SBA Clarifies PPP Loans and Bankruptcy | Dorsey & Whitney LLP
Since the first round of Paycheck Protection Program (P3) loans, there has been confusion regarding the eligibility of businesses or owners associated with bankruptcy. This has resulted in significant litigation between debtors in possession in Chapter 11 reorganization cases and the SBA (or lenders). The SBA has in all cases argued (and in the clear preponderance of cases prevailed) that any applicant (or one with a 20% owner) in a Chapter 11 bankruptcy was not eligible for a PPP loan. Congress did not help in the second round of the PPP because it “clarified” the law by stating that the SBA “may” allow debtors in possession in reorganization cases to obtain PPP loans. The SBA has chosen NOT to allow Chapter 11 companies to reorganize. Thank you Congress for a complete failure in solving the problem. After all, which businesses need help the most?
Thus, the confusion of bankruptcy continued into the second round of the PPP. The PPP application requires that each applicant and any owner of 20% or more of the applicant certify that they are NOT “currently involved in bankruptcy” in order to be eligible. Could there be a question worded more amorphously? Not surprisingly, this has created consternation among lenders in the interpretation of what “currently involved in bankruptcy” means and creates greater stress for applicants or owners who have been “involved” in bankruptcy matters.
On April 6, 2021, the SBA finally provided advice by posting FAQ 67. The SBA says three conditions end involvement in a bankruptcy case. First, if a person has been involved in Chapter 7 bankruptcy, that person is no longer “involved” in the bankruptcy once a discharge order is entered. Second, if the plaintiff (or the 20% owner) has been a debtor in a Chapter 11, 12 or 13 case, the plaintiff is no longer “currently involved in bankruptcy” once a confirmation order is issued. plan has been entered. Third, under any bankruptcy chapter, once an order dismissing the case is entered, bankruptcy participation ends. In each of the three circumstances, the order must be entered before the PPP application is filed.
Although the publication of FAQ 67 provides guidance, the theoretical foundations are suspect and leave other questions unanswered. The guidelines seem to focus on granting discharge. Once a discharge is granted in a Chapter 7, the individual is no longer “involved” under SBA guidelines, but that individual’s bankruptcy case remains open and the individual’s participation in the process. plaintiff remains the property of the bankruptcy estate – subject to sale by the trustee or abandonment. This could disrupt the applicant’s business. SBA does not provide any guidance on this issue. For example, an individual who owns 80% of a business files a Chapter 7 and the discharge order is seized (in many cases, around 120-150 days after filing). At this point, the individual is no longer “involved” in the bankruptcy and the business can apply for the PPP loan. Then, after receiving the proceeds from the PPP loan, the Chapter 7 bankruptcy trustee takes over or sells the business. It seems that is probably not what SBA had in mind.
The Bankruptcy Code governs the effect of a confirmed Chapter 11 plan to reinvest property in the debtor and provide discharge from the debt (with certain limitations). Upon confirmation of the plan, the applicant is no longer “involved” in bankruptcy and the applicant can apply for and get a PPP loan. However, not all plan payments have yet been completed or even started – and may extend for years into the future. This is a great advantage for a Chapter 11 debtor who can now anticipate future receipt of the proceeds from the PPP loan as part of a plan. In Chapters 12 and 13, a discharge takes place only after the completion of all payments under the scheme. But the debtor can apply for and get the PPP when confirming, and then use the proceeds. All of this begs the question of why applicants in need of PPP loans and who are likely relying on them to fund their bankruptcy plans have to wait for confirmation to apply for such a loan. Indeed, the only tangible result is an unnecessary delay which can lead to the demise of companies that cannot reach the confirmation finish line, thus undermining the very purpose of PPP loans.