PPP Loan Liability and Bankruptcy: Proceed with Caution


New Jersey Law Journal

February 1, 2021

By: Brett S. TheisenMark ConlanConor D. McMullan

On March 27, 2020, the United States Congress enacted the Coronavirus Aid, Relief, and Economic Stabilization Act (“CARES Act”); two key components of this legislation were the Payroll Protection Program (PPP) loan program and an increase to $7.5 million of the debt limits for debtors seeking relief under the recently enacted Subchapter V of Chapter 11 of the Bankruptcy Code. 11 U.S.C. §§1181-1195.

Subchapter V, enacted in 2019 through the Small Business Reorganization Act, streamlined Chapter 11 cases for small businesses with non-contingent, secured, and unsecured debts totaling less than $2,725,625. By proceeding under Subchapter V of the Bankruptcy Code, a debtor may, among other things, solicit disclosure and confirmation in a single-step confirmation process, make use of expedited filing deadlines, and retain equity ownership without those equity holders satisfying the “new value” exception to the absolute priority rule under 11 U.S.C. § 1129(b).

With the PPP, Congress aimed to incentivize small businesses to continue paying employees despite the COVID-19 shutdowns and included provisions for forgiveness of PPP loans if certain prerequisites are met. For some PPP borrowers, loan forgiveness applications will come due beginning in 2021. If a borrower failed to utilize some or all of its loan funds for authorized purposes under the CARES Act, the borrower will not be entitled to forgiveness of the unused portion of the debt; however, it may still be eligible for a discharge of PPP debt in bankruptcy (if it otherwise satisfied the discharge requirements). If a borrower made any material misrepresentations or omissions in connection with its loan application, however, such conduct could give rise to potential criminal liability—including for a corporate borrower’s officers and possibly directors. Thus, borrowers should carefully assess the accuracy of their loan applications, as well as the evidence of supporting documentation, prior to filing petitions for bankruptcy relief.

Loan Forgiveness, Bankruptcy Scrutiny, and Criminal/Civil Liability

Under the CARES Act, upon making the requisite disclosures to the Small Business Administration (SBA) and certifying its need and eligibility for loan monies, a small business could receive up to $10 million in potentially forgivable loans. Section 9005(b) of Title 15 provides that a PPP loan recipient shall be eligible for forgiveness of indebtedness for the amount spent on payroll costs, payment of interest on covered business mortgage obligations, covered rent obligations, and covered utility payments. 15 U.S.C. §9005(b).

With all of this in mind, PPP borrowers must proceed with caution if they seek to use bankruptcy as a means of discharging or restructuring their remaining PPP loan balances. Even a borrower that acted in good faith and with honest intent could run into problems if it failed to maintain the proper documentation of its financial condition at the time of the PPP loan application—including evidence of the borrowers’ need and eligibility for the loan, as required by the CARES Act. See SBA Form 2483 (Revised Jan. 8, 2021) at 2, https://www.sba.gov/document/sba-form-2483-paycheck-protection-program-borrower-application-form.

Additionally, federal law provides for a range of criminal penalties that could arise due to a borrower’s deceptive PPP loan application process. There are potential criminal charges a borrower could face due to failures in the disclosure process: false statement to a federal agency, false statement to the SBA, false statement on a loan application, or bank fraud. Each of these four potential criminal charges carries a “knowingly” standard for criminal liability; in other words, the borrower must have “knowingly” made the false statements. Under Section 3571 of Title 18, it is illegal to make a false, material statement with the goal of deceiving or misrepresenting a matter under the jurisdiction of the federal government or a federal agency. 18 U.S.C. §3571. It is also a crime for a person to knowingly make false statements to the SBA, or overvalue security or collateral, in order to obtain a SBA loan, or to otherwise use misinformation to influence the SBA’s decision making process. Section 1014 of Title 18 provides that an individual is liable for fraud in their loan application where the borrower knowingly provides false information to a federally insured financial institution (basically, all U.S. insured banks). 18 U.S.C. §1014.

Similarly, the False Claims Act (FCA) creates civil (31 U.S.C. §§3729-33) and criminal (18 U.S.C. §287) liability for false claims submitted to the federal government. A person is civilly liable under the FCA if that person “knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the [Federal] Government, or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government.” 31 U.S.C. §3729(a)(1)(G). Notably, as amended, the FCA now includes liability for “reverse false claims,” or the knowing omission or concealment of information in order to avoid repaying an obligation to the federal government.

A borrower’s officers and directors may also be at risk personally for conduct in connection with the PPP loan application process. Federal criminal statutes apply to “whoever” or to any “person” who violates their prohibitions, terms that include not only individuals but also corporations, companies, associations, firms, and partnerships. See, e.g., 18 U.S.C. §§371, 1956; 1 U.S.C. §1. Under Third Circuit law, “[a] corporate officer is individually liable for the torts he personally commits and cannot shield himself behind a corporation when he is an actual participant in the tort.” Donsco, Inc. v. Casper Corp., 587 F.2d 602, 606 (3d Cir. 1978). Therefore, an individual who causes a borrower to commit any of the above violations may not have the benefit of the corporate shield, especially where the misconduct was intentional.

Thus, while the PPP loan program could act as a lifesaving mechanism for a small business, it could also create even larger liabilities for the business in question. Those seeking to obtain loan forgiveness or discharge in bankruptcy must proceed with caution. Inherently, the bankruptcy process “opens” a debtor’s financial records to examination and scrutiny. See Fed. R. Bankr. P. 2004; see also Ryan Operations G.P. v. Santiam-Midwest Lumber, Co., 81 F.3d 355, 362 (3d Cir. 1996) (“The Code imposes on debtors an affirmative duty of full disclosure.”). This could be a greater issue for small business debtors proceeding under Subchapter V. Bankruptcy Code section 1183(b)(2), by way of section 1106(a)(3), provides that “[a] trustee shall … investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of the debtor’s business, and any other matter relevant to the case or to the formulation of a plan.” It follows that any trustee (in Subchapter V or otherwise) will likely scrutinize PPP liability on the debtor’s books. It is critical for PPP borrowers to ensure their use of PPP funds is proper and correctly documented, especially in a time of financial distress. Any use that puts PPP forgiveness at risk may also prohibit the borrower from confirming a Chapter 11 plan. The risk is that this further scrutiny of a debtor’s financial condition may bring to light issues in a debtor’s PPP loan application or other submissions to the federal government during the COVID-19 pandemic. As noted above, a borrower’s proper and complete recordkeeping is absolutely critical to mitigating the risk on both fronts.

Finally, it should be noted that as the COVID-19 pandemic continues to drag on, there have been calls from some lawmakers in Congress to increase the Subchapter V debt limit to $20 million (a further increase from the $7.5 million temporary limit established by the CARES Act) in an effort to afford broader relief to businesses impacted by the government shutdowns and other pandemic impacts. If such relief becomes law under the new 117th Congress and Biden Administration, the issues surrounding PPP indebtedness stand to take on a correspondingly larger role in Chapter 11 bankruptcy cases across the country.

Reprinted with permission from the February 1, 2021 issue of the New Jersey Law Journal. © 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved. For information, contact 877-257-3382 or reprints@alm.com or visit www.almreprints.com.