Vestavia Hills, Ltd. v. U.S. Small Bus. Admin. (In re Vestavia Hills, Ltd.), Bankruptcy No. 20-00018-LA11

618 B.R. 294

IN RE VESTAVIA HILLS, LTD. dba Mount Royal Towers, Debtor.

Vestavia Hills, Ltd., dba Mount Royal Towers, Plaintiff,

v.The U.S. Small Business Administration, and Jovita Carranza, solely as the Administrator of The U.S. Small Business Administration, Defendant.

Bankruptcy No. 20-00018-LA11

Adversary No. 20-90073-LA

United States Bankruptcy Court, S.D. California.

June 26, 2020

James P. Hill, Sullivan Hill Rez & Engel, APLC, San Diego, CA, for Plaintiff.

Glen F. Dorgan, United States Attorneys Office, San Diego, CA, for Defendant.

MEMORANDUM DECISION

LOUISE DE CARL ADLER, JUDGE

I.INTRODUCTION

On June 25, 2020, the Court held a hearing on the emergency motion of plaintiff, Vestavia Hills, Ltd. ("Plaintiff" or "Debtor") for a preliminary injunction against defendants, The United States Small Business Administration ("SBA") and Jovita Carranza, solely in her capacity as the Administrator of the SBA (collectively the "SBA"). The SBA has opposed the motion. For the reasons more fully stated herein, the motion is GRANTED.

II.PROCEDURAL BACKGROUND

On May 27, 2020, Plaintiff commenced this adversary proceeding against the SBA for injunctive relief and a declaratory judgment. A few days later it filed an emergency motion for a temporary restraining order ("TRO") and for a preliminary and permanent injunction. Like many other debtors across the nation, Plaintiff filed this action and the emergency motion because the SBA denied its application to obtain funding under the Paycheck Protection Program ("PPP") of the Coronavirus Aid Relief, and Economic Security Act (the "CARES Act")¹ solely because it is a debtor in a pending bankruptcy case.

The complaint pleads a claim for a preliminary and permanent injunction, and a claim for declaratory relief. The claims are two-fold. Plaintiff alleges that:

(1) It has the legal right to apply for a PPP loan and have its application considered on the same terms as other applicants without regard to its status as a chapter 11 debtor, as set forth in 11 U.S.C. § 525(a) ; and

(2) The SBA's First and Fourth Interim Final Rules ("First IFR; Fourth IFR") and subsequent denial of its application were "arbitrary and capricious" in violation of 5 U.S.C. § 706(2)(A) and exceeded the SBA's authority under the CARES Act in violation of 5 U.S.C. § 706(2)(C).

Specifically, the complaint and emergency motion seek a preliminary and permanent injunction,² directing the SBA to change the PPP application form for Plaintiff to remove all questions about its status as a debtor in a bankruptcy case; and prohibiting use of the Plaintiff's status as a chapter 11 debtor as a reason to reject its PPP application if it is otherwise qualified as a business eligible for the PPP funds. The emergency motion argues that expedited relief is necessary because applications for PPP funding will cease to be considered after June 30, 2020.

The parties agreed that in light of their earlier stipulation to set aside the PPP funds, the June 25, 2020 hearing would proceed as a hearing on Plaintiff's motion for preliminary injunction.

III.FACTUAL BACKGROUND

A. Plaintiff's Chapter 11 Case and Need for Postpetition Funding.

The Plaintiff, Vestavia Hills, Ltd., doing business as Mount Royal Towers, is the fee owner of real property located at 300 Royal Tower Drive, Vestavia Hills, Alabama 35209 ("Mt. Royal Towers Facility" or "Facility"), at which it has operated a senior housing community for nearly thirty years. The Facility includes a 143-bed skilled nursing facility, a 98-bed assisted living facility, a 113-bed specialty care assisted living facility and a 150-bed independent living facility. Currently, it houses approximately 148 residents and employs approximately 150 people to care for the residents and maintain the Facility.

On January 3, 2020, Plaintiff filed a voluntary chapter 11 bankruptcy case and continues to operate its business as a debtor in possession. Plaintiff's first day motions included a request for authority to obtain postpetition unsecured financing from its limited partners ("DIP Loan"). [Main Case ECF No. 15] Plaintiff's stated goal in filing this reorganization case was to sell substantially all of its assets (the Facility) as a going concern in order to yield the highest and best price. Plaintiff had historically operated at a monthly cash deficit and did not foresee that changing during this case. Plaintiff needed the DIP Loan to preserve its going concern value and operate while it solicited and obtained a buyer for the Facility and closed the sale. Further, it explained that closing its sale and transferring ownership would not occur immediately upon sale because the successful bidder at the auction sale was required to obtain regulatory licenses and approvals to operate the Facility. Plaintiff would need DIP funds to continue to operate the Facility until closing. The Court approved the DIP loan.

