A Creative Strategy For Repaying PPP Loans

By Thomas Lehman
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Law360 (June 5, 2020, 11:48 AM EDT) --
Thomas Lehman
Thomas Lehman
In the first few months of this year, Congress enacted two laws that, when used in combination, could be the solution for small businesses trying to survive the current pandemic era.

The first is the Small Business Debtor Reorganization Act, an addition to Chapter 11 of the Bankruptcy Code that makes reorganization easier and faster for small businesses. The second is the Payroll Protection Program, or PPP, a part of the Coronavirus Aid, Relief, and Economic Security, or CARES, Act economic relief legislation. PPP provides loans to businesses with up to 500 employees.

If used together, these two new laws could be the 1 + 1 = 3 formula for distressed small businesses to be able to weather the COVID-19 recession. If the PPP funds came too late to help revive a business, a bankruptcy discharge can be a creative way to make part of the PPP loan forgivable even if the funds were never allocated to meet the loan's forgivable requirements. This strategy would also extend the time to repay the reduced PPP loan.

PPP Program

PPP loans are loans from the U.S. Small Business Administration, or SBA, but without the usual SBA loan burden of personal guarantees, pledges of business assets or, in some cases, a mortgage on the business owner's home.

If the bulk of the loan is used for employee payroll and the rest for rent, mortgage interest and utilities, the PPP loan is forgiven without income tax consequences to the borrower. In short, the PPP is a government employment program funded through private employers. 

The PPP Loan Forgiveness Requirements Cannot Be Met by Most Small Businesses 

The PPP uses a one-size-fits-all approach for borrowers to qualify for loan forgiveness that few troubled businesses will be able to meet.

Current law sets a high standard for the full amount of the PPP loan to be totally forgiven: 75% of the loan must be used in an eight-week period for employee payroll at a business's prepandemic staffing levels; borrowers are penalized if they operate at reduced staffing levels and do not rehire or replace workers who were furloughed during the shutdown.

Recent legislation passed by Congress and awaiting the president's signature reduces the payroll requirement from 75% to 60% and triples the time to use all the funds. However, even with this modest change to the loan forgiveness requirements, the PPP still will not work well for businesses operating on a limited basis or not at all, or businesses whose payroll costs are relatively low compared to their rent, inventory and supply expenses.

For these businesses, little of the PPP loan will qualify for forgiveness and even worse, the remaining PPP loan must be repaid in two years. For most companies, a PPP loan will result in more short-term debt being added to their balance sheets, increasing the already difficult burdens imposed by the drop in business brought on by the coronavirus pandemic. 

Small Business Debtor Reorganization Act

The new Chapter 11 Small Business Debtor Reorganization Act, known as Subchapter 5, is available for businesses, including sole proprietors, with debts totaling as much as $7.5 million, if filed before March 27, 2021. Subchapter 5 removes two difficult to achieve Chapter 11 requirements that small businesses used to have to meet before a bankruptcy judge would approve a plan of reorganization.

First, Subchapter 5 eliminates the requirement that at least one class of creditors buy into the small business owner's plan of reorganization by voting to accept the plan. Instead, the only buy-in the business owner needs is for the reorganization plan to be approved by the bankruptcy judge. 

Second, Subchapter 5 dropped the requirement for a business owner to buy back her or his business by contributing cash or valuable property to the reorganization if the plan, like most, proposed to pay creditors only a portion of their debt.

Instead, the plan must provide for the business to pay its disposable income to creditors over a three or up to a five year period. In other words, after the owners of the business are paid reasonable compensation for their work, the profits of the business are paid to its creditors.

The PPP Plus Subchapter 5 Solution

If a PPP borrower anticipates it will not qualify for a meaningful amount of PPP loan forgiveness, filing Subchapter 5 can be a way to "enhance" loan forgiveness through a bankruptcy discharge of the portion of the PPP loan that does not qualify for forgiveness and would extend the time to repay the reduced PPP loan.

Since a PPP loan is unsecured debt, a court approved Subchapter 5 plan need only pay a portion of the PPP loan to obtain a bankruptcy discharge for the debtor's business. While a business is in Subchapter 5, a PPP lender will have little basis to block the small business Chapter 11 debtor's use of the PPP loan funds so long as the money is used to pay for payroll, employee benefits, interest on mortgage and other debt and utilities. 

And even if the SBA were to complain about its borrower's Chapter 11, it is doubtful the SBA would find a sympathetic ear in the bankruptcy courts:  The PPP is less than two months old and already, bankruptcy judges in New Mexico and Texas have issued orders requiring the SBA to stop refusing to process PPP loan applications submitted by Chapter 11 businesses or slowing PPP loan approval.

The second round of PPP funding is finding that fewer businesses are applying for the loans. At last check, about 20% of the appropriation for the loans remains unused. Most business owners now realize the SBA's original rules for loan forgiveness do not fit their business and are instead either trying to survive the downturn without government help or, worse, liquidating their businesses.

Subchapter 5 is an alternative for those businesses who want to try to survive this difficult period with the help of government funding but without adding substantial short-term government debt to their already difficult problems caused by COVID-19.



Thomas R. Lehman is a founding partner at Levine Kellogg Lehman Schneider & Grossman LLP

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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