Who CARES: Insolvency and the Payroll Protection Program

This article was originally published in the Oregon State Bar Debtor Creditor Newsletter in the Spring of 2020.

By Erich Paetsch, Attorney in the Creditors’ Rights & Bankruptcy and Litigation Practice Groups

The Coronavirus, Aid, Relief, and Economic Security Act (the “CARES Act”) became law on March 27, 2020.[1] The largest fiscal stimulus package in the history of the United States, the CARES Act includes vital resources for individuals and businesses impacted by COVID-19 and the life-saving public health response.[2] While each part of the CARES Act is important, one program created by the CARES Act that is receiving significant media attention is the Payroll Protection Program (the “PPP”).[3]  

The PPP is designed to assist small businesses—defined as those with less than 500 employees, including sole-proprietors, independent contractors, and gig workers—with paying certain payroll, loan interest, rent, and utility expenses.[4] The CARES Act requires the Treasury Secretary and the Small Business Administration (the “SBA”) to prepare to implement regulations for the application and administration of the PPP.[5] The initial regulations were released hours before the first loan applications were submitted to lenders under the PPP on April 3, 2020.[6] 

Since April 3, SBA regulations are regularly issued or clarified, with many important questions unanswered as of the writing of this article.[7] Because of the size and scope of the program, the extremely short time period involved in the creation and implementation of the PPP, and ever-evolving and sometimes conflicting regulatory guidance, the PPP requires debtor-creditor lawyers to rapidly learn, monitor, and explore how the PPP impacts their clients. 

Applying for Assistance under the PPP

The PPP has proven to be popular—and for some businesses, critical to survival. The PPP is implemented by making forgivable loans available under the existing SBA 7(a) program, SBA’s primary program for providing financial assistance to small businesses. Under the terms of the Small Business Act, SBA assistance to a small business under section 7(a) may take the form of a direct loan, immediate participation (joint) loan with a lender, or a deferred participation (guarantee) loan initiated by an authorized SBA lender but a portion of which SBA will purchase from the lender in the event of a default.[8] 

In implementing the PPP, the SBA removed requirements that typically limit loan availability under the SBA 7(a) loan program and provided very favorable loan terms.[9] The PPP loans take the form of a 100% guarantee (deferred participation) of amounts loaned by an approved originating lender and do not require a guaranty or any pledge of collateral.[10] The loan amount available to an eligible borrower is up to 250% of the average monthly payroll over a 12-month period.[11] There is no payment required for the first six months following receipt of funds, interest accrues at 1.00% percent, and amounts loaned must be repaid within two (2) years.[12] Perhaps most appealing, some or all of the amounts loaned may be forgiven if certain requirements are satisfied over an eight-week period immediately following receipt of funds.[13]

Important impacts are arising from seeking a loan under the PPP for borrowers. For example, as of the writing of this article, other than the CARES Act and general statements, no regulations have been issued by the SBA or the Department of the Treasury clearly explaining the conditions and requirements for forgiveness under the PPP. As a result, many borrowers are forced to guess on how to qualify for forgiveness after receiving funds under the PPP. Second, the CARES Act also provides important benefits for self-employed individuals, independent contractors, and gig workers. In addition to eligibility under the PPP, the CARES Act also permits those same parties to apply for and receive enhanced unemployment benefits.[14] As a result, such parties must assess which benefit will provide a better economic outcome for their situation. 

Despite these challenges—or perhaps as a reflection of the anxiety and uncertainty given the pandemic—in two weeks, the entire $349 billion allocated for distribution by approved lenders for the PPP was exhausted.[15] In response to the unprecedented demand, Congress passed the Paycheck Protection Program and Health Care Enhancement Act (the PPP II”) on April 23, 2020.[16] The PPP II added an additional $310 billion in funding under the PPP. Some estimates were that this sum would again be exhausted within 72 hours.[17] Consequently, by publication, funding under PPP II will likely be exhausted. It is unclear whether additional funds will be made available under the PPP. 

Insolvency Restrictions on Borrower Eligibility

As part of its regulatory authority under the CARES Act, the SBA has adopted several emergency interim regulations on how insolvency impacts eligibility under the PPP. Among other statements, the SBA has included a question on the PPP loan application form that the borrower certifies it is “not presently involved in a bankruptcy.”[18] In addition, the SBA has issued recent regulations clarifying that if an applicant or the owner of the applicant is the debtor in a bankruptcy proceeding either at the time it submits an application or any time before the loan is disbursed, it is ineligible to receive a PPP loan.[19] As a result, it is clear that the SBA’s position is that insolvent debtors currently in bankruptcy are ineligible to receive funds under the PPP. 

