Bankruptcy Debtor Prevails Over SBA in District of Arizona PPP Loan Dispute

By Andrea M. Hicks, Molly J. Kjartanson and Tanya N. Lewis

The Paycheck Protection Program (“PPP”) was a forgivable loan program administered by the US Small Business Administration (“SBA”) that was created as part of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in March 2020.  The PPP ended on May 31, 2021.  Since the passage of the CARES Act, litigation has ensued over whether companies in bankruptcy are eligible to receive PPP loans. 

The SBA has issued multiple interim final rules outlining the key provisions for implementing the PPP.  One such interim final rule issued on April 20, 2020—the Fourth Interim Rule—provided that debtors in active bankruptcy proceedings are ineligible to receive PPP loans.  Even though the original CARES Act was silent as to debtor eligibility for PPP loans, the Fourth Interim Final Rule specifically provided, among other things, that if a PPP loan applicant (or company owner) is the debtor in a bankruptcy proceeding—either when it submits the application or at any time before the loan is disbursed—it is ineligible to receive a PPP loan. 

Many bankrupt debtors sued the SBA over its decision to exclude debtors from the PPP.  Debtors’ objections coalesced around two main arguments.  First, debtors argued that the bankruptcy-specific disqualification from the PPP violates section 525 of the Bankruptcy Code—a section of the Bankruptcy Code that generally protects entities in bankruptcy from laws that discriminate against bankrupt entities.  Second, debtors argued that the SBA’s blanket proscription on lending PPP funds to debtors is arbitrary and capricious, and therefore unenforceable under the Administrative Procedures Act. 

Against this backdrop, on September 9, 2021, the United States District Court for the District of Arizona entered judgment in favor of PCT International Inc. (“PCT”), a debtor in a pending bankruptcy proceeding that obtained a PPP loan while in bankruptcy. See Carranza v. PCT International Inc., No. CV-20-01307-PHX-DJH, 2021 WL 4060551.  PCT initiated an action against the SBA in its bankruptcy proceeding, seeking a ruling that the SBA improperly denied PCT a PPP loan because PCT was in bankruptcy.  The bankruptcy court agreed and held that the SBA arbitrarily and capriciously exceeded its authority in issuing the Fourth Interim Rule that barred debtors from obtaining PPP loans.  The SBA orally requested that the bankruptcy court stay the ruling but did not subsequently file a motion to stay with the appellate court or the bankruptcy court.  Thereafter, the SBA appealed the bankruptcy court’s ruling.  In response, PCT filed a motion to dismiss the appeal, arguing that the appeal was equitably moot because the SBA did not protect its rights by seeking a stay as required under applicable bankruptcy rules, and because the PPP loan funds had been spent by PCT. 

The appellate court applied a four-factor test to determine if the appeal is equitably moot.  The first factor—whether a stay was sought by SBA—weighed in favor of a finding of equitable mootness because the SBA failed to obtain a stay from the district court or to file a motion to stay with the bankruptcy court.  The second factor—whether substantial consummation of the court’s order occurred—also weighed in favor of finding equitable mootness, because the PPP loan had been fully funded and the funds had been disbursed by PCT.  The third factor—the effect any remedy may have on third parties—also weighed in favor of a finding of equitable mootness, because it would be impractical to unwind the payments made to third parties with the proceeds of the PPP loan.  The fourth factor—the availability of the bankruptcy court to fashion effective and equitable relief—was neutral because PCT was unable to establish that the bankruptcy court would be unable to fashion an effective and equitable remedy. In total, the appellate court found three of the four factors weighed in favor of a finding of equitable mootness and determined that a finding of equitable mootness was warranted.  Therefore, the court did not reach the merits of the appeal. 

Because the PPP ended May 31, 2021, we may never have finality within the Ninth Circuit as to whether the SBA’s decision to bar debtors from obtaining PPP loans was arbitrary and capricious, or in contravention of the Bankruptcy Code.  However, the only two Courts of Appeal that ruled on this issue (the Fifth Circuit and the Eleventh Circuit) upheld the bankruptcy restriction in favor of the SBA and found that the SBA did not exceed its authority when declining to grant PPP loans to debtors.