THE CARES ACT and BANKRUPTCY: A Look at the SBA’s Potentially Discriminatory Stance Against Bankruptcy Debtors

06.10.20

On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, an approximately $2 trillion economic relief package with the goal of protecting the American people from the public health and economic impacts of COVID-19 by providing fast and direct economic assistance for American workers, families, and small businesses, and preserving jobs for American industries. The United States Department of Treasury has coined the CARES Act as “The CARES Act Works for All Americans,” however, some American businesses have been shut out from much needed economic relief.

The Paycheck Protection Program (“PPP”) was created as part of the CARES Act to provide small businesses with the resources needed to maintain their payroll, hire back employees who have been laid off, and cover applicable overhead. However, the Small Business Administration (“SBA”), the agency tasked with implementing this program, has imposed regulations relating to the use of funds in a way that is contrary to the intent of Congress and the CARES Act and discriminatory towards businesses that are insolvent and are currently in bankruptcy.

This article focuses on the SBA’s potentially discriminatory practice of shutting out businesses in bankruptcy from receipt of PPP funds.

I.           An Overview of the CARES Act and PPP

Section 1102 of the CARES Act establishes the PPP, a temporary program by which applicants can obtain unsecured loans in an amount up to the lesser of $10 million or 2.5 times an applicant’s average monthly payroll.  The funds are forgivable if used by the applicant to fund payroll, mortgage interest, rent and utility costs. The PPP loans are a lifeline for struggling businesses, as all interest and principal payments on the loans are deferred for six months and borrowers do not pay fees for obtaining or prepaying the loans. The PPP loans also are forgivable in whole or in part if the borrower satisfies certain requirements, including the requirements that a borrower maintains employment and wage levels and payroll costs account for 75 percent of the forgiven principal amount.

To obtain a PPP loan, a borrower must apply with a participating lender using an application form created by the SBA.  Upon approval of the loan, the SBA guarantees the loan. Lenders do not perform any due diligence or other investigation with respect to the truthfulness of the borrower’s application or its ability to repay the loan. Banks are authorized to rely on the statements in a borrower’s application in assessing whether the borrower qualifies for a PPP loan. The CARES Act states that PPP loans are available to: (1) any business concern, 501(c)(3) nonprofit organization, veterans organization or tribal business concern as described in Section 31(b)(2)(C) of the Small Business Act (15 U.S.C. 657a(b)(2)(C)) that: (a) qualifies as a small business concern under current SBA standards corresponding to its primary industry; (b) meets both tests in SBA’s “alternative-size standard” as of March 27, 2020; and (c) employs not more than 500 employees whose principal residence is in the United States; or (2) a sole proprietorship, independent contractor or eligible self-employed individual.

The PPP was also intended to prioritize borrowers in underserved and rural markets, including minority and woman-owned businesses.[1]

II.           SBA Regulation Excludes Debtors in Bankruptcy Proceedings

Despite absolutely no guidance from Congress in the CARES Act as it relates to prohibiting a debtor in bankruptcy from applying for or receiving a PPP loan, or limiting the availability of PPP loans based on an applicant’s status as a debtor or other party in interest in bankruptcy, the SBA issued a PPP loan application that asks if the applicant is “presently involved in any bankruptcy” or if the applicant, any owner of the applicant, or any business owned or controlled by any of them, ever obtained a direct or guaranteed loan from the SBA or any other federal agency that currently is delinquent or has defaulted in the last seven years and caused a loss to the government.  If the answer to either of these questions is yes, the SBA’s official form states that the loan will not be approved.

On or about April 15, 2020, the SBA released an interim final rule which states:

4. Eligibility of Businesses Presently Involved in Bankruptcy Proceedings

Will I be approved for a PPP loan if my business is in bankruptcy?

No. If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the applicant or the owner of the applicant becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant’s obligation to notify the lender and request cancellation of the application. Failure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes.

The Administrator, in consultation with the Secretary, determined 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. In addition, the Bankruptcy Code does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy. The Borrower Application Form for PPP loans (SBA Form 2483), which reflects this restriction in the form of a borrower certification, is a loan program requirement. Lenders may rely on an applicant’s representation concerning the applicant’s or an owner of the applicant’s involvement in a bankruptcy proceeding.

