By Matthew Santoni

Law360 (May 17, 2021, 5:46 PM EDT) -- The owners of strip clubs in Pennsylvania, California, New Jersey, South Carolina and Maryland are suing the U.S. Small Business Administration in a Pennsylvania federal court, claiming the agency is being prudish and freezing them out of relief funding for bars and restaurants crippled by the COVID-19 pandemic.

Seven companies operating a total of eight strip clubs said the SBA's rules improperly classified them as "prurient" and obscene and violated their First and Fifth Amendment rights by presumptively denying them access to Restaurant Revitalization Fund grants under the American Rescue Plan Act of 2021. They sought a nationwide injunction blocking the SBA from refusing them and similar businesses money from the program based on regulations that had not gone through the normal vetting and approval process.

"The SBA is arbitrarily and without authority incorporating and applying the regulation to prohibit adult entertainment establishments from receiving RRF grants," the complaint said. "The SBA determines whether a business presents live performances of a prurient sexual nature without having ever visited the establishments or having viewed the live performances at the establishment. Plaintiffs do not present live performances of a prurient sexual nature on their premises. All of the performances on plaintiffs' premises appeal to normal, healthy, sexual desires."

The clubs asked the U.S. District Court for the Eastern District of Pennsylvania for a declaration that the SBA's rules for the RRF program violated their constitutional rights and the Administrative Procedures Act.

According to the complaint filed Friday, the SBA had adopted part of the Code of Federal Regulations from 1995, concerning SBA loan programs, to determine whether businesses were eligible for the Restaurant Relief Act grant funds. That part of the CFR generally said the government could deny SBA loans to businesses that "present live performances of a prurient sexual nature."

But the plaintiffs — which include the owners of Cheerleaders Gentleman's Clubs in Philadelphia, Pittsburgh and Gloucester City, N.J.; the Vanity Club, Gold Club, Larry Flynt's Hustler Club and Condor Club in San Francisco; and Fantasies Nightclub & Sports Bar in Baltimore — said that the RRF program was a grant and that the standards the SBA had adopted were unjustifiably restrictive.

"As applied, the SBA's construction of the term 'prurient' is not supported by current constitutional standards of obscenity which, as articulated by the United States Supreme Court, defines and operationalizes 'prurient' as a 'shameful or morbid' and 'unhealthy' interest in sex, as opposed to 'normal, healthy sexual desires,'" the complaint said.

Other adult-oriented businesses had challenged similar restrictions on Paycheck Protection Program loans and won, including in DV Diamond Club of Flint, LLC v. United States Small Business Administration, the suit said. The Eastern District of Michigan had barred the SBA from following its previous definition of "prurient" in denying pandemic relief, but the agency continued to do so for the RRF program, the complaint claimed.

Calling strip clubs "prurient" and potentially denying them funds based on the expression going on in the clubs violated employees' and patrons' First Amendment rights while treating them differently from workers and customers of other establishments, such as comedy clubs, without good reason or due process violated their Fifth Amendment rights, the suit said.

The suit said the SBA was following a broader definition of "affiliated business" than that in the American Rescue Plan Act and was disqualifying businesses that had more than 20 such affiliates from even applying for RRF funds, barring several more of the strip club plaintiffs.

"The SBA and its administrator lack the authority to alter the statutory definitions in the RRF program or to implement the RRF program in a manner inconsistent with the statutory definitions," the complaint said. "The program guide changes the affiliated business inquiry from the statutorily defined inquiry of what the eligible entity owns or controls to what owns, controls, or manages the eligible entity."

The online application process, which follows the SBA's broader definition of "affiliated," would automatically end the application for businesses that had more than 20 affiliates, and the businesses' bookkeepers were afraid to follow the narrower statutory standard because lying on an SBA application could carry criminal penalties.

The plaintiffs also challenged part of the program that said they had to withdraw any pending applications for the second round of PPP loans if they were seeking RRF grants, since the legislation creating the grants already said they would be reduced by whatever the recipients had gotten in PPP loans.

"Plaintiffs have no intention of unlawfully 'double dipping' with the PPP, the second draw PPP, and the RRF," the complaint said. If the court granted the injunction they sought, the clubs still waiting on their second round of PPP loans said they'd rather forgo that funding and not have their RRF grants reduced, the suit said.

Brad Shafer of Shafer & Associates, representing the plaintiffs, told Law360 that none of the plaintiffs had been disqualified yet based on the SBA regulation's definition of "prurient" or the PPP withdrawal requirement, though several had been kicked out of the application process by the ban on more than 20 "affiliates." He noted that several of the plaintiff companies were owned by veterans, who were among the groups who were supposed to be first in line for the relief funds.

"We know what the statutes are. Congress said who was eligible; Congress defined what an affiliated business was; Congress didn't include the regulation; Congress didn't include a requirement to withdraw the second-draw PPP application," he said.

Representatives of the SBA declined to comment.

The strip clubs are represented by Bradley J. Shafer, Matthew J. Hoffer and Zachary M. Youngsma of Shafer & Associates PC, and Arthur P. Fritzinger of Cozen O'Connor.

Counsel information for the SBA was not immediately available.

The case is MAG Enterprises Inc. et al. v. United States Small Business Administration et al., case number 2:21-cv-02213, in the U.S. District Court for the Eastern District of Pennsylvania.

--Editing by Peter Rozovsky.

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