Ingenuity may be required to obtain a critical source of cash for debtors already in bankruptcy and impacted by the pandemic. In at least one reported case, a chapter 11 dismissal and intended refiling is occurring solely to permit an application for a PPP loan to be submitted without stating “YES” on the PPP loan application form to the bankruptcy question. In addition, adversary proceedings have been filed challenging the SBA’s regulatory position on insolvency prohibiting eligibility under the PPP.[20] For example, in the Southern District of Texas, the Honorable David R. Jones issued a temporary restraining order on April 25, 2020, barring the SBA from limiting Hidalgo County EMS from participating in the PPP.[21] Among other theories, such suits suggest that the SBA’s exclusion of parties in bankruptcy is unlawful discrimination under 11 U.S.C. § 525(a), which provides that:

…a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or another similar grant to, condition such a grant to, discriminate with respect to such a grant against…a person that is or has been a debtor under this title…solely because such bankrupt or debtor is has been a debtor under this title…

In support of such discrimination allegations, debtors commonly note that certain sections of the CARES Act specifically amend the Bankruptcy Code. For example, the CARES Act temporarily increases the debt limit for Subchapter V bankruptcy cases to $7,500,000 (up from $2.7 million).[22] In addition, the CARES Act in other sections expressly restricts a debtor already in bankruptcy from eligibility for benefits.[23] No such restriction exists under the PPP within the CARES Act. 

In contrast, the SBA relies upon its broad regulatory authority and the conditions and requirements for issuing and receiving a loan under the 7(a) Small Business Act incorporated in the PPP by the CARES Act.[24] In addition, subsequent to arguments in Hidalgo, the SBA issued interim regulations making clear a borrower in bankruptcy is ineligible.[25] Not raised by the SBA in Hidalgo, there is a further relationship between the PPP and funding that might separately bar the SBA from issuing loans. To ensure liquidity for the originating lenders to make loans under the PPP, the United States Federal Reserve has created something called the PPP Liquidity Facility (the “PPPLF”).[26] The PPPLF exists pursuant to and under § 13(3) of the Federal Reserve Act (the “FRA”). As provided under the FRA “[t]he Board shall establish procedures to prohibit borrowing from programs and facilitates by borrowers that are insolvent.”[27] However, participation in the PPPLF is not a requirement of the PPP. Practically speaking, without the liquidity provided under the PPPLF, lenders are unable to make loans on the scale and in the amounts required under the PPP. It is unclear how the recent regulations and the PPPLF issue might impact the discrimination arguments being raised under the Bankruptcy Code.  

Absent a new round of funding, efforts to obtain loans under the PPP by insolvent debtors are limited to a very narrow time period. It is unclear whether the efforts to enforce the anti-discrimination provisions under Section 525 of the Bankruptcy Code will be successful and, if so, timely, given the limited available funds. The SBA has made clear loans are available on a first-come, first-served basis. For those eligible borrowers who do receive funds, obtaining forgiveness can become crucial. 

Government CARES and Forgiveness

A compelling aspect and intended outcome for many borrowers is forgiveness of all amounts borrowed under the PPP, essentially converting the loan into a grant. To date, official regulations and clear guidance on forgiveness remain elusive. In general, forgiveness under the CARES Act is available if during an eight-week period starting on the date funds are received, the funds are spent on:

          – Payroll costs (not to exceed individual compensation over $100,000 annually).

          – Interest payments on any mortgage in existence before February 15, 2020.

          – Rent on any lease in existence on or before February 15, 2020.

          – Utility costs.

These same restrictions impact how the funds can be used generally. The amount eligible for forgiveness will be reduced proportionally by any reduction in employees during the eight-week period and requires that at least 75% of the funds go towards eligible payroll costs.[28] Outside of these general guidelines contained in the CARES Act itself and in the limited regulatory guidance issued to date, many borrowers are left guessing on how to spend PPP loan funds to ensure forgiveness. 

At the same time, it is unclear whether or how traditional legal issues impacting debtors and creditors might impact funds once received under the PPP and affect forgiveness. For example, does a creditor have a right to setoff or to garnish such funds, essentially eliminating the ability of the borrower to obtain forgiveness and defeating the intended use of the funds under the PPP? What is the impact on a borrower seeking forgiveness if, during the eight-week period, they subsequently file a bankruptcy petition? Is it better to pursue forgiveness or preserve the funds for use in subsequent bankruptcy or insolvency proceedings? Do the PPP restrictions on the use of funds for designated purposes survive a bankruptcy filing? Do the prohibitions expressly referencing bankruptcy also apply to other insolvency proceedings—for example, a state court receivership or an assignment for the benefit of creditors? Given the limited position of the originating lender and the SBA by extension as an unsecured creditor, these issues will be the subject of future judicial proceedings in state and federal court. 


