Bankruptcy Courts Rule SBA Must Consider Bankrupt Applicants for Loans

Judge Cynthia C. Jackson of the U.S. Bankruptcy Court for the Middle District of Florida became the latest judge to rule that the Small Business Administration cannot reject an applicant for an emergency loan designed to aid employees of small companies just because the would-be borrower is in bankruptcy. Judge Jackson granted family entertainment center company NRP Lease Holdings an injunction prohibiting the SBA from disregarding the company’s loan application just because it’s in Chapter 11.

This follows the recent rulings of Judge David R. Jones’, of the U.S. Bankruptcy Court for the Southern District of Texas,  In re Hidalgo Cnty. Emerg. Servc. Found., Bankr. S.D. Tex., Adv. No. 20-2006, Preliminary Injunction issued 5/8/20; Judge Colleen A. Brown of the U.S. Bankruptcy Court for the District of Vermont, who granted a temporary restraining order on behalf of Springfield Hospital, Inc., which sued for the right to apply for a Paycheck Protection Loan; and 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

Conversely, 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.

distinction between loan and grant

Debtors’ arguments are centered on Section 525(a) of the United States Bankruptcy Code. 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. Judge Jackson found that the PPP is a grant. However, the Judge indicated she didn’t believe that NRP would likely succeed in its argument that section 525(a) prohibits the SBA from automatically excluding bankrupt PPP applicants. Instead, she concluded that the agency overstepped its authority when it decided to exclude all bankrupt buyers. Congress wanted the PPP loan program to apply broadly, with the express intention of saving employees’ jobs, she said.

“The PPP program has no underwriting criteria, no financial analysis” for determining who should be entitled to the loans, and so there’s no basis to single out bankrupt companies, Jackson said. Doing so was arbitrary and capricious, she ruled Tuesday.

“I think Chapter 11 debtors are less likely to misuse the funds,” Jackson said last week. Debtors-in-possession have to act under the watchful eyes of the court as well as their creditors and the U.S. Trustee, the Justice Department’s bankruptcy watchdog, she said.

Credit-worthiness expressly isn’t a requirement for the loan under the CARES Act, she said. “Congress did not pick winner and losers, but provided relief for all Americans employed by all small businesses,” she said.

The SBA’s argument is centered on the fact that the PPP loans created by the CARES Act are not grants but in fact loans. The SBA argued that Congress gave it authority to set guidelines for granting PPP loans. It also said it’s protected from suit by sovereign immunity, and the bankruptcy court lacks jurisdiction over the issue.

fifth circuit court of appeals

Given the split among the Bankruptcy Court decisions in Texas, the Fifth Circuit Court of Appeals has allowed the issue to be appealed directly to the Circuit Court. Accordingly, we should have a Fifth Circuit Court of Appeals decision on the issue very shortly. This should provide some guidance to the Bankruptcy Courts throughout the country, although it will not have any precedential effect on the cases in New Jersey.


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