Such a requirement is contrary to the legislative history of the CARES Act, which stated that: “In evaluating the eligibility of a borrower for a loan under section 7(a) of the Small Business Act (15 U.S.C. 636(a)) with the terms described in this subsection and subsection (c), a lender shall only consider whether the borrower—(i) was in operation on March 1, 2020; and (ii) had employees for whom the borrower paid salaries and payroll taxes.”[2]

III.           Anti-Discrimination Provisions of 11 U.S.C. § 525(a)

The SBA’s rule against allowing the disbursement of funds to debtors in bankruptcy is contrary to and violates Title 11 of the United States Code (the “Bankruptcy Code”).  Several debtors throughout the country have argued that the SBA’s actions violate section 525(a) of the Bankruptcy Code which states, that a governmental unit:

may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise or other similar grant to, condition such a grant to, discriminate with respect to such a grant against, deny employment to, terminate the employment of, or discriminate with respect to employment against a person that is or has been a debtor under this title … or another person with whom such bankrupt or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title …, has been insolvent before the commencement of the case under this title, or during the case but before the debtor is granted a discharge, or has not paid a debt that is dischargeable in the case under this title …[3]

IV.           SBA’s Violation of the APA and the Arbitrary and Capricious Standard of Review

When an agency, including the SBA, promulgates legislative rules, or rules made pursuant to congressionally delegated authority, the exercise of that authority is governed by the rulemaking procedures outlined in the Administrative Procedures Act (“APA”).  Under the APA, courts must “hold unlawful and set aside agency action” that is “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right” or “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”[4]  An agency decision is arbitrary and capricious: “if the agency has relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise.”[5]

In Roman Catholic Church of the Archdiocese of Santa Fe v. United States of America Small Business Administration, Adv. Pro. No. 20-1026-t, (Bankr. D.N.M. May 1, 2020), the Court found that the SBA’s adoption of the rule excluding debtors in bankruptcy proceedings was arbitrary and capricious. The Court noted: (1) the PPP was a grant or support program instead of a loan program, whereby the statutory eligibility requirements do not include creditworthiness; (2) the CARES Act makes PPP money available regardless of financial distress, as financial distress is presumed; (3) the test itself (are you a bankruptcy debtor?) is arbitrary and capricious because it does not accurately gauge a borrower’s likelihood of complying with the PPP and is unsupported by the terms of the CARES Act; and (4) the SBA’s articulated justification for the bankruptcy disqualification is “completely frivolous.”[6]

V.           New Jersey Based Company, Aspen Landscaping Contracting, Inc. Files for Injunctive Relief

In New Jersey, Aspen Landscaping Contracting, Inc. (“Aspen”), represented by Richard D. Trenk, Robert S. Roglieri, and Andrew E. Arthur of McManimon, Scotland & Baumann, LLC, is also challenging its right to use PPP funds within its Chapter 11 Bankruptcy.  Aspen, a minority and woman-owned small business, applied for a PPP loan by marking “Yes” to the question regarding its bankruptcy filing and including an addendum explaining that it should not be precluded from participating in PPP based on its bankruptcy status because it was due to emerge from Chapter 11 on April 17, 2020 but due to COVID-19 delays, the hearing was rescheduled to May.  After full disclosure of Aspen’s bankruptcy and meeting all other eligibility criteria, on or about April 14, 2020, the SBA approved the PPP funding to Aspen.  However, the April 15 Rule, which further clarified the SBA’s stance on bankruptcy filers was issued after Aspen’s PPP Grant was already funded.

On May 12, 2020, Aspen filed an Adversary Complaint in the United States Bankruptcy Court for the District of New Jersey to allow Aspen to use the PPP funds.

On May 15, 2020, the United States Bankruptcy Court for the District of New Jersey entered an Order to Show Cause for a temporary, preliminary and permanent injunction, restraining and enjoining the SBA from withdrawing the PPP funds and setting a hearing for the permanent injunction on June 16, 2020.

If you would like to discuss the Payroll Protection Program, the CARES Act or corporate and personal restructuring options, please contact Richard D. Trenk at (973) 721-5039 or Robert S. Roglieri at (973) 721-5032.


[1] Section 1102(P)(iv) of the CARES Act.

[2] 2019 CONG US S 3548, 116th CONGRESS, 2nd Session.

[3] 11 U.S.C. § 525(a).

[4] 5 U.S.C. § 706(2).

[5] Motor Vehicle Manufacturers Association v. State Farm Auto Mutual Insurance Co., 463 U.S. 29, 42-44 (1983).

[6] Roman Catholic Church, Adv.Pro. No. 20-1026-t at 10-11.