In early March, Plaintiff obtained approval of its stalking horse bidder and auction procedures for its § 363 sale and set the motion to approve the sale for mid-May 2020. Then COVID-19 hit. This worldwide pandemic severely impacted Plaintiff's business by diminishing its ability to accept new residents, impacting its workforce, increasing the costs of doing business due to mandatory social distancing and stay at home orders, and prohibiting outside visitors. The pandemic also affected the progress of its § 363 sale. Plaintiff requested and the Court has granted its mid-May request to amend its auction procedures and delay the auction sale until late July because of the challenges posed by attempting to market and sell a Facility that no one can physically inspect. This delay has imposed additional demand for DIP funding by the limited partners.

On May 4, 2020, Plaintiff applied to Comerica Bank for a PPP loan in the amount of $1,138,100. Plaintiff intended to use the PPP loan to pay its payroll costs, utilities, and mortgage interest expenses as allowed by the PPP; and, upon maturity, to apply for forgiveness as a grant. Plaintiff submits it has ample qualifying expenses to qualify for full loan forgiveness. Plaintiff needs to use the PPP loan for these permissible expenses to avoid drawing down further on its diminishing DIP funding so it can move forward and close its sale. However, on May 6, 2020 Comerica Bank rejected Plaintiff's PPP loan application. The sole reason Comerica gave for Plaintiff's rejection was that Plaintiff truthfully answered "yes" to the question on the PPP application, asking if Plaintiff was presently involved in a chapter 11 bankruptcy. [ECF No. 5-2 (Moriarty Decl. ¶ 20) ] This adversary proceeding and emergency motion followed.

B. The CARES Act and PPP Loan Program

In response to the COVID-19 pandemic, Congress enacted, and the President signed into law on March 27, 2020, the CARES Act. Section 1102, of the CARES Act created the PPP by amending "Section 7(a) of the Small Business Act ( 15 U.S.C. § 636(a) )" to add new subparagraph (36). See CARES Act § 1102; 15 U.S.C. § 636(a)(36). The PPP provides that an eligible small business may obtain a guaranteed loan to cover certain expenses, including "payroll costs," "interest on any mortgage obligation," "rent," and "utilities." CARES Act § 1102(a)(2); 15 U.S.C. § 636(a)(36)(F)(i). Plaintiff has stated without contradiction that it intends to use the PPP funding precisely for these purposes. To obtain a PPP loan, the borrower must certify that: (i) economic uncertainty makes the loan necessary, (ii) the funds will be used for payroll and other authorized uses; (iii) the applicant does not have a duplicative application pending; and (iv) the applicant has not already received a PPP loan. CARES Act § 1102(a)(2); 15 U.S.C. § 636(a)(36)(G).

The CARES Act provides that PPP loans may be forgiven under certain circumstances, but forgiveness is not automatic. CARES Act § 1106. To receive forgiveness of a PPP loan, the borrower must submit an "application" for forgiveness to the lender servicing the PPP loan along with certain certifications regarding how PPP funds were spent. CARES Act § 1106; 15 U.S.C. § 9005(e).

The CARES Act also granted to the SBA, "emergency rulemaking authority" over the PPP, directing the Administrator to issue regulations to carry out the program without regard to typical notice requirements. CARES Act § 1114; 15 U.S.C. § 9012 ; see also 15 U.S.C. §§ 633(a), (b)(1)(7) (placing management of the SBA in the hands of the Administrator); see also 15 U.S.C. § 633(d) (the SBA shall "establish general policies ... which shall govern the granting and denial of application for financial assistance by the SBA.").

Although the PPP is part of the SBA's Section 7(a) loan program, a PPP loan differs from other Section 7(a) loans in certain respects. See CARES Act § 1102(a)(2); 15 U.S.C. § 636(a)(36)(D)-(R). For example, a PPP loan can be made to "any [small] business concern," non-profit organization and other organization or business concern that qualifies as small under industry-specific rules. See 15 U.S.C. § 636(a)(36)(D)(i).

The PPP loan underwriting criteria also differs. For regular Section 7(a) loans, the SBA "will consider" several factors to reasonably assure payment, including credit history, strength of business, ability to repay the loan, and even bankruptcy history. 13 C.F.R. § 120.150. See e.g., SOP 50-10-5 K, p. 180 (available at www.sba.gov/document/sop-50-105-lender-development-company-loan-programs). However, in administering the PPP, the SBA eliminated Section 7(a)'s typical underwriting guidelines, including a creditworthiness check. See First Interim Final Rule ("First IFR"), 85 Fed. Reg. 20811-01 at Art. III § 1 (April 15, 2020)(stating the PPP lending procedures are "streamlined" so the "SBA will not require lenders to comply with [ 13 C.F.R. §], 120.150," which sets forth SBA underwriting requirements such as a creditworthiness check, necessary to ensure "sound value"); see also First IFR at Art. III § 2(a)-(c); ...