Southern District of Texas Enters Temporary Restraining Order Extending PPP Loan Benefits to Debtor in Bankruptcy

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In a potentially ground-breaking decision, Judge David R. Jones of the United States Bankruptcy Court for the Southern District of Texas temporarily enjoined the Small Business Administration (SBA) from denying a Paycheck Protection Program (PPP) loan to Hidalgo County Emergency Service Foundation due solely to its status as a Chapter 11 debtor in bankruptcy. While the order will expire on May 8, 2020, and only applies to Hidalgo, the order could mark a significant change in the SBA’s administering of the PPP.

Congress passed the CARES Act in response to the coronavirus pandemic to provide financial relief to small businesses. The act provides substantial funding for the SBA’s 7(a) Loan Program under the Paycheck Protection Program. Qualified applicants can receive up to $10 million, with amounts spent on payroll and other covered expenses (subject to certain limitations) eligible for debt forgiveness. In furtherance of the act, the SBA promulgated a Borrower Application Form for small businesses to complete when applying for PPP loans. Question 1 of the Borrower Application Form requires the applicant to disclose if the applicant, or any owner of the applicant, is “presently involved in any bankruptcy.” The form further provides that if the answer to this question is “yes” then the loan will not be approved. Consequently, PPP loans have heretofore been unavailable to debtors involved in a bankruptcy case.

Enter Hidalgo, the primary 911 patient transfer provider for a large part of its service area in South Texas and a debtor in a Chapter 11 bankruptcy proceeding pending in the Southern District of Texas. Hidalgo applied for a PPP loan with a local bank on April 3, 2020, and disclosed that it was involved in a bankruptcy on the Borrower Application Form. On April 9, 2020, the bank denied Hidalgo’s request on the grounds that Hidalgo was not eligible due to its status as a debtor involved in a bankruptcy case. Hidalgo then filed an adversary proceeding seeking injunctive relief prohibiting the SBA from unlawfully prohibiting it from participating in the PPP based on its status as a debtor in bankruptcy. Among its legal arguments, the SBA contended that “[t]he prohibition on lending to companies in bankruptcy allows the Program to continue with shorter-than-normal due diligence periods.”

The court, however, disagreed. The court found that Hidalgo had shown a substantial likelihood that the SBA had (i) exceeded its statutory authority under the CARES Act by categorically prohibiting debtors in bankruptcy from qualifying for PPP loans and (ii) violated section 525(a) of the Bankruptcy Code, which prohibits governmental units from discriminating against parties applying for licenses, permits, charters, franchises or other similar grants who are or have been in bankruptcy. The court further found that Hidalgo would suffer significant harm if the SBA continued in its refusal to permit Hidalgo to apply for a PPP loan. In evaluating the public interest, the court also found that Hidalgo provides critical health services to South Texas and that the continued employment of Hidalgo’s 200+ workforce benefits the public interest.

Based on these findings, the court entered a temporary injunction in favor of Hidalgo enjoining and prohibiting the SBA from, among other things, summarily rejecting Hidalgo’s application for a PPP loan based on its involvement in a bankruptcy proceeding.

While Hidalgo is not the only debtor to be refused a PPP loan, Judge Jones’ order appears to be the first ruling, albeit limited and temporary, prohibiting the SBA from conditioning access to the PPP on a debtor’s involvement in a bankruptcy. The order may provide a path forward for debtors looking to participate in the expected second round of funding for PPP loans. The court will hold a hearing on whether to extend the temporary restraining order into a preliminary injunction on May 8, 2020.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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