A PPP Lender’s Dilemma: What to Do If a PPP Loan Is in Default?

The CARES Act established the Paycheck Protection Program (“PPP”) under Section 7(a) of the Small Business Act (Section 7(a)) to provide forgivable loans that are fully guaranteed by the Small Business Administration (“SBA”) in order to aid qualified small businesses to keep workers on the payroll. As created by the CARES Act, if a borrower uses its PPP loan proceeds to fund payroll and other eligible operating expenses during a designated time period (“Covered Period”), that portion of the loan proceeds up to the entire loan amount will be forgiven, resulting in a PPP loan becoming essentially a grant.

Indeed, a debtor subject to a Chapter 11 Bankruptcy is usually allowed to continue to use PPP loan proceeds to pay payroll and other permitted operating expenses

The PPP Flexibility Act (H.R. 7010) (the “Flexibility Act”) enacted earlier this month makes the forgiveness requirements of the PPP more flexible by increasing the amount of time a borrower has to spend loan proceeds, lowering installment loans Arkansas the amount of proceeds that are to be used for payroll costs and providing additional safe harbors for full-time-equivalent employee reductions. As a result of these enhancements, it is likely that a greater percentage of PPP loans will qualify for forgiveness of the entire loan amount.

These PPP features were designed to expedite relief to small businesses from the economic devastation wrought by the pandemic. It is therefore surprising that in rolling out the PPP, the SBA and the Treasury Department decided not to draft a new promissory note template for the PPP but rather to authorize the use of the SBA promissory note for a standard Section 7(a) loan, SBA Form 147. As a result, the SBA form of the PPP Note (“PPP Note”), used by banks and other lenders in the origination of most PPP loans, contains a number of provisions that conflict with the very purpose of the PPP and has created unnecessary uncertainty for PPP lenders and servicers.

A PPP loan is unlike any other Section 7(a) loan as a result of, among other things, its (i) forgiveness feature, (ii) 100% SBA guarantee, (iii) below-market interest rate, (iv) lack of collateral requirement, and (v) limited streamlined origination procedures

In particular, the PPP Note provides for, among others, the following “events of default”: (i) a default by the borrower on any other loan with the lender, (ii) a default by the borrower on any loan or agreement with another creditor, if the lender believes the default may materially affect the borrower’s ability to repay the PPP loan, (iii) the borrower fails to pay any taxes when due, (iv) the borrower has an adverse change in its financial condition or business operation that the lender believes may materially affect the borrower’s ability to repay the PPP loan, (v) the borrower reorganizes, merges, consolidates, or otherwise changes ownership or business structure without the lender’s prior written consent, (vi) the borrower becomes the subject of a civil or criminal action that the lender believes may materially affect the borrower’s ability to repay the PPP loan, and (vii) the borrower (a) becomes the subject of a proceeding under any bankruptcy or insolvency law, (b) has a receiver or liquidator appointed for any part of its business or property, or (c) makes an assignment for the benefit of creditors ((a) to (c) collectively, “Bankruptcy”).

Upon the occurrence of any event of default, the lender may, but is not required to, call the loan immediately due and payable. Acceleration of the loan is not mandatory even in the case of a default resulting from a Bankruptcy. In our experience, most debt instruments provide for immediate acceleration without any further action by a lender in the case of a default caused by a Bankruptcy. In any event, upon a Bankruptcy, a lender would require relief from the automatic stay to implement any remedy. See In Re Toojay’s Management LLC, et al. Bankruptcy No. 20-14792-EPK, Bankr. Ct. SD Fla. Order of .

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