By Shane Ramsey and John Baxter

Law360 (July 16, 2020, 3:25 PM EDT) --

Shane Ramsey

John Baxter

On June 22, U.S. Circuit Judge Judge Jerry Smith issued a short, three-page opinion in the case Hidalgo County Emergency Service Foundation v. Carranza that appeared, at first blush, to be a death blow to many debtors' ability to obtain Paycheck Protection Program, or PPP, loans under the Coronavirus Aid, Relief and Economic Security, or CARES, Act.

Despite the dire consequences that could have arisen as a result of this order for debtors across the country, the cases that have addressed this decision since its passage have not all fallen in line with the U.S. Court of Appeals for the Fifth Circuit's approach. As such, while debtors in the Fifth Circuit are unlikely to enjoin the U.S. Small Business Administration from denying them PPP loans, debtors in other circuits could still be eligible.

The Hidalgo Decision

On April 25, the U.S. Bankruptcy Court for the Southern District of Texas entered a preliminary injunction that prohibited the SBA from refusing to provide a PPP loan to debtor Hidalgo County Emergency Service Foundation.

The primary rationale for the Hidalgo bankruptcy court's ruling was two-fold: (1) that the debtor was likely to succeed in its claim that the SBA had exceeded its statutory authority by including a bankruptcy-specific bar that was not included in the CARES Act; and (2) that the debtor was likely to succeed on its claim that allowing lenders to deny a PPP loan application solely on the grounds of the debtor's bankruptcy case would violate Section 525(a) of the Bankruptcy Code.

Section 525(a) provides that


At the hearing, U.S. Bankruptcy Judge David Jones made clear that he was not buying the SBA's argument that the issuance of PPP loans to debtors would result in a situation where it was highly unlikely that the funds issued would either be used for an improper purpose or otherwise unlikely to be repaid.

Judge Jones noted that this argument was "so out of context in this program that it's a frivolous argument." This was so, according to Judge Jones, because the PPP program was not a "loan program," but a "support program." As such, the argument that extending the loans to debtors would result in a position where they were unlikely to be repaid was inapposite to the purpose behind the enactment of the PPP.

The bankruptcy court's decision in Hidalgo was the first decision on this particular issue and was immediately cited by many bankrupt debtors seeking similar relief across the country. These debtors had mixed success, but generally it appeared that the debtors were finding more success in having preliminary injunctions imposed than the SBA was in opposing the injunctions.

For example, among others, both the U.S. Bankruptcy Court for the District of Maine in In re: Calais Regional Hospital and the U.S. Bankruptcy Court for the District of Vermont in In re: Springfiled Hospital Inc. both issued temporary restraining orders enjoining the SBA shortly after the bankruptcy court's Hidalgo decision — although the court in Maine ultimately reversed its prior decision and denied further injunctive relief.

Unsurprisingly, the SBA appealed the bankruptcy court's ruling in Hidalgo. At the first level of appeal, the U.S. District Court for the Southern District of Texas stayed the preliminary injunction and certified the case for immediate circuit court review. After accelerated briefing, the Fifth Circuit entered its order.

Rather than addressing the merits of the debtor's arguments in favor of the injunction — the arguments that won the day before the bankruptcy court — the Fifth Circuit found one issue dispositive: The Fifth Circuit had previously held that Title 15 of the U.S. Code, Section 634(b)(1) absolutely prohibits all injunctions directed toward the SBA.

Section 634(b)(1) states that "no attachment, injunction, garnishment, or other similar process, mesne or final, shall be issued against the [SBA] administrator or his property." Following this Fifth Circuit precedent on Section 634(b)(1), and refusing to create an exception thereto, the Fifth Circuit panel followed its rule of orderliness in refusing to ignore the binding precedent of the circuit. The debtor did not seek en banc review and the mandate was issued on July 14. The decision is, thus, final — barring U.S. Supreme Court review

How Other Courts Are Treating Hidalgo

Although the Hidalgo decision unquestionably bars debtors in the Fifth Circuit from enjoining the SBA in order to obtain PPP loans, the case has not been universally followed. As of the date of this article, at least three courts have cited the Fifth Circuit's Hidalgo decision. Two of these three courts have entered injunctions against the SBA, despite the Hidalgo holding.

