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Courts Grapple With Bankrupt Companies’ Loan Access (Corrected)

May 4, 2020, 10:30 AMUpdated: May 4, 2020, 7:44 PM

How courts interpret a little-known bankruptcy code provision is likely to make a big difference for bankrupt small businesses seeking Paycheck Protection Program loans.

Bankrupt companies have asked the courts for help in accessing the stimulus funds following the Small Business Administration’s move to block applications from companies in Chapter 11.

Whether or not bankruptcy courts will require the SBA to consider a company’s loan application has been pegged to how the judge reads section 525(a) of the bankruptcy code. That provision bans governments from denying a license, permit, charter, franchise, or other similar grant because the applicant is or was a debtor in bankruptcy.

“You can’t except bankruptcy debtors from accessing programs that are unique to the government, like the PPP,” said Andrew Helman of Murray Plumb & Murray. Helman represents bankrupt hospitals in Maine and Vermont that sued the SBA to require consideration of their PPP applications.

The small number of results so far have been mixed.

One bankruptcy judge in Texas has issued a temporary restraining order requiring the agency to consider a loan application from an emergency services company, and a Maine bankruptcy judge Friday granted similar TROs for two hospitals.

But a judge in a different district in Texas denied similar emergency relief, as has a bankruptcy judge in Delaware.

The issue is far from settled: at least six other courts considering businesses’ motions for TROs haven’t ruled yet.

Corporate ‘Breadline’

The CARES Act, which went into effect March 27, created the PPP to provide relief to small businesses unable to meet payroll and other fundamental expenses because of revenue halted by coronavirus shutdowns.

Qualifying businesses can borrow up to 2.5 times their average monthly payroll, with a $10 million cap, at only 1% interest and with a six-month deferral on any payments.

“PPP is the breadline for corporate America, and we want to be able to stand in that line with other small businesses,” Helman told Bloomberg Law.

Companies challenging the SBA’s policy argue that the agency exceeded its authority when it decided that bankrupt companies aren’t eligible for the loans. Nothing in the CARES Act has that limitation, they say.

In fact, the CARES Act made clear Congress’ intent to give aid to struggling small businesses in bankruptcy, the companies say. The same law increased the debt limit for small businesses to be eligible to participate in a new, streamlined sub-chapter of Chapter 11.

“The bankruptcy exclusion engrafted by the SBA onto the PPP loan program is blatant discrimination on account of being in bankruptcy, which is prohibited pursuant to 11 U.S.C. § 525(a),” family entertainment center company NRP Lease Holdings LLC said in its motion for a TRO, filed in the the Bankruptcy Court for the Middle District of Florida.

Grant Versus Loan

At the same time, there’s an expectation that the loans will ultimately will be forgiven, said N. Chris Glenos, leader of the Bankruptcy and Creditors’ Rights practice group at Bradley Arant Boult Cummings LLP in Birmingham, Ala.

The section 525(a) prohibition on denying grants to companies in bankruptcy applies if a PPP loan is more of a grant than a loan, said Jay L. Westbrook, Benno C. Schmidt chair of business law at the University of Texas School of Law.

“If the money is most likely never required to be repaid, then the decision is really one to grant it rather than to lend it and bankruptcy shouldn’t matter,” he said in an email to Bloomberg Law.

It’s “terrible policy” to deny bankrupt companies the virus aid, Westbrook said. “To deny money to businesses in Chapter 11 reorganization bankruptcy for that reason only is like denying health care benefits to people if they go into the hospital.”

A representative for the SBA didn’t respond to requests for comment.

Judge David R. Jones of the U.S. Bankruptcy Court for the Southern District of Texas granted a TRO April 25 on behalf of Hidalgo County Emergency Service Foundation.

PPP loans, with favorable terms and probable forgiveness, are akin to a money grant which can’t be denied because of an applicant’s bankruptcy under section 525(a) of the bankruptcy code, Jones ruled.

Judge Michael A. Fagone of the U.S. Bankruptcy Court for the District of Maine Friday granted TRO requests by Penobscot Valley Hospital and Calais Regional Hospital. He found that the SBA likely violated section 525(a) by systematically denying PPP applications based only on a borrower’s bankruptcy.

But Judge Brendan L. Shannon reached a different conclusion in restaurant chain Cosi Inc.'s Chapter 11 case in Delaware. Cosi, however, may get another shot at convincing the judge later in the case.

Judge Craig A. Gargotta of the U.S. Bankruptcy Court for the Western District of Texas Thursday denied Asteria Education Inc.'s request for a temporary order against the SBA. Although the loan is “virtually a grant,” it’s still a loan, and he has to defer to the SBA, said Asteria’s lawyer, E. Paul Keiffer of Rochelle McCullough LLP.

To Be Determined

Several other cases, however, are still in the works.

Judge Colleen A. Brown of the U.S. Bankruptcy Court for the District of Vermont Friday conducted a hearing on a TRO motion from Springfield Hospital.

The U.S. Bankruptcy Court for the District of Arizona is considering Starplex Corp.'s motion May 21, while the U.S. Bankruptcy Court for the Middle District of Florida will look at NRP Lease Holdings’ motion May 6.

How these courts rule could have lasting implications for many small businesses as the economic effects of the pandemic persist.

For additional legal resources, visit Bloomberg Law In Focus: Coronavirus.

(Story corrected with proper spelling of U.S. Bankruptcy Judge Michael A. Fagone.)

—With assistance from Leslie A. Pappas in Wilmington, Del.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bloomberglaw.com

To contact the editors responsible for this story: Seth Stern at sstern@bloomberglaw.com; Laura D. Francis at lfrancis@bloomberglaw.com

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