SBA Issues Additional Guidance on PPP Loan: Damn You Shake Shack and Why Does the SBA Hate Debtors in Possession?
On Friday, April 24, 2020 after President Trump signed the legislation increasing funding for PPP loans. At approximately the same time, the SBA and Treasury issued additional guidance in the form of FAQs. The guidance, while seeming to fly under the radar, creates uncertainty for borrowers and clarifies that companies considering or in bankruptcy cannot obtain PPP loans. However, it’s more complicated than that.
New Regulations for Borrowers
FAQ 31 asks whether “businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?” There is no definition of “large company” or “adequate sources of liquidity” or “ongoing operations”. Moreover, the answer does not appear to apply just to the Shake Shacks, and hedge funds that applied for PPP loans. The answer says:
Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.
While the answer references public companies as generally excluded, it does not afford any safe harbor to non-public companies, or define what is meant by a “large” company. It references “borrowers,” which would seem to mean all PPP loan borrowers. The only guidance is that the loan must be “necessary.” Is this “necessary” to: (a) remain open, (b) not lay off employees, (c) not reduce salaries? Does this inject a requirement of owners of closely held companies to expend personal resources or take out other loans? While there needed to be clarification to stop certain activity, the vagueness of this rule is troubling.
The goal of the PPP was to provide small firms with forgivable loans to retain personnel, even if they may not be working (or working at full capacity). For example, a dentist, whose office is shut down would normally layoff all her employees. However, if she takes out the PPP loan, even though shut down, she will continue to pay the employees. If the dentist is personally wealthy, should she not take out the PPP loan? How about a medical or accounting office that is working at 50% capacity? How about a law firm that can’t litigate because court operations are reduced? How about a factory that can operate on a limited basis due to falling orders? Particularly with respect to service businesses, the list goes on. All of these businesses would reduce their operations and layoff off employees but for getting a PPP loan. Thus, it would seem, that the loan is “necessary.” However, if the owners have other sources of funding or personal wealth and savings, decisions could apparently be questioned after the fact.
As a result, FAQ 31, directed to large hospitality companies that took advantage of the relaxation of affiliation rules, now creates uncertainty. Hopefully, this FAQ will be clarified to limit its application, otherwise there will be substantial litigation caused if banks do not forgive loans or the SBA refuses to honor guarantees after the fact. It would be unfortunate if small business owners are required to decide between expending personal savings and laying off employees.
Bankruptcy Companies Cannot Obtain PPP Loans (or Can They?)
I wrote last week that the CARES Act does not specifically prohibit the SBA or banks from extending PPP loans to chapter 11 debtors. However, the SBA generally does not lend to distressed companies. On April 24, 2020, the SBA revised the “Final Interim Rule” to provide that a debtor in bankruptcy may not apply for a PPP loan: “[i]f 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.” The guidance goes on to require a company that applies for a PPP loan and later files bankruptcy to rescind its application. It is unclear what happens if the loan was disbursed prior to the bankruptcy filing. While this rule may be somewhat consistent with existing SBA guidelines concerning EIDL loans or standard SBA loans, neither of those are forgivable. If the goal is to keep employees employed right now, a company’s status as a debtor in bankruptcy should not matter. Thus, the limitation seems ill conceived.
Several lawsuits have already been filed challenging the refusal of the SBA to approve PPP loans for chapter 11 debtors. Indeed, on Friday, a bankruptcy judge in Texas in the matter of: Hidalgo County Emergency Service Foundation, Adv. Prov. No. 20-2006 (Bankr. S. D. Tex.), issued a TRO enjoining the SBA from disapproving a PPP loan just because the borrower was a debtor in a chapter 11 case. Essentially, the TRO requires the bank and SBA to process the PPP loan striking the question about “presently involved in any bankruptcy.” The court has scheduled a further hearing for May 8th.
As I argued previously, PPP loans to small businesses in chapter 11 appear to be a good idea. They keep people employed and reduce cash requirements of debtors. PPP loans may afford a struggling business some runway to reorganize given the times in which we live. Hopefully, the SBA will reconsider its position.
 Note, FAQ 31 has a safe harbor for companies that return PPP loan funds by May 7, 2020.