One of the landmark protections enacted by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was the Paycheck Protection Program (“PPP”). Under the PPP, small businesses (businesses with fewer than 500 employees) are eligible to receive loans that will be fully forgiven if utilized under the terms of the Program, including applying at least 75% of the loans to payroll. The loans may also be used for payment of interest on mortgages, rent, and utilities. The PPP loans are capped at $10 million for each small business. The Small Business Administration (the “SBA”) administers the PPP with support from the Department of the Treasury.

Since enactment of the PPP, there has been a flurry of litigation in the bankruptcy courts regarding the availability of PPP loans to companies that are currently debtors in chapter 11 cases. The primary point of contention in these cases arises from the language of the PPP applications. While the CARES Act itself, including the section enacting the PPP, is silent as to any requirement that PPP applicants not be in bankruptcy, the PPP loan applications require that applicants state whether they are “presently involved in active bankruptcy.” The application further notes that, if the applicant answers “yes” to this question, the application will be denied.

Because the applications include a bankruptcy bar that the statute does not, debtors whose applications have been denied on this ground have taken to the courts to resolve this apparent inconsistency. The first court to hear and rule on the issue was the United States Bankruptcy Court for the Southern District of Texas in Houston in the case In re Hidalgo County Emergency Service Foundation (Case No. 19-20497). In Hidalgo, Judge David Jones entered a Temporary Restraining Order (“TRO”) on April 25, 2020 enjoining the SBA from denying the Debtor’s PPP Application on the sole basis that the debtor was in bankruptcy.

The primary justification for the Hidalgo court’s ruling was two-fold: (1) that the debtor was likely to succeed in its claim that the SBA had exceeded its statutory authority by including a bankruptcy-specific bar that was not included in the CARES Act, and (2) that the debtor was likely to succeed on its claim that allowing lenders to deny a PPP loan application solely on the grounds of the debtor’s bankruptcy case would violate section 525(a) of the Bankruptcy Code. Section 525(a) provides that “a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to . . . a person that is or has been a debtor under this title or a bankrupt or debtor under the Bankruptcy Act . . . solely because such bankrupt or debtor is or has been a debtor under this title or . . . the Bankruptcy Act . . . .”

On April 24, 2020, one day prior to the Hidalgo decision, the SBA released a new “Interim Final Rule” that expressly noted that debtors in bankruptcy could not be eligible for PPP loans based on the justification 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.” This argument was raised by the SBA and rejected by the Hidalgo court. The Interim Final Order was published and, thus, effective as of April 28, 2020.

Since the entry of both the Hidalgo decision and the new Interim Final Order, Courts are split as to how to treat the debtors’ requests for TROs regarding PPP loans. Some courts, including the United States Bankruptcy Court for the District of Delaware, have rejected the Hidalgo precedent in deference for the SBA’s new Interim Final Order. In In re Cosi, Inc. (Case No. 20-10417), Judge Brendan L. Shannon denied the debtor’s request for a TRO, stating that although he was “dismayed” at the potential negative consequences of the SBA’s refusal to grant debtors access to PPP funds, he was nevertheless going to defer to the SBA as to how the loans were to be disbursed.

Conversely, in In re Calais Regional Hospital, Judge Michael A. Fagone of the United States Bankruptcy Court for the District of Maine entered a TRO similar to the Hidalgo TRO on May 1, 2020. The Calais court focused primarily on the section 525(a) analysis, noting that although loans are not traditionally covered by the section, the PPP loans under the CARES Act could qualify as an “other similar grant” of aid sufficient to fall within the confines of the statute. Accordingly, the Calais Court allowed the Debtor to seek PPP loans despite the Interim Final Order being in place.

This is a dynamic and fluid situation and it appears that the Courts are currently taking disparate approaches to how debtors are to be treated under the PPP system. Debtors’ counsel for small business should keep an ear to the ground on this issue to ensure that they are providing their clients with the best advice possible in this ever-changing landscape.