Back in March, Congress enacted the Paycheck Protection Program (“PPP”) under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, previously detailed here. The PPP authorized unsecured loans to businesses with up to 500 employees along with loan forgiveness for businesses meeting certain restrictions and guidelines for employee retention and salary disbursements. In particular, in order to obtain loan forgiveness, the PPP, which is administered by the Small Business Administration (“SBA”), required a substantial majority of the funds to be used for employee payroll while businesses maintained staffing levels from prior to the COVID-19 pandemic.

Recognizing the difficulty small businesses faced to meet the loan forgiveness requirements, the subsequently-enacted Paycheck Protection Program Flexibility Act of 2020 (“PPPFA”), detailed here, made significant changes to the PPP easing a number of these restrictions. The PPPFA lowered the percentage of the loan that must be utilized toward employee payroll (75% to 60%), and while the PPPFA as written seemed to mandate an “all-or-nothing” approach to forgiveness based on the new sixty percent (60%) threshold, the Treasury Secretary and SBA issued a joint statement expressing the adoption of sliding scale forgiveness below that threshold.

The PPPFA also extended the time to make use of the funds (8 weeks to 24 weeks) but indicated that borrowers must maintain payroll levels for the applicable period of time. In addition, the maturity date for the loans was extended (2 years to 5 years) with the 5-year period applying automatically to loans subsequent to June 5, 2020, with the possibility of applying by consent to loans prior to that date. The Act also extended the deadline to rehire employees until December 31, 2020, with certain exemptions and safe harbors for employers that could demonstrate a difficulty retaining employees due to increased unemployment benefits or a difficulty returning to business activities due to government closures and restrictions.

In spite of Congress easing these restrictions, some business owners may have concluded that the requirements for PPP loan forgiveness are too onerous or simply impossible to adapt to their particular businesses. Notably, businesses with a significantly higher ratio of costs allocated to other expenses besides employee payroll, or businesses otherwise operating on a limited basis probably arrived at the conclusion that there are limited benefits from the program without prospects of significant forgiveness. For these reasons, while the initial round of PPP loans were quickly exhausted, subsequent funding for the program has not been exhausted and still exceeds $100 billion. Small businesses have instead seemingly considered other avenues to survive, or simply shutter. Businesses have little time remaining to apply for PPP loans with the deadline fast approaching on June 30, 2020. Recent legislation, however, proposes extending this deadline to the end of the year.

Small businesses may want to reconsider applying for loans because even small businesses unable to meet the restrictions or qualify for meaningful loan forgiveness under the PPP or PPPFA may still benefit from the Small Business Reorganization Act (“SBRA”), Subchapter V of Chapter 11 of the Bankruptcy Code, passed earlier this year on the eve of the COVID-19 pandemic. In a typical Chapter 11 bankruptcy, the debtor company continues to operate as it pursues a Chapter 11 reorganization plan (which must be approved by the creditors and confirmed by the Bankruptcy Court) to pay pre-bankruptcy debts and obligations over a period of time. Subchapter V, as amended by the CARES Act, allows debtors with debt up to $7.5 million (threshold reverts to $2,725,625 after one year) a streamlined process in a Chapter 11 reorganization.

In particular, under Subchapter V, the business owner files a reorganization plan within a much shorter time period (90 days). The business owner only needs approval for its reorganization plan from the Bankruptcy Court as opposed to at least one class of creditors and without the appointment of a creditors’ committee. Furthermore, the business owner no longer needs to contribute cash or property to the reorganization and no longer needs to fully repay unsecured creditors such as would be the case with respect to PPP lenders in a typical Chapter 11 bankruptcy. Instead, the business pays creditors from disposable income (profits over and above reasonable compensation to the business owners) over a period of three to five years. Essentially, some proportion of PPP loans may be discharged or otherwise “forgiven.” The time to repay the remainder of the loan would be between 3 to 5 years. The SBRA also provides for the appointment of a trustee to facilitate reorganization and monitoring for payments.

Small businesses considering this option must be mindful that there is some uncertainly about the availability of PPP loans for businesses already in bankruptcy. The SBA formalized a rule against providing PPP loans to debtors in bankruptcy at any time before the loan is disbursed. The SBA loan application form requires applicants to affirm that they are not involved in a bankruptcy and advises that the loan will not be approved if that is the case, even though the CARES Act itself is silent on the subject matter. The SBA further advises that if any business subsequently enters bankruptcy after the PPP loan application is filed but before the funds are disbursed, the business must contact the SBA to cancel the application or else the disbursements will be considered for an unauthorized purpose requiring full repayment or else subjecting the business to potential liability.

Debtors have contested the SBA’s rule arguing that the SBA lacks authority under the legislation to prohibit loans to debtors in bankruptcy, and that the rule otherwise violates the Bankruptcy Code in that it constitutes discrimination against applicants on the basis of their debtor status. Bankruptcy Courts have been split on these arguments. Some have refused to enjoin the implementation of the SBA’s non-bankruptcy rule while others have entered temporary restraining orders prohibiting rejection of PPP loan applications submitted by Chapter 11 businesses. Limited Bankruptcy Courts have even ordered judgment against the SBA requiring disbursement of the requested loan amount. Another strategy some debtors have successfully employed is seeking voluntary dismissal of the Chapter 11 bankruptcy action in order to complete the PPP loan application process only to file a subsequent bankruptcy petition.

In the end, for small businesses, the prudent action most likely is to complete the PPP loan application process before filing any bankruptcy petition. Another reason that this approach may be most prudent is that PPP loans disbursed prior to bankruptcy will most likely be considered an unsecured debt subject to partial discharge while PPP loans disbursed during a bankruptcy may enjoy administrative priority subject to full repayment. In the end, small businesses will need to balance the potential forgiveness that may apply under both the PPP/PPPFA and SBRA. Again, all these considerations will become moot for small businesses that do not apply for PPP loans by the rapidly approaching deadline of June 30,2020, absent any further extension.

If you have any questions please contact any member of our Carmody Torrance Sandak & Hennessey LLP team below.

Liam S. Burke
(203) 252-2689; [email protected]

Thomas R. Candrick, Jr.
(203) 784-3103; [email protected]

Patrick J. Hanna
(203) 252-2667; [email protected]

David S. Hardy
(203) 784-3119; [email protected]

Joseph L. Kinsella
(203) 575-2645; [email protected]

Marc J. Kurzman
(203) 252-2680; [email protected]

Howard K. Levine
(203) 784-3102; [email protected]

Todd Michaelis
(203) 578-4287; [email protected]

Peter M. Nolin
(203) 252-2688; [email protected]

Christopher J. Rooney
(203) 784-3109; [email protected]

Thomas J. Sansone
(203) 784-3100; [email protected]

Timothy A. Smith
(203) 252-2651; [email protected]