The Bankruptcy Code's Anti-Discrimination Section and COVID-19

The court noted the loans provided by the PPP came with "extremely favorable terms." Borrowers were not required to pledge collateral or provide guarantees. A borrower's creditworthiness was not relevant. No fees were charged. The interest rate was 1%. The loans were forgiven if the funds were used as required. Moreover, PPP had few eligibility requirements. Applicants were required to be a small business, nonprofit organization, veterans organization, or Tribal business, generally have fewer than 500 employees, been in operation on Feb. 15, and have employees to whom salary and payroll taxes were paid.

Funds were available on a first-come, first-served basis. The court wrote: "Demand for the PPP funds has been overwhelming. The funds were exhausted once, but were replenished by Congress on or about April 24, 2020." As of the date of the opinion, the court did not know the current status of PPP funds and further replenishment prospects.

The CARES Act also provided the SBA with "emergency rulemaking authority" to issue regulations to carry out the law. On April 2, the SBA issued the application form to apply for a PPP loan. The form stated applicants involved in any bankruptcy were not eligible for a loan.

The court found the debtor met all of the eligibility requirements under the CARES Act. However, when the debtor filed an application for a $900,000 loan, its bank would not process the loan because of the bankruptcy ineligible provision. On April 28, the SBA issued a second interim final rule, which expressly disqualified bankruptcy debtors from the PPP. The court observed there were no administrative appeals or remedies available for applicants to seek review of the SBA's decision to exclude bankrupt debtors from PPP.

The court noted that, like many businesses, the debtor had been severely financially harmed by the federal, state, and local government "lockdown" orders. At the time the opinion was issued on May 1, the governor of New Mexico had announced that the stay-at-home order would be extended through at least May 15. The court noted that the debtor was losing about $300,000 per month, and losses would continue until, at a minimum, the lockdown orders were lifted. The court wrote, "Without a PPP loan, the plaintiff's operations and reorganization effort will be substantially adversely affected. The PPP funds are essential to plaintiff's 'fresh start.'"

The debtor filed a complaint seeking a preliminary injunction that would compel the SBA to process the debtor's loan application notwithstanding its status as a Chapter 11 debtor. The court conducted a hearing on April 30, but converted it to a trial on the merits. The debtor argued that the SBA's exclusion of bankrupt debtors from the PPP loan program was not permitted under the Administrative Procedures Act. The APA authorizes a court to set aside agency action that is, among other things, "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law" or "in excess of statutory jurisdiction, authority, or limitations, or short of statutory right." See, 5 U.S.C. Section 706(2).

The court stated that although the standard is generally deferential to the agency, a court must determine whether the agency considered all relevant factors, and whether there had been a clear error of judgment. The court concluded that the SBA's actions were arbitrary and capricious. The court reasoned that while a borrower's bankruptcy would be relevant for a normal loan program, PPP was "not a loan program at all. It is a grant or support program." The CARES Act did not require a borrower be creditworthy. In fact, financial distress was presumed. Further, Congress expressly excluded debtors from another CARES Act program that provided loans to midsize businesses. The court reasoned the "unmistakable implication is that Congress did not intend to exclude bankruptcy debtors from the PPP."

The court also sharply criticized the SBA's argument that bankruptcy debtors present an unacceptably high risk for unauthorized use of funds. The opinion describes how Chapter 11 debtors are under court supervision, must file detailed operating reports with attached bank statements, in cases monitored by creditor committees. The court stated "In short, the Chapter 11 bankruptcy system is a hundred-eyed Argus. In contrast, nondebtors can spend their PPP funds without any oversight." The court found the SBA's justification for excluding bankruptcy debtors "so weak the court has to wonder if [the SBA] really believes it."

The court held the SBA had exceeded its statutory authority in denying PPP loans to bankrupt debtors. The court reasoned that Congress had directly addressed the PPP eligibility requirements, and charged the SBA with issuing regulations to carry out the program. The SBA had no authority to change the eligibility requirements. The court found that was exactly what it had done by adding a nonbankruptcy requirement into the eligibility criteria.

