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SBA Says PPP Funds Cannot Be Loaned to DIP, but One Court Finds the Prohibition Violates 11 U.S.C. § 525(a)

April 28, 2020

On April 24, the Small Business Administration published additional interim rules which clarified that the SBA would not allow Paycheck Protection Program (PPP) loans to be used for debtor in possession (DIP) funding by stating as follows:

If the applicant or the owner of the applicant is the debtor in a bankruptcy proceeding, either at the time it submits the application or at any time before the loan is disbursed, the applicant is ineligible to receive a PPP loan. If the applicant or the owner of the applicant becomes the debtor in a bankruptcy proceeding after submitting a PPP application but before the loan is disbursed, it is the applicant’s obligation to notify the lender and request cancellation of the application. Failure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes.

The Administrator, in consultation with the Secretary, determined 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. In addition, the Bankruptcy Code does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy. The Borrower Application Form for PPP loans (SBA Form 2483), which reflects this restriction in the form of a borrower certification, is a loan program requirement. Lenders may rely on an applicant’s representation concerning the applicant’s or an owner of the applicant’s involvement in a bankruptcy proceeding.

Recent Ruling in the U.S. Bankruptcy Court in Texas Challenges SBA’s Prohibition of Using PPP for DIP

On April 23, the SBA’s ability to limit a DIP from obtaining PPP funds was challenged in the United States Bankruptcy Court for the Southern District of Texas. (In re County Emergency Service Foundation, Bankr. SD Tex. Case No. 19-20497). In a ruling from the bench, Judge David R. Jones agreed with the debtor’s argument that the SBA prohibition on the use of PPP funds for the DIP violated 11 U.S.C. § 525(a), which prohibits a governmental unit from discriminating against a debtor in bankruptcy.

Thus, the issue as to whether a DIP can obtain and use PPP funds remains subject to debate. As long as this issue remains unsettled, the lender that knowingly makes a PPP loan to a DIP risks losing the SBA guaranty and the DIP remains at risk for losing the forgiveness component of the loan.

Evolution of the PPP

Since the launch of the SBA’s PPP Program, there has been some discussion among bankruptcy and turnaround professionals as to whether a troubled company could file for Chapter 11 bankruptcy relief and then obtain PPP funds for DIP financing to take advantage of the lower standards for obtaining such funds compared with more typical DIP loans, low interest rate, the lack of risk to the lender based on the SBA guaranty and the ability to incorporate the forgiveness of some of the funds if used as required under the PPP (e.g., for payroll, rent and other allowed expenses).

It is worth noting that since the inception of the PPP, the SBA has been issuing guidance in the form of interim rules and FAQs, so the interpretation and application of the PPP continues to evolve.

Our team will continue to share the latest developments and provide insights on the PPP program and its impact on businesses.