Virus Bill Leaves Bankrupt Firms in Limbo Without SBA Directions

Aug. 3, 2020, 10:31 AM

A new legislative proposal wants to steer coronavirus stimulus package loans to bankrupt businesses, but its lack of specific directions to the loan administrator is stirring doubts that it could achieve the goal.

The Small Business Administration, which oversees the Paycheck Protection Program loans, has refused to issue the loans to bankrupt companies, wary that they’d present too much risk.

A Senate Republican bill, (S. 4321), introduced last week, would amend the bankruptcy code to specifically allow bankruptcy courts to approve PPP loans. It also gives the PPP loan a super-priority status in the order of fund distributions in bankruptcy cases.

But the measure doesn’t explicitly require the SBA to accept loan applications from bankrupt borrowers. The text of the bill says that bankrupt companies are only eligible if the SBA tells the executive director of the US Trustee, the Justice Department’s bankruptcy watchdog, that it will accept debtor applications.

The bill is “a step in the right direction,” said Andrew Helman, co-chair of the bankruptcy practice at Murray Plumb & Murray. But it “probably won’t be effective until the administrator decides to make them eligible.”

Helman represents several bankrupt companies that sued the SBA after being blocked from applying for PPP loans earlier in the year. Bankruptcy courts have been split on whether the agency could deny PPP loans to companies solely because they’re bankrupt.

The SBA doesn’t comment on pending legislation, an agency representative told Bloomberg Law.

Message to SBA

The Senate bill could help the SBA see that Congress wants bankrupt companies to get the same emergency virus relief as non-bankrupt companies, said Jared Ellias, a bankruptcy law professor at the University of California, Hastings, who’s part of an academics group pushing for federal Covid-19 aid to apply to bankrupt businesses.

“The PPP and the other small business provisions under the CARES Act have been an historic lifeline to millions of small businesses and tens of millions of American workers,” according to a statement from Sen. Marco Rubio (R-Fla.), who, along with Sen. Susan Collins (R-Maine), introduced the bill. “Now, Congress must take action to help industries and businesses, especially minority-owned small businesses and those in low-income communities, that have been hit hard by the COVID-19 pandemic.”

The SBA determined to exclude bankrupt applicants “because more complex, multi-factor assessments of creditworthiness were not practicable given the need to disburse billions of dollars in an extremely short period of time,” it said in a brief filed in the Fifth Circuit.

The administrator found that providing PPP loans to bankrupt debtors would present an “unacceptably high risk” of both “unauthorized use of funds” and “non-repayment of unforgiven loans,” the SBA said.

The SBA’s statements in the filings reflect its wariness regarding loans issued during bankruptcy, known as debtor-in-possession loans. DIP loans, which require court approval, are any borrowing agreements reached post-bankruptcy, and PPP loans would be categorized as DIP loans.

“I worry that the SBA has shown such a negative attitude toward DIP loans that the provision will not achieve its goals,” said University of Texas bankruptcy professor Jay Westbrook, referring to Rubio’s bill.

The SBA’s policy stems from its determination that loans to bankrupt companies aren’t of “sound value,” a requirement for SBA loans, Helman said. But PPP loans aren’t as risky as the SBA may think, he said.

“If anything, a PPP advance to a debtor is subject to greater transparency and protection through supervision of the bankruptcy court, which can ensure that the funds are not used for improper purposes and which can prevent other creditors from accessing the funds,” Helman said.

Mixed Rulings

Bankrupt companies’ litigation over the SBA policies marches on while the bill is contemplated in Congress.

Companies challenging the bankrupt borrower exclusion have argued that the SBA acted arbitrarily and capriciously in violation of the Administrative Procedure Act.

They’ve also said the SBA policy violates a bankruptcy code provision that forbids government entities from discriminating against bankrupt companies seeking a “license, permit, charter, franchise, or other similar grant” from the government. Because the loans have extremely favorable terms and are ultimately forgiven, they’re more akin to a grant, they’ve argued.

Bankruptcy court rulings have yielded mixed results, with some agreeing with either or both arguments. Others have found that the SBA acted within its authority, and that the bankruptcy code provision doesn’t apply.

The U.S. Court of Appeals for the Fifth Circuit ruled in June that no courts can issue injunctions against the SBA. It’s the only federal appeals court to weigh in so far.

The resultant uncertainty, which remained as of the June 30 expiration of the first round of PPP lending, caused companies in or considering bankruptcy to try and maneuver around the ban, either by dismissing their bankruptcy cases or filing only after getting a loan.

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

To contact the editors responsible for this story: Roger Yu at ryu@bloomberglaw.com; Laura D. Francis at lfrancis@bloomberglaw.com

To read more articles log in.

Learn more about a Bloomberg Law subscription.