Finally, the court concluded that the SBA's actions violated Section 525(a) of the Bankruptcy Code, which prohibits discriminatory treatment by the government of a person that is or has been a bankrupt debtor. Specifically, the section provides 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 this title … solely because such bankrupt or debtor is or has been a debtor under this title."

11 U.S.C. Section 525(a).

The court noted in a footnote that the government does not violate Section 525(a) by taking a borrower's bankruptcy status into account when considering a loan application. However, the court had found PPP was not a loan program but a grant or support program. As such, denying the debtor access to PPP funds solely because it was a debtor violated Section 525(a).

The court summarized its view in quite a holding:

With only the flimsiest of justifications the defendant took one of many underwriting criteria from its "normal" loan programs (bankruptcy status of the borrower), changed it to an eligibility condition, and then applied it to an emergency grant program where it clearly had no place. The defendant'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. Section 525(a). By a separate final judgment, the court will grant the plaintiff the relief it requests. If the defendant's actions result in the plaintiff not obtaining the $900,000 it requested, the plaintiff may file an adversary proceeding for compensatory and, if appropriate, punitive damages.

Numerous other courts have ruled in favor of debtors requesting orders directing access to PPP funds. See, Springfield Hospital v. Carranza (In re Springfield Hospital), Case No. 19-10283 (Bankr. D. Vt. May 4, 2020) (granting debtor's emergency motion for restraining order forcing SBA to process PPP application); Penobscot Valley Hospital v. Carranza (In re Penobscot Valley Hospital), Adv. No. 20-ap-01005 (Bankr. D. Me. May 1, 2020) (issuing TRO preventing denial of PPP loan based on debtor status); Calais Regional Hospital v. Carranza (In re Calais Regional Hospital), Adv. Case No. 20-1006 (Bankr. D. Me. May 1, 2020) (same).

That being said, some courts have denied such requests to obtain injunctions compelling the SBA to process Chapter 11 debtor loan applications. See, In re Blue Ice Investments v. U.S. Small Business Administration (In re Blue Ice Investments), Adv. No. 2:20-AP-00095 (Bankr. Ariz. May 26, 2020) (finding the SBA acted within its authority in denying PPP to bankrupt debtors); The Diocese of Rochester v. U.S. Small Business Administration (In re Diocese of Rochester), Adv. No. 20-cv-06243 (W.D.N.Y. June 10, 2020) (finding SBA did not overstep statutory authority and loans are exempt from antidiscrimination provision of the Bankruptcy Code).

One interesting situation involved a case where the U.S. Bankruptcy Court for the Southern District of Texas issued a temporary restraining order authorizing the debtor to submit a PPP loan application to any lender with the words "or presently involved in any bankruptcy" stricken from the SBA's form, and process the loan without any consideration of its involvement in any bankruptcy. See, Hidalgo County Emergency Service Foundation v. Carranza (In re Hidalgo County Emergency Service Foundation), Adv. No. 20-2006 (Bankr. S.D. Tex. April 25, 2020). The court's decision was reversed on appeal by the U.S. Court of Appeals for the Fifth Circuit in Hidalgo County Emergency Service Foundation v. Carranza, Case No. 20-40368 (June 22, 2020) which held the Small Business Act forecloses injunctive relief against the SBA and Fifth Circuit precedent prohibits injunctive relief against the SBA. As such, the Fifth Circuit held the Bankruptcy Court exceeded its authority when it issued the preliminary injunction, and vacated the TRO.

Conclusion

The PPP program was created to aid small businesses from falling into distress as a result of the pandemic and governmental closure orders. It is ironic that operating businesses that are the most distressed and in need of relief under the Bankruptcy Code are not viewed by the SBA as worthy to be eligible for relief under the CARES Act. Bankruptcy courts will have to continue to reconcile these two federal relief-based statutes that were both enacted to assist financially distressed businesses.

*****

Andrew C. Kassner is co-chair of Faegre Drinker Biddle & Reath and a member of the firm's board. He can be reached at [email protected] or 215-988-2554. Joseph N. Argentina Jr. is a senior attorney in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, DE, offices. He can be reached at [email protected] or 215-988-2541.