How a Federal Agency Excluded Thousands of Viable Businesses From Pandemic Relief

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Like every other storefront in downtown Lincoln, Nebraska, the Coffee House — a cavernous student hangout slinging espresso and decadent pastries since 1987 — saw its revenue dry up almost overnight last spring when the coronavirus pandemic made dining indoors a deadly risk. Unlike most, however, the business wouldn’t have access to the massive loan fund that Congress made available for small enterprises in late March.

The reason had nothing to do with the business itself, which had been having one of its best years ever, according to its owner, Mark Shriner. Rather, it all came down to one box on the application for the Paycheck Protection Program money, which asked whether the company or any of its owners were “presently involved in any bankruptcy.” Shriner had filed for Chapter 13 in 2018 after a divorce and was still making court-ordered debt payments, so he checked “yes.” He was automatically rejected and lost about $25,000 in payroll and other costs that the program would have covered.

“My money is my store’s money. When I got divorced and she was entitled to half, it’s not like a company can raise money real quick,” Shriner said, noting the way in which many small businesses are structured as pass-through entities that pay taxes on any profits as individual income. “All these businesses that had a tough time and are trying to make payments at the same time are getting kind of hosed.”

Thousands of people file for Chapter 13 bankruptcy every year — 282,628 did so in 2019 alone. Although it’s not clear how many of them own businesses, all of those individuals were barred from the PPP program, along with the thousands of businesses currently working through a reorganization plan under Chapter 11 and the family farms that file under the lesser-known Chapter 12.

In December, Congress allowed the Small Business Administration to give exceptions to some debtors. But so far the SBA has stuck to its position that debtors in bankruptcy aren’t entitled to government aid. “Currently, the SBA is administering the law as written,” SBA spokeswoman Shannon Giles emailed in response to questions.

Although Shriner did receive the $10,000 Economic Injury Disaster Loan advance payment, which doesn’t have to be repaid, the SBA turned him down for a larger Economic Injury Disaster Loan because of his personal credit. Instead, he took out two loans worth $107,000 from Square — with total fees of nearly $12,000 — to keep the lights on and the staff paid as they operated on a drastically limited basis, still down by more than half since before the pandemic.

“The biggest consequences are that we haven’t had the time to take a week and shut down and plot our way forward, come up with a to-go menu or some new things, because we’re busy working the counter trying to save money,” Shriner said. “A lot of other businesses that got PPP have been able to hire people to help them head in a different direction, get apps made, fix their websites, that kind of thing.”

The prohibition on PPP loans going to debtors began with the SBA’s original concept for the program: It extended its 7(a) loan program, its most common credit offering for small businesses, which already bars bankrupt companies. New pandemic relief measures were basically grafted on to those rules, which reflect an agency position dating back to its beginnings in the 1950s that bankrupt companies were more likely to default.

“SBA has an institutional prejudice against people who file bankruptcy,” said Ed Boltz, a North Carolina bankruptcy lawyer who serves on the board of the National Association of Consumer Bankruptcy Attorneys. “The attitude of government in a lot of things is, ‘Bankruptcy is hard and confusing and these people are probably bad people.’”

Almost immediately, this position was challenged in courts across the country. In Hidalgo County, Texas, for example, an emergency medical transportation company in bankruptcy sued after it was denied a PPP loan. A bankruptcy judge issued a temporary injunction against the SBA, saying it was in the public interest during the pandemic to make sure the company’s trucks and helicopters could keep ferrying patients to hospitals. In June, the 5th U.S. Circuit Court of Appeals vacated that decision, saying the judge had exceeded his authority.

Meanwhile, the SBA hastily published a rule explicitly barring companies in bankruptcy from participating in its pandemic relief program. “The Administrator, in consultation with the Secretary, determined 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,” the rule read. “In addition, the Bankruptcy Code does not require any person to make a loan or a financial accommodation to a debtor in bankruptcy.”

Around the same time, a Florida radiology center also serving COVID-19 patients received a PPP loan, even though it was reorganizing under Chapter 11 bankruptcy. When it filed for approval with its bankruptcy court to take on the additional debt, the SBA objected again. The bankruptcy court found in favor of the radiologists in June, writing that “it is plain Congress did not intend to exclude chapter 11 debtors from the Paycheck Protection Program.” In December, however, the 11th Circuit overturned the lower court and sided with the government.

Maury Udell, the radiology company’s lawyer, said he plans to appeal to the Supreme Court. The PPP is more of a grant than a loan, he argues, since all companies had to do in order for the money to be forgiven is spend most of it on payroll. Bankrupt companies are arguably more likely to do so, given that they’re on court-ordered plans for how they must manage their expenses. Besides, the program did not require that companies demonstrate their ability to repay — plenty of businesses on very shaky footing applied for and received funding, sometimes filing for bankruptcy later.

“The SBA’s argument for not allowing Chapter 11 debtors is that the risk of nonpayment is high,” Udell said. “That’s not a factor in whether you were approved. It’s just as high as anyone else, because there’s no other underwriting guidelines.”

Frustration with the SBA’s position mounted through the fall until December, when Congress passed a fresh round of $900 billion in pandemic-related relief, along with the regular budget. It included $285 billion for a second draw of PPP loans, and a bit of potential relief for debtors: an amendment to the U.S. Bankruptcy Code that allows PPP loans to businesses that have filed for bankruptcy under Chapters 12, 13 and Subchapter V, a new category for small businesses established in 2019. (Chapter 11 debtors were left out.)

However, there was a catch: In order to trigger the exemption, the SBA would have to write a letter to the Executive Office of the U.S. Trustee, an division of the Justice Department that oversees U.S. bankruptcy courts, alerting it to the change. So far it has not done so, even as Congress has extended the deadline for PPP applications to May 31, with $103 billion in authorized funds yet to be expended.

President Joe Biden’s choice to run the SBA, Isabella Guzman, was confirmed on March 16. The SBA would give no indication of whether she plans to change course. Spokespeople for senators on the committees of jurisdiction either had no comment or said they were looking into the issue.

Last week, as his hope of getting a PPP loan waned, Mark Shriner set up a GoFundMe page to try to keep his doors open. More than $21,000 has flowed in. Meanwhile, he also learned about the Restaurant Revitalization Program established by the $1.9 trillion American Rescue Plan. So far, since it’s a straightforward grant rather than a loan, it doesn’t seem to prohibit applications from companies — or company owners like him — who’ve filed for bankruptcy. But he’s not counting on anything, since aid programs have been so disappointing.

It’s a difficult contrast, he said, when he looks around town and sees all the federal money that helped people who didn’t always need it.

“I’m not a wealthy person at all, but I have many millionaire friends who own businesses, insurance firms, architecture firms,” Shriner said. “These millionaires got money and money and money and money from the government, and they’re all driving on the golf course. It is tough when I think about it.”