Bankrupt debtor trumps SBA in District of Arizona PPP loan dispute | Snell and Wilmer

The Paycheck Protection Program (“PPP”) was a repayable loan program administered by the U.S. Small Business Administration (“SBA”) that was created as part of the Coronavirus Aid, Relief, and Economic Security Act ( “CARES Act”) in March 2020. The PPP ended on May 31, 2021. Since the passage of the CARES Act, litigation has ensued over whether failed businesses are eligible to receive PPP loans.

The SBA has issued several Interim Final Rules outlining key provisions for implementing the PPP. One of these interim final rules issued on April 20, 2020 – the fourth interim rule – provided that debtors in active bankruptcy proceedings are not eligible to receive PPP loans. Even though the original CARES Act was silent on debtor eligibility for PPP loans, the Fourth Interim Final Rule specifically provided, among other things, that if a PPP loan applicant (or business owner) is the debtor in bankruptcy proceedings, either when he submits the application or at any time before the disbursement of the loan – he is not eligible to receive a PPP loan.

Many bankrupt debtors have sued the SBA for its decision to exclude debtors from the PPP. The debtors’ objections were grouped around two main arguments. First, the debtors argued that the PPP’s bankruptcy-specific disqualification violates Section 525 of the Bankruptcy Code, a section of the Bankruptcy Code that generally protects bankrupt entities from laws that discriminate against bankrupt entities. . Second, the debtors argued that the SBA’s blanket prohibition on lending PPP funds to debtors is arbitrary and capricious, and therefore unenforceable under the Administrative Procedures Act.

In this context, on September 9, 2021, the United States District Court for the District of Arizona granted judgment in favor of PCT International Inc. (“PCT”), a debtor in pending bankruptcy proceedings who got a PPP loan while bankrupt. . See Carranza v. PCT International Inc., No. CV-20-01307-PHX-DJH, 2021 WL 4060551. PCT sued SBA in its bankruptcy proceedings, seeking a ruling that SBA improperly denied PCT a PPP loan because PCT was bankrupt. The bankruptcy court agreed and ruled that the SBA had arbitrarily and capriciously exceeded its authority by enacting the Fourth Provisional Rule which barred debtors from obtaining PPP loans. The SBA orally asked the bankruptcy court to stay the decision, but did not subsequently file a motion to stay with the appeals court or the bankruptcy court. The SBA subsequently appealed the bankruptcy court’s decision. In response, PCT filed a motion to dismiss the appeal, arguing that the appeal was fairly moot because the SBA failed to protect its rights by seeking a stay as required by applicable bankruptcy rules. , and because the PPP loan funds had been spent by PCT.

The appeals court applied a four-factor test to determine whether the appeal is fair moot. The first factor – whether a stay was sought by the SBA – weighed in favor of a fair moot finding because the SBA failed to obtain a stay from the district court or to file petition for a stay with the bankruptcy court. The second factor – whether substantial performance of the court order occurred – also weighed in favor of the finding of mootness, as the PPP loan had been fully funded and the funds had been disbursed by PCT. The third factor – the effect that any remedy may have on third parties – also weighed in favor of a theoretically fair conclusion, as it would be impossible to unwind payments made to third parties with the proceeds of the PPP loan. The fourth factor – the availability of the bankruptcy court to fashion an effective and fair remedy – was neutral because PCT was unable to establish that the bankruptcy court would be unable to fashion an effective and fair remedy. In total, the Court of Appeal concluded that three of the four factors weighed in favor of a fair moot finding and determined that a fair moot finding was warranted. Therefore, the court did not rule on the merits of the appeal.

Given that the PPP ended on May 31, 2021, we may never have a final decision in the Ninth Circuit as to whether the SBA’s decision to bar debtors from getting PPP loans was arbitrary and capricious, or in violation of the Bankruptcy Code. However, the only two appellate courts to rule on this issue (the Fifth Circuit and the Eleventh Circuit) upheld the bankruptcy restriction in favor of the SBA and found that the SBA did not exceed its jurisdiction by refusing to issue PPP loans to debtors.