The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, analyzing a recent decision of interest:

SUMMARY

In Springfield Hospital, Inc. v. Guzman, ___F.4^th ___, 2022 WL 790689 (No. 20-30902) (2d Cir. March 16, 2022) (“Guzman”), in a fifty-three page opinion, the United States Court of Appeals for the Second Circuit (the “Court”) held that the Small Business Administration can deny a Paycheck Protection Program loan to a debtor simply because the debtor is in bankruptcy, concluding that Bankruptcy Code § 525(a)’s prohibition against governmental agencies denying a “grant” because of a borrower’s bankruptcy is inapplicable because such a loan is not a “grant”.

Guzman can be found by clicking the here.

FACTS

Springfield Hospital and Springfield Medical Care System (together, “Springfield”) are related organizations providing medical care in a small Vermont community. They were already facing financial stress when the COVID pandemic arrived; their situation collapsed. They filed Chapter 11 cases in June 2019. They applied for a Paycheck Protection Program (“PPP”) loan to be made by a financial institution and guaranteed by the Small Business Administration (the “SBA”) under a structure created by Congress as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES”). The purpose of CARES was to help alleviate the economic distress caused by the Coronavirus. The PPP is particularly attractive because if the borrower meets certain criteria, the “loan” is forgiven, with the SBA repaying the actual lender.

After filing bankruptcy, Springfield applied for a PPP loan twice. Both times its application was denied because it was in bankruptcy. The PPP legislation permitted the SBA to impose restrictions on PPP lending designed to assure a reasonable prospect of repayment by the borrower. At the time Springfield applied for the loans, the SBA had issued some rules for that purpose. None of these rules specifically proscribed loans to borrowers in bankruptcy. However, a section of the application form declared that if the applicant was in bankruptcy the loan would be denied. Later iterations of the SBA’s PPP rules expressly made bankruptcy a per se ground for denial of a loan application.

After the SBA denied Springfield’s applications, Springfield filed an adversary proceeding in the Bankruptcy Court claiming that the SBA’s action violated § 525(a), the Bankruptcy Code’s anti-discrimination provision, which states that “a governmental unit may not . . deny a license, permit, charter, franchise, or similar grant” (emphasis added) simply because of the bankruptcy of the prospective applicant, and sought related injunctive relief against the SBA. The debtors asserted that their claim for injunctive relief against the SBA was not foreclosed by 15 U.S.C. § 634(b)(1), a provision of the Small Business Act that established the SBA. Section 634(b)(1) authorizes suits by or against the SBA in state or Federal court, but prohibits the issuance of injunctions against the SBA in any such action. In addition, Springfield sought damages and other related relief against the SBA. After some initial proceedings, the Bankruptcy Court granted Springfield summary judgment on its claims. The SBA appealed to the District Court, but the Bankruptcy Court on its own initiative certified a direct appeal to the Court under 28 U.S.C. § 158(d), and the Court granted the certification, ultimately reversing the summary judgment for Springfield and directing entry of summary judgment for the SBA.

REASONING

The Court focused on two main issues. One was whether it had subject matter jurisdiction over the action in light of § 634(b)(1). The other was whether the SBA’s policy of declining PPP loans to applicants in bankruptcy violates § 525(a)’s prohibition against denial of a “grant” because of the applicant’s pending bankruptcy.

Subject Matter Jurisdiction. Though the Court’s treatment of the issue is instructive, a discussion here would unduly lengthen this Report. The Court concluded that it had subject matter jurisdiction.

Alleged Violation of § 525(a). Noting that its first task was to consider the language of the statute itself, the Court concluded that on that point the result was clear. It first noted that the parties agreed that of the string of transactions that a governmental unit may not deny under § 525(a), only “other similar grants” (emphasis added) could apply to a PPP loan. And as a simple matter of ordinary language (not to mention definitions in a leading legal dictionary), a “grant” and a “loan” by their very nature are different. Because the PPP transaction clearly was a loan, even though some or all of it could be forgiven (making it look in part like a grant), it was not a grant and therefore not encompassed by § 525(a).

