By Rose Krebs

Law360 (April 28, 2020, 6:17 PM EDT) -- Fast-casual restaurant operator Cosi Inc. filed a lawsuit Tuesday in Delaware bankruptcy court asserting the U.S. Small Business Administration has put its Chapter 11 reorganization plans in jeopardy by disqualifying the chain from receiving federal coronavirus payroll protection relief funds.

In an adversary suit filed against the SBA, Cosi contends that the agency has "without notice or justification, adopted a position that bankruptcy debtors" are not eligible to receive loans under the Paycheck Protection Program established by the federal Coronavirus Aid, Relief, and Economic Security Act.

"The SBA's discrimination based solely on an applicant's status as a debtor is legally unsupported, arbitrary and capricious, and runs completely counter to the stated purposes of the CARES Act and the PPP," the complaint says. "Accordingly, the debtors bring this complaint seeking a declaratory judgment, a writ of mandamus, and related relief to compel the SBA to allow them to participate in the PPP."

Under the program, businesses reeling from the financial impact of the COVID-19 pandemic can seek forgivable loans of up to $10 million.

Cosi says it has been tripped up in its attempt to receive a loan because of the lender application process, with prospective lenders telling the company its loan request would be rejected because the chain is in bankruptcy.

"Due to what appears to be a completely arbitrary, baseless, and discriminatory requirement imposed by the SBA, the debtors are ineligible to participate based solely on their status as a debtor under Title 11 of the United States Code," the suit says.

Once the SBA begins to accept applications under the latest round of PPP funding, Cosi and related entities say they intend to apply again for a loan of "up to $3,681,759.86, to cover their payroll costs and protect the jobs of their employees."

"The debtors are precisely the sort of business the PPP was enacted to protect — they are a small business (as defined by the SBA) in one of the industries hardest hit by the pandemic and are desperately trying to obtain funding to meet payroll for their employees," the complaint says. "A PPP loan would allow the debtors to endure the pandemic without having to make further layoffs."

Cosi asserts that the impact of the public health crisis is putting its Chapter 11 reorganization in peril and the PPP funds are greatly needed to make things even worse.

"But now, virtually overnight, their income has been reduced to a trickle, severely jeopardizing their chances of reorganizing and remaining in business if the impact of the pandemic continues," the filing says. "Since the commencement of the outbreak, the debtors' sales are down over 80% from pre-filing projections."

Cosi said it has been "working feverishly to reduce costs" through measures such as landlord concessions so it can "stave off a potential liquidation."

The company is seeking a declaratory judgment from the bankruptcy court "that the SBA's implementation of the PPP in a manner that arbitrarily excludes debtors in bankruptcy" violates bankruptcy code and seeks injunctive relief on an expedited basis to bar the SBA from denying the loan bid because Cosi is in bankruptcy.

Also, Cosi seeks to have the court bar the SBA from "disbursing or otherwise allocating $3,681,759.86 from the PPP, i.e. setting aside such amount, which represents the debtors' loan amount."

Cosi hit Chapter 11 in February after shuttering 30 stores and looking to reduce rental costs while maximizing profits on its catering business. Cosi hoped to hold off filing the Chapter 11, but facing lawsuits from a supplier and landlords as it cut back restaurant operations, the company needed the benefit of the litigation stay that came with the bankruptcy filing.

At a hearing in February, Cosi said it was likely to hang around in Chapter 11 for up to a year as it enacts a shift in its business model to a catering-centered operation.

It is the Boston-based restaurant chain's second trip into bankruptcy in three years, after it emerged from a Massachusetts Chapter 11 case in May 2017. In a first-day declaration filed with its most recent Chapter 11, before the virus reached pandemic proportions, company Vice President Vicki Baue said its restaurant operations had been facing the same negative trends affecting the entire casual dining industry.

During that time, however, its catering business has seen significant growth and presents an opportunity for continued profitability, the declaration said.

Since 2010, Cosi's revenue from restaurant operations fell by more than 85%, but Baue said in the declaration that revenue from the catering business has increased 44% over the same period.

Responding to the change in revenue streams, Cosi closed 30 of its 43 company-owned restaurants; the company also has 16 franchised restaurants, the declaration said. It also operates the three standalone catering kitchens.

Cosi started as a Parisian flatbread restaurant in 1989 that later expanded to open franchises in the U.S. The first American restaurant opened in 1996 in New York City, according to the declaration.

A representative for the SBA declined to comment Tuesday.

Counsel for Cosi did not immediately respond to requests for comment Tuesday.

Cosi is represented by Mark E. Felger and Simon E. Fraser of Cozen O'Connor.

The adversary suit is Cosi Inc. v. Small Business Administration et al., case number 1:20-ap-50591, in the U.S. Bankruptcy Court for the District of Delaware.

The underlying bankruptcy case is In re: Cosi Inc. et al., case number 1:20-bk-10417, in the same venue.

--Additional reporting by Joyce Hanson and Vince Sullivan. Editing by Abbie Sarfo.

For a reprint of this article, please contact reprints@law360.com.