These disparate decisions arise from a split in the circuits as to how broadly the prohibition imposed by Section 634(b)(1) should be interpreted. Some circuits, like the Fifth, have taken a broad interpretation of "injunction" and held that the plain language of Section 634(b)(1) bars all injunctions against the SBA.

Other circuits, like the U.S. Courts of Appeal for the First and Federal Circuits, have held that the prohibition imposed by Section 634(b)(1) does not prohibit injunctions based on claims where the SBA is acting solely as a commercial actor and not a regulator or where the SBA's actions exceeded their statutorily granted authority.

In Defy Ventures Inc. v. U.S. Small Business Administration, the U.S. District Court for the District of Maryland on June 29 held that because there was no Fourth Circuit decision analogous to that in the Fifth Circuit, the SBA was subject to being enjoined. Defy Ventures was not a bankruptcy case but dealt with the prohibition in the PPP application that prevents companies whose owners have been convicted of certain crimes within the past five years from obtaining loans.

Similarly, in In re: Vestavia Hills Ltd., the U.S. Bankruptcy Court for the Southern District of California held on June 26 that the SBA could be enjoined from preventing a debtor in bankruptcy from applying for a PPP loan. Like the District of Maryland in Defy Ventures, the Vestavia Hills court relied on the lack of similar precedent in the U.S. Court of Appeal for the Ninth Circuit to that in the Fifth Circuit.

Finally, also on June 26, the U.S. District Court for the District of Maryland in Tradeways Ltd. v. U.S. Department of the Treasury denied a request for an injunction against the SBA. Critically, however, the Tradeways court did not expressly hold that Section 634(b)(1) barred imposition of an injunction, but held that the plaintiff had not met its burden for seeking the injunction. Only three days later, the Defy Ventures case was decided by a different judge in the same court and allowed for imposition of the injunction.

Moving Forward

While this issue will likely only be litigated for a relatively short time moving forward — as of now, the extended deadline for filing PPP loan applications is Aug. 8 — those debtors seeking PPP loans outside of the Fifth Circuit still have a chance to enjoin the SBA from denying their applications.

Because the Fifth Circuit's decision in Hidalgo did not address the merits of the SBA's position, but merely followed prior precedent, the issues articulated by Judge Jones in the bankruptcy court and that have been cited in other jurisdictions remain viable.

And debtors have other, albeit cumbersome, alternatives to obtaining PPP loans beyond enjoining the SBA.

Companies that are on the verge of filing for bankruptcy protection could file their PPP applications prior to filing their bankruptcy petitions. Once the loans are approved, they can then file and utilize the PPP loan to float payroll during the opening stages of a bankruptcy case. TooJay's Original Gourmet Deli based out of Florida is one company that took this approach.

For companies that are already in bankruptcy, some debtors have taken the drastic step of having their cases dismissed, temporarily, to obtain the PPP loans. Multiple debtors — including Blue Ice Investments LLC in Arizona, Eastern Niagara Hospital in New York and Faith Community Health System in Texas — have elected to take this extraordinary step.

This strategy, of course, is not without risk. Not only is refiling a bankruptcy case expensive and cumbersome, the PPP loan forgiveness process is in its infancy and the SBA may well challenge whether a loan may be forgiven under such circumstances.

Many, if not all, notes evidencing PPP loans list filing for bankruptcy as an event of default. While this ipso facto clause is not immediately enforceable in bankruptcy, it could provide support for an argument that the loan should not be forgiven.

While the Fifth Circuit's decision in Hidgalgo is certainly a hurdle, it is not the game-changer that it could have been. Debtors' counsel will need to look to the precedent in their circuit to determine how Section 634(b)(1) has been interpreted and analyze whether an alternative to seeking an injunction against the SBA is the best path forward.

If the debtor's circuit falls in line with the Fifth Circuit, it is likely that Hidalgo may prevent an injunction and dismissal may be the only path towards obtaining a PPP loan. If, however, the circuit has come down the side of the First Circuit, or not yet addressed the issue, the debtors may still be able to successfully enjoin the SBA and obtain these critical PPP loans.

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Shane Ramsey is a partner and vice chair of the bankruptcy and financial restructuring practice group at Nelson Mullins Riley & Scarborough LLP.

John Baxter is an associate at the firm.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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