Moving on to other confirming considerations, the Court devoted a lengthy passage to harmonizing two of its precedents about § 525(a), with the older case treating the SBA PPP guarantees as credit guarantees. Springfield claimed that the cases conflicted with each other, with the newer case overruling the older one and thereby favoring its broad interpretation of § 525(a). The Court rejected that view. In the end, applying the maxim that language such as “other similar grants” contemplates that the items in the § 525(a) list share certain characteristics, the Court explained that the string of transactions that § 525(a) prohibits share two characteristics: they are unavailable in the “private sector” and critical to the debtor’s fresh start through bankruptcy. But a credit guarantee, such as that given by the SBA under the PPP, fails to satisfy either characteristic since credit guarantees are available outside of government sources and may in particular cases help with a fresh start, but are not in principle keyed to that objective.

In addition, the Court noted that an amendment to § 525(a) that made it apply to government-guaranteed student loans did not broaden the scope of that section to all government-guaranteed loans (such as PPP loans). That Congress added such a narrow band of government-guaranteed loans to § 525(a) indicates that Congress knew how to fine tune amendments to its purpose and therefore did not mean to include PPP loans. This is even more persuasive in that this amendment took place in the midst of a long series of conflicting cases on the very issue Guzman presented, with the vast majority agreeing that § 525(a) does not apply to PPP loans. This fact tends to confirm that Congress very carefully did not mean to include PPP loans in § 525(a). Finally, that Congress amended the PPP in the midst of that series of cases without addressing the Guzman issue also tends to confirm that it never intended § 525(a) to apply to PPP loans.

AUTHOR’S COMMENT

The Court in Guzman makes a good case for its conclusion. The opinion marshals a number of independently credible arguments for the result. But the reasoning is not iron clad. Consider the following points, for example. Is there really such a dispositive distinction between a loan and a grant? True, most loans have to be repaid and most grants do not. But most grants are for specific purposes and often have milestones to be met; if the grantee uses the funds for other purposes or defaults on milestones, it may have to repay the grant money. And, by the same token, some loans can be forgiven in whole or in part for various reasons. And in ordinary language we often refer to the “granting” of approval of a loan application, suggesting that a loan is a kind of grant subject to conditions, as many grants are. Similarly, that Congress has amended § 525(a) without resolving the split in authority among courts on the question of its application to PPP loans does not necessarily mean that Congress agrees with the majority rule. As anyone who has watched bankruptcy legislation (or legislation of any kind for that matter), all Congress’s failure to act may mean is that it cannot reach a consensus on how to fix a problem, not that it agrees with the prevailing rule. Think, too, how the Guzman line of cases undermines the fresh start objective of bankruptcy (not to mention the purpose of CARES and the PPP) by providing a disincentive for a troubled company to file for relief in the hope that it can pull of a PPP loan, thus perhaps only worsening its condition and prospects for when it finally does have to file.

Finally, the SBA’s decisively linking of bankruptcy to the issue of whether the borrower has a reasonable prospect of repayment is questionable in light of the fresh start policy of bankruptcy. Is a company that files bankruptcy any less likely to repay a PPP loan the moment it files than the moment before it did so? Indeed, in some cases the filing of a timely bankruptcy enhances the debtor’s recovery prospects that might suffer a fatal blow if it holds off in order to get a PPP loan and then files. The point is not that bankruptcy should not be a consideration for the SBA in whether to make a PPP loan, but that it should not be an ipso facto disqualification of a PPP applicant. The SBA should add to its credit analysis the advantages and disadvantages of bankruptcy in any particular case. Nowhere does the Court discuss policy considerations; perhaps, as these comments suggest, that is because such a discussion might have favored sustaining the Bankruptcy Court.

In short, it is likely that the issue will continue to plague courts, and it is possible that it may even result in a split at the Circuit level, although the limited life of the PPP may tamp down judicial action.

These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.