck Protection Program

The $670 billion in loans was made available to small businesses through the Paycheck Protection Program (PPP). The PPP is guaranteed under section 7(a) of the Small Business Act (15 U.S.C. § 636(a)), which is administered by the SBA.

Neither the Small Business Act nor the CARES Act prohibits a chapter 11 debtor from requesting or receiving a PPP loan. However, the PPP loan application form promulgated by the SBA (Form 2483) asks whether “the Applicant or any owner of the Applicant . . . [is] presently involved in any bankruptcy” and provides that if the answer to this question is “Yes,” that the “loan will not be approved.” Furthermore, on April 24, 2020, the SBA issued a new interim final rule, affirming that, “[i]f 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.” Thus, SBA expressly conditions the approval of PPP loans on the borrower not being “presently involved in any bankruptcy,” a requirement that was not legislated by the Congress.

This SBA-created eligibility requirement has no doubt dissuaded many small businesses that are otherwise eligible for a PPP loan from applying for the loan and has led to applications being denied. Indeed, many of the companies that are struggling the most to maintain their business as a going concern—the intended beneficiaries of Congressional response to the global pandemic—are left defenseless and are being discriminated against.


SBA Blocked by Texas Court

The bankruptcy-related eligibility requirement has already been challenged in two federal courts and was recently enjoined, albeit very narrowly, in one. On April 24, 2020, the Bankruptcy Court for the Southern District of Texas granted chapter 11 debtor Hidalgo County Emergency Service Foundation’s (HCESF) request for a TRO against SBA.

HCESF is an ambulance company based in South Texas that filed for bankruptcy on October 8, 2019. HCESF has maintained 100% of its approximately 250 employees while working to reorganize in chapter 11 in the midst of the global pandemic. HCESF applied for a loan on the first day that the lenders began accepting loan applications. As indicated on its application, HCESF had planned to use its PPP loan to pay its rent, utility, insurance, and full-time employees’ payroll costs—all of which are permissible uses of the PPP loans pursuant to both the Small Business Act and the CARES Act. HCESF had met, and continues to meet, all other requirements for receipt of a PPP loan. However, HCESF’s PPP loan application was rejected solely because HCESF had truthfully answered “Yes” to Form 2483’s question regarding its involvement in a bankruptcy.

After failed attempts at appealing directly to the SBA and elected officials, on April 22, 2020, HCESF filed a complaint in the Bankruptcy Court, seeking, among other things, (1) removal of all references to the applicant’s involvement in bankruptcy in Form 2483 and all other PPP policies, procedures, etc., (2) an instruction to all participating lenders that applicants involved in bankruptcy shall not be excluded from the PPP loan program on account of such involvement, and (3) a declaration that the bankruptcy-related exclusion is an unlawful discrimination in violation of the Bankruptcy Code. HCESF argued that the SBA exceeded its administrative authority by creating an additional eligibility requirement for PPP borrowers that neither the CARES Act nor the Small Business Act requires. Furthermore, HCESF argued that the SBA’s exclusion of bankruptcy debtors from participating in the PPP loan program constitutes unlawful discrimination under section 525 of the Bankruptcy Code. Section 525(a) provides, in relevant part, that “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 [the Bankruptcy Code] . . . solely because such bankrupt or debtor is or has been a debtor under [the Bankruptcy Code].”

On April 24, 2020, the Bankruptcy Court held a hearing on HCESF’s request for a TRO, and in an oral ruling stated that it will grant the TRO, finding that (1) HCESF has a substantial likelihood of success on the merits of its complaint, (2) HCESF will suffer irreparable injury if the TRO is not granted, (3) the risk of harm to HCESF if the TRO is not granted outweighs the harm to SBA if the TRO is granted, and (4) the TRO is in the public interest. As of today (April 25, 2020), the Bankruptcy Court has not yet entered the TRO, but HCESF has filed a proposed amended TRO. The proposed amended TRO is narrower in scope than the one originally proposed by HCESF, and protects only HCESF from SBA’s requirement that an applicant not be involved in bankruptcy, instead of removing the bankruptcy-related eligibility requirement from PPP loan applications for all applicants as originally requested. The TRO, once signed, will remain in effect until May 8, 2020, when the Bankruptcy Court will conduct a hearing for a preliminary injunction.


What Does This Mean for Other Chapter 11 Debtors?

As of today, on the eve of the second round of PPP loan applications, the official forms and policies promulgated by the SBA continue to prohibit chapter 11 debtors from receiving PPP loans. The $320 billion may be depleted before the Bankruptcy Court rules on HCESF’s request for injunctive relief, and it is unclear whether the injunction, if granted, will apply to other debtors. However, the District Court for the Western District of New York is scheduled to hear oral arguments on Wednesday, April 29, 2020 in another action challenging the SBA’s disqualification of bankruptcy debtors from participating in the PPP loan program (The Diocese of Rochester v. The U.S. Small Business Administration, Case No. 20-cv-06243-EAW). It remains to be seen whether either of these courts will grant permanent injunctive relief, and if so what—if any—remedy it will provide to those chapter 11 debtors who may have already been denied PPP loans, because of their status as a debtor under the Bankruptcy Code. Current chapter 11 debtors should consider applying for PPP loans as soon as possible and should be prepared to litigate any bankruptcy-based denial by the SBA.