PPP Litigation Update: Eleventh Circuit Says No PPP Loans for Debtors in Bankruptcy
The Eleventh Circuit Court of Appeals recently joined the Fifth Circuit Court of Appeals in holding that the Small Business Administration cannot be compelled to consider Paycheck Protection Program loan applications submitted by small business debtors in bankruptcy. See In re: Gateway Radiology Consultants, PA, 983 F.3d 1239 (11th Cir. 2020); see also In re: Hidalgo County Emergency Serv. Foundation, 962 F.3d 838 (5th Cir. 2020).
When the PPP was enacted, Gateway Radiology Consultants, PA was a small business that had filed for Chapter 11 bankruptcy protection. The company applied for a PPP loan despite SBA’s rule making debtors in bankruptcy ineligible. Like all debtors in bankruptcy, Gateway needed approval from the bankruptcy court to incur additional indebtedness outside the ordinary course of business. When the company filed a motion for approval, SBA objected on the grounds that the company was ineligible for a PPP loan because it was in bankruptcy. The bankruptcy court disagreed with SBA and granted Gateway’s motion. The court held that SBA’s rule rendering bankruptcy debtors ineligible for PPP loans was an unreasonable interpretation of the CARES Act and was arbitrary and capricious under the Administrative Procedure Act.
On appeal, the Eleventh Circuit reversed, holding that PPP loans were §7(a) loans administered under 15 U.S.C. § 636(a) of the Small Business Act. This means that the rules, requirements, regulatory precedents, and case law governing §7(a) loans apply in resolving legal questions concerning PPP loans. In so holding, the Eleventh Circuit adopted the Fifth Circuit’s reasoning in Hidalgo County.
The court noted that §7(a) loans are, by statute, subject to a “sound value” requirement. Because of that statutory requirement, SBA has long imposed regulations for §7(a) loans requiring that a loan applicant must be creditworthy and be of such “soundness” that there are reasonable assurances that the loan will be repaid. Consistent with these creditworthy and soundness criteria, SBA considers an applicant’s bankruptcy status or history. Under normal §7(a) rules, an existing bankruptcy does not automatically disqualify a debtor, but it creates a high hurdle. SBA requires a lender to examine closely the loan applicant’s ability and likelihood to repay the loan from its cash flow.
With respect to the PPP, SBA went further and explicitly stated that debtors in bankruptcy were ineligible. SBA reasoned that providing PPP loans to debtors in bankruptcy would present “an unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans.” After a lengthy analysis, the Eleventh Circuit held that SBA did not exceed its authority in excluding debtors in bankruptcy; it also held that the rule was not arbitrary or capricious. The rule was established in consultation with the Treasury Department and was not unreasonable on its face. Thus, the court declined to substitute its judgment for that of the SBA administrators who were deemed to have expertise in matters of loan risk and repayment.
Gateway Radiology joins a growing list of cases holding that the PPP is subject to the preexisting SBA regulatory and administrative regime. Consider, for example, M&M Consulting Grp., LLC v. JP Morgan Bank, N,A., No. SACV2001318JVSKESX, 2021 WL 71436, at *6 (C.D. Cal. Jan. 6, 2021) (“Accordingly, the Court holds that, absent an agreement between agent and lender pursuant to the traditional Section 7(a) guidelines, lenders are not required to pay agent fees under the text of the CARES Act or its implementing regulations.”); Fruci & Assocs., PS v. A10 Capital LLC, No. C20-864 RSM, 2020 WL 7714413, at *4 (W.D. Wash. Dec. 29, 2020) (same); Radix Law PLC v. Silicon Valley Bank, No. CV-20-01304-PHX-DWL, 2020 WL 7388488, at *4 (D. Ariz. Dec. 16, 2020) (same); Juan Antonio Sanchez, PC. v. Bank of South Texas, Case No. 7:20-cv-00139 (S.D. Tex. October 14, 2020) (same).
Interestingly, many of the district and bankruptcy courts addressing the specific issue of whether SBA’s exclusion of debtors in bankruptcy from the PPP loan program is arbitrary and capricious have favored debtors over SBA. Consider, for example, In re Vestavia Hills, Ltd., 618 B.R. 294, 305 (Bankr. S.D. Cal. 2020) (“The Court finds that Defendant’s decision to exclude bankruptcy debtors from the PPP is arbitrary and capricious.”); Diocese of Rochester v. U.S. Small Bus. Admin., 466 F. Supp. 3d 363, 380 (W.D.N.Y. 2020) ([T]he Court finds the Bankruptcy Exclusion is unlawful as arbitrary and capricious under 5 U.S.C. § 706(2)(A).”); Alaska Urological Inst., P.C. v. United States Small Bus. Admin., 619 B.R. 689, 710 (D. Alaska 2020) (same); contra In re Roman Catholic Church of Archdiocese of Santa Fe, 615 B.R. 644, 654 (Bankr. D.N.M. 2020) ([T]he Court finds that the SBA did not run afoul of § 525(a) in adopting the bankruptcy exclusion”). Given the split between many of the lower court decisions and those of the appellate courts on this specific issue, we can expect to see other courts of appeals handing down decisions in 2021.
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