Daily Tax Report: State

Virus Aid Continues to Elude Bankrupt Companies as Deadline Hits

June 30, 2020, 9:16 AM

Small businesses’ deadline for applying for the government’s coronavirus relief loans is here, but the fight over bankrupt companies’ eligibility status could drag on.

Companies have until midnight June 30 to apply for the loans made available by the Paycheck Protection Program, administered by the Small Business Administration to help businesses manage payrolls amid the economic turmoil caused by Covid-19.

The SBA blocks bankrupt companies from applying for the loans, a rule that has triggered lawsuits. Courts are conflicted on whether the SBA rule is legal.

That’s left some companies navigating the waters between the PPP and reorganizing their businesses to survive. Distressed small businesses have been forced to choose between passing up federal funds and ditching bankruptcy. Bankrupt companies that missed the loan due to the policy may switch to seeking damage payments from the federal government.

“That’s the ridiculous charade the government is making these debtors play,” said Phoenix-based bankruptcy attorney Thomas Salerno of Stinson Leonard Street LLP. “You just have this terrible conundrum the SBA has put debtors in.”

A South Carolina Burger King franchisee abandoned its bankruptcy proceedings to obtain $1.5 million through the PPP. Advanced Power Technologies LLC, a Florida lighting installation and design company, re-entered Chapter 11 in May less than three weeks after voluntarily dismissing its bankruptcy in order to obtain a $1.8 million PPP loan to pay employees.

With the deadline at hand, federal courts’ wrangling over the issue may be just “an academic point,” Salerno said.

‘Unacceptably High Risk’

The PPP, created by the CARES Act, allows small companies to borrow money based on payroll needs and have their loans forgiven if they apply those funds towards paying employees and other overhead expenses.

As enacted, the PPP didn’t expressly exclude bankrupt businesses from obtaining funds. But the SBA created a rule prohibiting bankrupt applicants from becoming borrowers.

Such lending “would present an unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans,” the agency said.

More than a dozen bankrupt companies and organizations, from the Roman Catholic Archdiocese of Santa Fe to USA Gymnastics, have sued SBA Administrator Jovita Carranza over the agency’s policy.

The issue has split a number of bankruptcy and other federal courts, with some deferring to the SBA and others ordering the agency to allow bankrupt borrowers’ applications.

“I don’t think I’ve ever seen so many cases on one issue in such a short amount of time with such divergent results,” said attorney Zev Shechtman of Danning, Gill, Israel & Krasnoff LLP.

Several judges have reasoned that the PPP is more like grant funding, which can’t exempt bankrupt parties from participating without running afoul of the bankruptcy code. A growing number of courts also have found that the SBA’s rule oversteps its authority.

Handling Uncertainties

Despite the litigation, the SBA’s policy is still a barrier for businesses without the resources to challenge a government agency in court, attorneys say.

At least one bankrupt business didn’t apply for the PPP, concerned that it “would be a fight and just a waste of time,” Shechtman said.

Most bankrupt companies that could’ve used PPP loans don’t have the time or money for litigation, said Morgan, Lewis & Bockius LLP attorney Sandra Vrejan.

“The businesses that are going to have the resources to actually stay that course are few and far between,” she said. The funds are a potential “lifeline” for some businesses, she said.

Those that can’t or choose not to wage legal battles against the SBA have maneuvered around the eligibility restrictions by either exiting Chapter 11 and submitting a PPP application or waiting for their loan applications to be approved before filing for bankruptcy.

Florida-based bakery chain Toojay’s said it received $6.4 million in PPP funds before seeking bankruptcy protection in late April. Earlier this month, medical device developer Proteus Digital Health said it received $2.2 million through the loan program to fund employee obligations before it filed for restructuring relief.

Blue Ice Investments LLC, the majority shareholder of a company that provides security for concerts and other events, is seeking to reinstate its Chapter 11 case after dismissing proceedings in May to obtain nearly $1.6 million in PPP funds.

“What kind of nonsense is that?” Salerno asked. “If you can wait, get your loan and then file,” he said.

Legal Fight Continues

Despite the PPP application window closing, a tangled web of federal lawsuits and appeals will likely continue into the future.

The U.S. Court of Appeals for the Fifth Circuit recently reversed a Texas bankruptcy judge’s order that the SBA consider the PPP loan application for Hidalgo County Emergency Service Foundation, saying that courts don’t have the power to issue an injunction against the agency.

The ruling doesn’t touch on the merits of the policy, but it creates the potential for a circuit split if other federal appeals courts decide differently.

The end of the application period may not mean bankrupt companies are abandoning the issue.

They could sue the government for damages if they’re ultimately unable to obtain a loan, Judge David T. Thuma of the U.S. Bankruptcy Court for the District of New Mexico said in the Santa Fe Archdiocese’s Chapter 11 case.

“I do think it’s interesting to see what the courts do procedurally,” said Rachel Jaffe Mauceri, also an attorney with Morgan Lewis. “I think the damages question will be an interesting one to watch.”

To contact the reporter on this story: Alex Wolf in New York at awolf@bloomberglaw.com

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

To read more articles log in. To learn more about a subscription click here.