Given the size and scope of the PPP under the CARES Act, it is likely that debtor-creditor lawyers in Oregon will require an understanding of how PPP loans work and what the limitations are on the use of loan funds. Despite limitations, the PPP provides an important source of cash flow for distressed businesses at an unprecedented time. Considering how such funds may be used to address insolvency situations and how the purpose and authority behind the PPP might limit or restrict a creditor’s rights may become crucial to benefit all parties involved. 

[1]       Pub. L. 116-136, 134 Stat. 281 (March 27, 2020). 

[2]       https://www.npr.org/2020/03/26/821457551/whats-inside-the-senate-s-2-trillion-coronavirus-aid-package

[3]       See generally §§1101-1109 of the CARES Act. 

[4]       https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program#section-header-2

[5]        See SBA, Interim Final Rule, “Business Loan Program Temporary Changes; Paycheck Protection Program” (“PPP Interim Final Rule”), Fed Reg. Vol. 85, No. 73 at 20811 (2020). 

[6]       Id. 

[7]       See generally https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program#section-header-2 (last updated on 4/28/2020). 

[8]       13 C.F.R. § 120.2(a).

[9]       See PPP Interim Final Rule at 20811 and Section 1102(a) of the CARES Act. 

[10]      Id.

[11]      See generally, https://www.sba.gov/document/support–faq-lenders-borrowers

[12]      Id.

[13]      Id. 

[14]      See generally https://www.dol.gov/newsroom/releases/eta/eta20200402-0

[15]      https://www.forbes.com/sites/advisor/2020/04/16/the-paycheck-protection-program-ran-out-of-funding-whats-next-for-small-business-owners/#5377d1847440

[16]      See generally https://www.sba.gov/about-sba/sba-newsroom/press-releases-media-advisories/joint-statement-sba-administrator-jovita-carranza-and-treasury-secretary-steven-t-mnuchin-resumption

[17]      See “Senate Oks $408B More Virus Relief for Small Biz, Hospitals” Law 360 (April 21, 2020)(quoting Richard Hunt of the Consumer Bankers Association). 

[18]      Available at https://www.sba.gov/sites/default/files/2020-04/PPP-Borrower-Application-Form-Fillable.pdf

[19]      See 85 FR 23450-23452 (April 28, 2020). 

[20]      For the latest on adversary proceedings and outcomes challenging the SBA’s regulatory implementation of the CARES Act, please visit the American Bankruptcy Institute’s COVID-19 resource page: abi.org/covid19

[21]      See In re Hidalgo County Emergency Service Foundation v. Jovita Carranza (Case No. 19-20497, Adversary Proceeding 20-2006)(ECF Docket #18, Temporary Restraining Order)(dated April 25, 2020). See also generally, Commentary: This DIP Loan Brought to you by Someone who CARES! (Or, “I’m from the Government and I’m Here to Help You), Part One” (April 1, 2020)(American Bankruptcy Institute). 

[22]    CARES Act, § 1113(1).

[23]      See CARES Act at § 4003(c)(3)(D)(i)(V)(requiring any recipient of a loan under Title IV not be a “debtor in a bankruptcy proceeding.”

[24]      See “Defendant’s Brief Concerning Temporary Restraining Order,” In re Hidalgo County Emergency Service Foundation v. Jovita Carranza (Case No. 19-20497, Adversary Proceeding 20-2006)(ECF Docket #8)(dated April 24, 2020). See also CARES Act, Section 1102 amending the Section 7(a) of the Small Business Act. 

[25]      See 85 FR 23450-23452 (April 28, 2020).

[26]      See https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200409a6.pdf

[27]      FRA § 13(3)(B)(ii).

[28]      See PPP Interim Final Rule at 20811.

Erich Paetsch is a partner in the Litigation and Creditors’ Rights & Bankruptcy practice groups and a member of the Financial Services and Construction Industry Groups. The information in this article is not intended to provide legal advice. For professional consultation, please contact Erich at Saalfeld Griggs PC.  503.399.1070.  epaestch@sglaw.com  © 2020 Saalfeld Griggs PC