Second Circuit Separation Resolved: No PPP Loans for Bankrupt Debtors | Kelley Drye & Warren LLP

In March, the United States Court of Appeals for the Second Circuit joined a growing majority of courts with Springfield Hospital, Inc. v. United States SBA Administratorbelieving that, however lenient its terms, a CARES Act Paycheck Protection Program (“PPP”) the loan is not protected under Section 525(a) of the Bankruptcy Code, which prohibits government units from refusing, revoking, suspending or refusing to renew a license, permit, charter, franchise, or other similar grant to a debtor solely because of his quality of debtor within the meaning of the Bankruptcy Code. Specifically, the Second Circuit held that the PPP was not an “other like subsidy” protected under Section 525(a).

At the start of the COVID-19 pandemic, the majority of non-essential procedures and office visits at Springfield Hospital were canceled, postponed, or rescheduled due to stay-at-home orders that had an immediate impact and serious on cash flow. As a result, Springfield filed for Chapter 11 in June 2019 in the District of Vermont. To meet short-term operating obligations, Springfield applied for several state and federal emergency grants, including PPP loans that were denied because the hospital was a Chapter 11 debtor at the time of the application.

Claiming that the SBA’s administration of the PPP discriminated against Springfield and violated Section 525(a) of the Bankruptcy Code, Springfield filed a lawsuit in bankruptcy court seeking, among other things, an order restraining the SBA from denying the hospital’s PPP loan application on the basis that the applicant is a debtor in bankruptcy. The bankruptcy court ruled in Springfield’s favor, granting a temporary restraining order and then an order restraining the SBA from denying Springfield’s PPP loan application. Specifically, the bankruptcy court found that the Second Circuit line of business excluding credit extensions from protection under Section 525(a) had been struck down by Congress or subsequent Second Circuit rulings; and regardless, the PPP is an “other like grant” under section 525(a) in law. The bankruptcy court certified its decision for a direct appeal to the Second Circuit due to a division of powers resulting from a contrary ruling by the Western District of New York.

The Second Circuit, focused on the plain language of Section 525(a), overturned the bankruptcy court. After analyzing the definition of “grant”, the Second Circuit acknowledged that the PPP is a grant, but concluded that the words “other” and “like” in Section 525(a) narrow the scope of protected grants to those that are comparable to the other terms listed in the law – licenses, permits, charters and franchises. The Second Circuit further clarified that its previous precedent, which excluded a New York student loan guarantee program from Section 525(a) protections, had indeed been rescinded, but only for student loans, pursuant to an amendment to Section 525(a). In other words, Congress must expressly include certain types of loans within the scope of Section 525(a). The Second Circuit also disagreed with the bankruptcy court’s reliance on later Second Circuit jurisprudence that eligibility for a public housing lease was protected under Section 525(a). , because lending and leasing are “significantly different”. Finally, the court concluded that a PPP loan is a loan program despite its forgiveness mechanism because, among other things, PPP loans are evidenced by promissory notes, earn interest and can be deferred like traditional loans.

The Second Circuit said Section 525(a) is unambiguous and cannot be read broadly to protect every type of government subsidy. Even though the PPP ended on May 31, 2021, debtors should expect similar challenges to qualify for future government grant and loan programs without specific action from Congress.