Health Law Monitor

Healthcare Debtors Receive Court Relief (For Now) from the SBA’s Rule against Debtors Receiving PPP Loans—Some Lawmakers Want Permanent Relief

May 7, 2020

By: Chacey R. Malhouitre

While many ICUs in various parts of the country have been overwhelmed with COVID-19 patients, many healthcare providers have suffered significant financial losses due to non-emergent visits and elective procedures being put on hold while states prepared for their respective peaks for COVID-19 cases. Several healthcare providers, including large hospital systems, have filed for bankruptcy in the wake of the pandemic, while providers already in bankruptcy proceedings that were on track to reorganize or sell their assets to a new operator, experienced severe setbacks between the decreased income and the declining economy. 

Like other bankruptcy debtors, many providers were surprised when they learned they were ineligible for loans through the Paycheck Protection Program (“PPP”) under the March 2020 CARES Act, which provides loans in amounts up to $10 million to businesses meeting certain criteria, and, if used as authorized, the PPP loans can be forgiven in whole or in part. The PPP loans are guaranteed by the United States Small Business Administration (“SBA”). 

While the CARES Act also provided changes to the Bankruptcy Code and Rules to accommodate small businesses, the SBA recently announced that PPP loans would not be available to businesses involved in bankruptcy proceedings. Docket No. SBA-2020-0021, Section III. 4. In fact, the first question on the PPP loan form prepared by the SBA requires the applicant to disclose whether it is presently involved in bankruptcy proceedings. See SBA Form 2438. Lenders have been instructed by the SBA that a debtor in a pending bankruptcy is ineligible for a PPP loan. In addition, if a business applies for a loan, but subsequently files for bankruptcy prior to funds being disbursed, it must notify the lender of the filing and withdraw the application. Docket No. SBA-2020-0021, Section III. 4. The SBA has made it clear that it does not want to be the guarantor of loans used to repay a debtor’s secured and unsecured creditors. The SBA has also expressed its belief that PPP loans to debtors “would present an unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans.” Id. Contrary to that position, however, if a business files for bankruptcy after it receives PPP loan funds there does not appear to be any issue.

Debtors have challenged the SBA Administrator’s rule in their bankruptcy proceedings. The results vary by jurisdiction, but at least three healthcare providers recently prevailed at the temporary restraining order stage. 

In each of the three cases, the bankruptcy courts held that the debtors showed a substantial likelihood of success on their claims that the SBA violated 11 U.S.C. § 525(a), which provides 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” solely because the person filed bankruptcy. And based on the circumstances of each debtor, the courts found that the debtors were entitled to a temporary restraining order against the SBA and various other parties to prevent the restrained parties from denying PPP loans solely because the applicant was in bankruptcy

Hidalgo County EMS filed for Chapter 11 bankruptcy in 2019 and was progressing in its bankruptcy case. But with COVID-19, its run volume decreased significantly, and the debtor experienced significant cash flow issues while trying to maintain its pre-pandemic employee level to be able to service the community. Hidalgo County EMS was denied a PPP loan in the first round of funding because it was in bankruptcy. When the second round of PPP funding became available, it filed an adversary proceeding and sought a temporary restraining order against the SBA Administrator. Hidalgo County EMS expressed concern that it would not be able to fund the next payroll without a PPP loan.

The court found that the risk of harm to Hidalgo County EMS and the public interest to keep Hidalgo County EMS in full operation outweighed any harm to the SBA. The court held that Hidalgo County EMS could strike out the "or presently involved in any bankruptcy" language on the PPP form and answer no to the question, and it could do something similar for any other bank PPP documents or forms with bankruptcy conditions. Finally, the Court ruled that the restrained parties could not condition the approval of any PPP loan or guaranty to the debtor contingent on the debtor or any owner of the debtor not being "presently involved in any bankruptcy."

The temporary restraining order is set to expire May 8, 2020, and the court scheduled a hearing for that same date to determine if a preliminary injunction is necessary.

In a set of cases filed and decided in tandem in Maine, both Penobscot Valley Hospital and Calais Regional Hospital were debtors in bankruptcy when the pandemic hit, and both applied for PPP loans and were denied. The SBA acknowledged that the applications were denied because the hospitals were involved in bankruptcy proceedings and deemed ineligible for the loans. 

In granting a temporary restraining order, the bankruptcy court clarified why 11 U.S.C. § 525 likely barred the SBA from denying debtors PPP loans when bankruptcy law also provides that a lender is not obligated to loan money to a debtor. Judge Fagone held that it would “miss the point” if the PPP loans were likened to a “garden-variety loan that is not . . . protected under section 525(a).” Rather, PPP loans, as part of the entire CARES Act aid package, are part of a “grant of aid necessitated by a public health crisis” and thus, the hospitals made a significant showing that PPP loans could fall under 11 U.S.C. § 525’s “other similar grant” language.

The court also found that both debtors faced significant irreparable harm if the restraining orders were not granted because available PPP funds have been exhausted quickly and the hospitals would not be able to maintain the requisite staff to meet their charitable missions and provide healthcare services to the community. The harm to the hospitals was found to exceed the potential harm to the SBA.

In addition to requiring the SBA and the lenders to ignore the hospitals’ bankruptcy status when reviewing the loan applications, and allowing the debtors to strike the bankruptcy language from the forms, the court also ordered that the SBA Administrator set aside funds in an amount equal to the loan amount the hospitals qualified for so that the funds would be available in the event the hospitals otherwise qualified.

The temporary restraining order is set to expire on May 14, when, like with Hidalgo County EMS, the court has scheduled a hearing to determine if a preliminary injunction is warranted.

Take Aways

It should be noted that each order applied only to the debtor addressed therein and to the facts of each case. The courts did not definitively find that 11 U.S.C. § 525(a) barred the SBA from excluding debtors from PPP loans, only that the debtors showed a substantial likelihood that they could prevail on that issue. Further, the injunctive relief granted turned on the fact that the providers needed to maintain staff to continue to provide care for the community, despite steep declines in revenue because of shelter in place-type orders. 

While the findings in each of the orders regarding the application of 11 U.S.C. § 525(a) would be applicable to healthcare and non-healthcare debtors alike, if decided on the merits, whether non-healthcare debtors would be able to make a case for injunctive relief in the meantime before the PPP funds are exhausted is unclear. Several non-healthcare debtors have been denied the same relief, despite the fact they were also at risk of terminating employees and possibly liquidating, while other have had success. Compare Cosi, Inc. v. U.S. Small Bus. Admin., Case No. 20-ap-50591 (Bankr. D. Del.) (denying motion for temporary restraining order) with Roman Catholic Church of the Archdiocese of Santa Fe v. U.S. Small Bus. Admin., Case 20-ap-01026-t, Docs. 15 & 16 (Bankr. D. N.M. May 1, 2020) (finding in debtor’s favor and allowing debtor to file suit against SBA if debtor missed out on $900,000 in funds because of SBA’s delay). This is further complicated by bankruptcy-specific issues and jurisprudence that may ultimately weigh in favor of the SBA on this issue. 

Nevertheless, lawmakers, such as Senators Susan Collins (ME), Angus King (ME), Bernie Sanders (VT), and Patrick Leahy (VT), as well as Representatives Jared Golden (ME) and Peter Welch (VT), have written the SBA Administrator urging the SBA to include exceptions to the rules for healthcare debtors.

• Chacey R. Malhouitre