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As we remain glued to the national and local news about return-to-work procedures and the effects that the pandemic has had on the worldwide economy, we take a look at an interesting decision that just came down from the Bankruptcy Court for the Western District of Tennessee.

The individual debtor filed his voluntary petition in December 2019. An operating trustee was appointed who asserted that as trustee he stepped into the debtor’s shoes as the shareholder of the debtor’s businesses. Alpha Visions Learning Academy, Inc. (Alpha), one of the debtor’s businesses, is a childcare center with 20 employees and about 70 children attending. As a result of the COVID-19 pandemic, attendance dropped and the trustee applied to the Small Business Administration (SBA) for a loan under the Paycheck Protection Program (PPP).

The trustee brought a motion and complaint seeking entry of a temporary restraining order, preliminary injunction and permanent injunction directing the SBA to consider Alpha’s PPP application without consideration of the debtor-owner’s bankruptcy proceedings. In addition, Alpha sought a declaration that SBA violated the Administrative Procedures Act and 11 USC Section 525(a) in excluding applications from entities who are in bankruptcy or who have an owner in bankruptcy.

The trustee alleged that the SBA made approval of any PPP loan expressly contingent on the applicant or any owner of the applicant not being “presently involved in any bankruptcy,” even though this condition is not articulated in the CARES Act that enacts the PPP, or in the Small Business Act. The trustee relied upon Section 525(a) of the Bankruptcy Code, which provides in part:

a governmental unit may not deny…a grant to…a person that is or has been a debtor under [the Bankruptcy Code]…solely because such…debtor is or has been a debtor…has been insolvent before the commencement of the case…or during the case but before the debtor is granted or denied a discharge, or has not paid a debt that is dischargeable in the case under this title or that was discharged…

The trustee argued that Section 525 applied because the PPP is by nature a grant rather than a loan because the debt is to be forgiven.

The SBA responded that the Small Business Act precluded the injunctive relief sought by the trustee, which provides that the SBA:

May…sue and be sued in any court…but no attachment, injunction, garnishment, or other similar process…shall be issued against the [SBA].

The SBA relied on a case from the Sixth Circuit Court of Appeals in asserting that the Small Business Act:

…provides basically that parties may proceed against the SBA but only as Congress has provided. [When the SBA brought] an action against a private party, and where that private party brings a counterclaim that implicates the SBA’s rights, the SBA’s rights are unaffected unless it is made a party to that action pursuant to the consent statute.

The SBA argued that the bankruptcy court’s authority to adjudicate Alpha’s Section 525(a) claim did not extend to its PPP claim, which did not arise under the Bankruptcy Code. The SBA said that it did not consent to the entry of a final judgment on the PPP claims.

The bankruptcy court, however, found that the SBA violated the Bankruptcy Code’s anti-discrimination provision when it directed lenders to refuse to accept PPP applications from entities owned by bankruptcy debtors. The court stated:

Perhaps nothing illustrates the arbitrariness and caprice of the bankruptcy exclusion rule better than SBA’s explanation. In order to implement a Congressional program intended to protect American workers from unemployment and loss of health insurance, SBA arbitrarily eliminated all workers employed by debtors in bankruptcy and all workers employed by entities whose owners are debtors in bankruptcy… In attempting to expedite the PPP application process, SBA chose a path that was diametrically opposed to its prior practice and the stated intention of Congress to provide funds for payroll, mortgage interest, rent, and utilities to struggling businesses. As the Administrator herself explained “no creditworthiness assessment is required for PPP Loans,” yet the explanation offered by SBA in its Opposition to Alpha’s Motion and Complaint is that it excluded bankruptcy debtors in order “reasonably to assure repayment.”…“Given the obvious purpose of the PPP, it was arbitrary and capricious for Defendant to engraft a creditworthiness test where none belonged.”

The court joined two other courts that considered similar claims in finding that the PPP “loan” is in the nature of a “license, permit, charter, franchise, or similar grant” without which a debtor’s fresh start would be impeded.

As there is no question that the only reason that Alpha’s application was turned away by Community Bank was the ruling by SBA that entities owned by debtors in bankruptcy are ineligible for the PPP program, the court finds and concludes that the SBA’s bankruptcy exclusion violates section 525(a) of the Bankruptcy Code.

The court ruled that the SBA violated the Administrative Procedures Act, 5 USC § 706(C), when it exceeded its rulemaking authority by excluding entities owned by bankruptcy debtors from the PPP program; 706(B), when it arbitrarily and capriciously excluded entities owned by bankruptcy debtors from the PPP program; and Section 525(a), when it directed lenders to refuse to accept PPP applications from entities owned by bankruptcy debtors.

Various courts that have considered these issues have determined that the PPP is not a loan program:

It is a grant or support program. The target grant recipients are small businesses in financial distress. The PPP could only be offered by the government; private lenders do not give away money. PPP funds “are unobtainable from the private sector.” … They also are essential to Plaintiff’s fresh start. … Of all the benefits a government can grant, free money might be the best of all. Denying Plaintiff access to PPP funds solely because it is a debtor violates § 525(a).

Free money? 

Alpha Visions Learning Academy, Inc., v. Jovita Carranza, in her Capacity as Administrator for the United States Small Business Administration, Defendant (Bankr. WDTN) 2020 WL 2893413


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