Opinion Of Interest – Springfield Hospital, Inc. v. Guzman: Second Circuit Confirms Federal Government’s Ability To Deny PPP Loans To Bankrupt Companies – Insolvency/Bankruptcy/Restructuring

Recently, the Second Circuit became the first federal district court to rule that the federal government could deny a bankrupt debtor a loan under the Paycheck Protection Program (“PPP”) solely based on an applicant’s bankruptcy status. Before the decision of the Second Circuit in Springfield Hospital, Inc. v. GuzmanSeveral lower federal courts have disagreed on the issue, although a majority of those courts reached the same conclusion as the Second Circuit.

When Congress enacted the Coronavirus, Aid, Relief and Economic Security Act, known as the CARES Act, they set up the PPP loan program, a temporary program that provided potentially forgivable loans to small businesses used for payroll and other operating expenses should keep their employees busy during COVID-related shutdowns. The Small Business Administration (the “SBA”) was responsible for administering the program. The SBA automatically denied PPP loans to any applicant who was a bankrupt debtor on the grounds that “the administrator, in consultation with the Secretary [of the Treasury]determined that making PPP loans to bankrupt debtors would pose an unacceptably high risk of unauthorized use of funds or non-repayment of unforgiven loans.”2

Springfield Hospital in Springfield, Vermont, entered voluntary Chapter 11 bankruptcy in June 2019. The COVID-19 pandemic severely impacted the hospital’s revenue streams as the majority of its outpatient and non-essential medical procedures were canceled or postponed due to federal and state closures. The hospital sought relief through bankruptcy and also applied for PPP loans, but because it was in bankruptcy at the time it applied, the hospital’s PPP loan application was denied. The hospital challenged that refusal in bankruptcy court, arguing that it violated Section 525(a) of the Bankruptcy Code, which prohibits the government from denying an applicant a grant simply because they are bankrupt. The bankruptcy court agreed, noting that the PPP loan was essentially a grant to support companies in financial distress, citing in part the potential forgiveness of the PPP loan and the lack of risk assumption. The government appealed.

The question before the Second Circuit was whether the PPP loan was a Section 525(a) “grant”. Section 525(a) of the Bankruptcy Code is an important protection for bankruptcy debtors and provides in part that “an entity of government shall hold a license, permit, charter, franchise, or other similar grants to … a person who is or was a debtor under that title … merely because such … debtor is or was a debtor under that title …”3 Ultimately, the Second Circuit ruled that the PPP loan was not a Section 525(a) “grant” and reversed the bankruptcy court’s decision.

The Second Circuit pointed to the fact that Congress referred to the PPP loans as “loans” in the CARES Act, noting that the word “loan” occurs at least 75 times in the Act. In addition, the court found that PPP loans share common “loan characteristics,” including a fixed interest rate, maturity date, refinancing terms, and a deferral mechanism. While PPP loans could be forgiven, the court found that forgiveness was not guaranteed. Instead, a PPP borrower had to seek and be approved for forgiveness. In the court’s reasoning, the fact that a loan has a forgiveness function does not change that loan into a grant: “A forgiveness option, however favorable, cannot change the structure of what a loan forgiveness program is, a program change forgive loan.”

Eventually, the Second Circuit dismissed the bankruptcy court’s appeal Proudlyan earlier Second Circuit decision.4 In proudthe Second Circuit stated that, based on Section 525(a), public housing leases cannot be denied on the basis of the applicant’s bankruptcy status, since public housing leases are “property rights not obtainable from the private sector and intended for the fresh start of a debtor are essential”.5 The Second Circuit noted that the PPP loans were distinguishable from public housing leases because a borrower could still apply for traditional loans from a bank or receive other government assistance grants (which Springfield Hospital did) even if the borrower received a PPP loan was denied. As a result, unlike public housing rents, PPP loans are in Proudlywere not absolutely necessary for a debtor to start over.

While the PPP loan program ended on May 31, 2021,
Springfield Hospital provides insight into how future government aid programs may be interpreted by courts, including the meaning and legal relevance of the distinction between grant and loan programs (even loan programs with generous writ provisions).

footnotes

1 Springfield Hospital Inc. vs. Guzman, #20-3902 (2nd Circ. March 16, 2022).

2 ID. at 44

3 11 U.S.C. § 525(a).

4 Stolz vs. Brattleboro House. auth. (Regarding pride)315 F.3d 80 (2nd Circle 2002).

5 ID. at 90

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