Second Circuit Split Resolved: No PPP Loans for Debtors in Bankruptcy

Kelley Drye Client Advisory

In March, the U.S. Court of Appeals for the Second Circuit joined a growing majority of courts with Springfield Hospital, Inc. v. Administrator for the U.S. SBA, holding that no matter how forgiving its terms, a CARES Act’s Paycheck Protection Program (“PPP”) loan is not protected under section 525(a) of the Bankruptcy Code, which prohibits governmental units from denying, revoking, suspending, or refusing to renew a license, permit, charter, franchise, or other similar grant to a debtor solely because of its status as a debtor under the Bankruptcy Code. Specifically, the Second Circuit held that the PPP is not an other similar grant” protected under section 525(a).

At the onset of the COVID-19 pandemic, a majority of Springfield Hospital’s non-essential procedures and office visits were cancelled, postponed, or rescheduled pursuant to stay-at-home orders which had an immediate and severe impact on cash flow. As a result, Springfield filed for chapter 11 in June 2019 in the District of Vermont. To satisfy near-term operating obligations, Springfield applied for multiple state and federal emergency grants, including the PPP loans that were denied because the hospital was a debtor in chapter 11 at the time of application.

Claiming that the SBA’s administration of the PPP discriminated against Springfield and violated section 525(a) of the Bankruptcy Code, Springfield commenced a lawsuit before the bankruptcy court seeking, among other things, an order enjoining SBA’s denial of the hospital’s PPP loan application on the basis that the applicant is a debtor in bankruptcy. The bankruptcy court ruled in favor of Springfield, granting a temporary restraining order and then an order enjoining the SBA from denying Springfield’s PPP loan application. Specifically, the bankruptcy court held that the line of Second Circuit cases excluding extensions of credit from protection under section 525(a) had been overruled by Congress or subsequent Second Circuit decisions; and regardless, the PPP is an other similar grant” under section 525(a) as a matter of law. The bankruptcy court certified its decision for direct appeal to the Second Circuit because of a split in authority stemming from a contrary Western District of New York decision.

The Second Circuit, focusing on the plain language of section 525(a), reversed 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 similar” in section 525(a) restrict the scope of protected grants to only those that are comparable to the other listed terms in the statute—licenses, permits, charters, and franchises. The Second Circuit further clarified that its prior precedent, which excluded a New York student loan guaranty program from section 525(a) protections, was indeed overruled, 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 section 525(a)’s purview. The Second Circuit also disagreed with the bankruptcy court’s reliance on subsequent Second Circuit precedent, which held that eligibility for a public housing lease was protected under section 525(a), because loans and leases are starkly 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, accrue interest, and can be deferred like traditional loans.

The Second Circuit stated that section 525(a) is unambiguous and cannot be read broadly to protect every type of government grant.  Even though the PPP ended on May 31, 2021, debtors should expect similar challenges in receiving the benefit of future government grants and loan programs without specific Congressional action.