SBA: No, Bankrupt Companies Are Not Eligible to Receive PPP Loans

April 28, 2020

Can businesses obtain a Paycheck Protection Program (PPP) loan to fund their chapter 11 bankruptcy cases? This question has been looming over companies facing bankruptcy and in immediate need of financing. On April 15, the Small Business Administration (SBA) issued its answer.

In its Interim Rule, the SBA stated, among other things, that companies in bankruptcy cannot apply for PPP funds made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The SBA stated that the Bankruptcy Code “does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy.” Further, the SBA stated that if a company is in bankruptcy after applying for the PPP loan, they must contact the lender, and “[f]ailure by the applicant to do so will be regarded as a use of PPP funds for unauthorized purposes.” The SBA based its ruling upon a determination that “providing PPP loans to debtors in bankruptcy would present an unacceptably high risk of an unauthorized use of funds or non-repayment of unforgiven loans.” Both sides have challenged the availability of PPP loans to fund a chapter 11 bankruptcy case.

Bankruptcy Code section 364 provides a debtor-in-possession (DIP) the ability to obtain post-petition financing on either a secured or unsecured basis (DIP Financing), subject to bankruptcy court approval. DIP Financing is a form of lending by which banks and other lenders will finance the credit needs of a DIP that has sought protection under the Bankruptcy Code. It is typically required in cases where the DIP does not have enough cash to operate and fund the restructuring. DIP loans range in size and complexity. They are designed to provide a debtor with immediate cash and ongoing working capital to sustain its business. DIP loans require a combination of loan documents and a DIP order entered by the bankruptcy court, and they often include significant protections for the lender. The PPP loans appeared to be a potential source of DIP Financing, and providing such loans to a debtor seeking to reorganize is consistent with the purpose of the CARES Act.

The CARES Act allocated approximately $376.5 billion for financing “small businesses” (those under 500 employees or the standard business industry size established by the SBA). It included $349 billion under the new PPP created under the SBA’s 7(a) loan program. After the initial PPP loans were fully drawn within days of the CARES Act enactment, Congress approved $484 billion of additional funding. Of that, $310 billion is earmarked for the SBA to add funds to the PPP.

  • $60 billion is set aside for loans made by small banks, credit unions, minority-owned banks and other smaller lenders.
  • The loan will be forgiven if used for payroll and related expenses and benefits.
  • The SBA will administer $50 billion through the Economic Injury Disaster Loan program. This program provides loans of up to $2 million, which can be used for working capital. Small businesses qualifying for such loans may use the proceeds to pay fixed debts, payroll, accounts payable and other expenses. Interest rates on these loans is fixed at 3.75% for small for-profit businesses and 2.75% for non-profits.

The PPP provisions of the CARES Act do not expressly prohibit the use of the program for DIP Financing in a bankruptcy case. However, the SBA lending criteria do require a borrower to be “creditworthy” and that loans be “so sound as to reasonably assure repayment.” Further, the PPP loan application asks if “the Applicant … [is] presently involved in any bankruptcy” and the application form says that if the question is answered “Yes,” the loan will not be approved. So, are PPP loans available as a source of bankruptcy funding? According to the SBA’s recent ruling, the unfortunate answer for debtors is NO. Undeterred, debtors have sought bankruptcy court approval to use PPP loans as DIP Financing:


In re: Village East, Inc., 20-31144 (USBC, WDKY), Doc. 29 - Village East, a senior living community in Louisville, Kent., was approved for a PPP loan on April 8. The next day, Village East filed for Chapter 11 bankruptcy, and the bank canceled the loan based upon a “material change in circumstances.” Village East filed a motion for turnover of the loan proceeds, citing no provisions in the CARES Act that disallows a debtor in bankruptcy from receiving such loans. A hearing was held over the phone on April 24, and the motion was denied. The court did not render an opinion, but one reason could be the recent SBA interim ruling.


In re: Mountain States Rosen, LLC, 20-20111 (USBC, DWY), Doc. 68 - Mountain States Rosen, LLC filed a Chapter 11 petition in Wyoming on March 19. While in bankruptcy, Mountain States Rosen filed a PPP loan application that was approved and funded on April 17. Mountain Rosen then filed a motion seeking authority to enter into the loan as post-petition DIP Financing. Objections are due by May 11. It is expected that the SBA will object to the release of such funds, relying upon its interim ruling.


In re: Starplex Corporation, 20-2224 (USBC, DAZ) - Starplex filed a Chapter 11 petition in Arizona on March 4. While in bankruptcy, Starplex filed a PPP loan application on April 3. The loan application was rejected on April 6 because Starplex was “presently in bankruptcy.” On April 13, Starplex filed a lawsuit to prevent the SBA from denying a PPP loan to a debtor in bankruptcy. It seeks declaratory relief that its loan application be considered despite being a debtor in bankruptcy. The parties have agreed to a briefing schedule, and a hearing on the preliminary injunction is set for May 21.

The CARES Act was created to assist businesses economically damaged by the COVID-19 virus. In light of the unprecedented economic impact upon small businesses, the reality is that most of them are in financial distress (whether in bankruptcy or not). Now is the time for the SBA to permit access to such loans in bankruptcy (for the benefit of the owners, employees and vendors). The basis for the SBA’s de facto denial of access to such funds in bankruptcy is also unsupported by the protections afforded a lender providing DIP Financing. For instance, a bank that issued a PPP loan to a DIP is in a much more favorable position than one that funded a PPP loan before the debtor filed for bankruptcy because the DIP loan is, at a minimum, afforded administrative expense priority. If a plan is confirmed, the DIP loan must be repaid. On the other hand, a lender issuing a loan on the eve of bankruptcy is subject to its loan being reduced, altered or diminished. The SBA rule only applies when the loan has not been paid out before a bankruptcy filing. Businesses are, therefore, incentivized to obtain the loan before filing for bankruptcy. This policy is fundamentally at odds with the SBA’s basis for denying bankrupt entities access to PPP funds—the unacceptably high risk that such loans will not be repaid. It also ignores the Bankruptcy Code protections afforded a DIP Financing lender. Given the protections afforded a lender in bankruptcy, the SBA should reconsider the availability of PPP loans as DIP Financing.

As this issue continues to evolve, Phelps will continue to monitor the implications of the CARES Act and offer guidance on whether its financing provisions can be included as part of a restructuring analysis. Please contact Rick Shelby, Danielle Mashburn-Myrick or Phelps’ Bankruptcy team if you have any questions or need compliance advice and guidance. For more information related to COVID-19, please also see Phelps’ COVID-19: Client Resource Portal.