This article examines when it is permissible and when it is not permissible to discriminate against an individual on the basis of a bankruptcy filing.Section 525 of the Bankruptcy Code (11 U.S.C. 525) states:(b) No private employer may terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor under this title, a debtor or bankrupt under the Bankruptcy Act, or an individual associated with such debtor or bankrupt, solely because such debtor or bankrupt--(1) is or has been a debtor under this title or a debtor or bankrupt under the Bankruptcy Act; (2) has been insolvent before the commencement of a case under this title or during the case but before the grant or denial of a discharge; or (3) has not paid a debt that is dischargeable in a case under this title or that was discharged under the Bankruptcy Act.Litigation in connection with this subsection has been limited. However, recent appellate court decisions have discussed how Section 525 provides both freedoms and restrictions to employers.

As a result, Springfield filed for chapter 11 in June 2019 in the District of Vermont. To satisfy near-term operating obligations, Springfield applied for multiple state and federal emergency grants, including the PPP loans that were denied because the hospital was a debtor in chapter 11 at the time of application.Claiming that the SBA’s administration of the PPP discriminated against Springfield and violated section 525(a) of the Bankruptcy Code, Springfield commenced a lawsuit before the bankruptcy court seeking, among other things, an order enjoining SBA’s denial of the hospital’s PPP loan application on the basis that the applicant is a debtor in bankruptcy. The bankruptcy court ruled in favor of Springfield, granting a temporary restraining order and then an order enjoining the SBA from denying Springfield’s PPP loan application.

t it is in bankruptcy. Hidalgo County EMS asserted that the loan would be used for working capital purposes permitted under the PPP. On April 9, the bank denied the loan on the basis that Hidalgo County EMS’s bankruptcy rendered it ineligible under the PPP.The Bankruptcy Code prohibits a governmental unit from discriminating against debtors solely on the basis that they have sought bankruptcy protection. Among other things, section 525(a) of the Code states that a governmental unitmay not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to, condition such a grant to, discriminate with respect to such a grant against . . . a person that is or has been a debtor under this title . . . solely because such bankrupt or debtor is or has been a debtor under this title . . .On April 22, following the announcement of additional PPP funding, Hidalgo County EMS filed a complaint alleging that the SBA had violated its own authority, as well as section 525 of the Bankruptcy Code, in denying Hidalgo County EMS’s PPP application solely on the basis of its bankruptcy. Hidalgo County EMS asked the bankruptcy court for broad declaratory and injunctive relief, including to determine that the SBA had exceeded its authority by including the disqualifying bankruptcy question in the borrower application, as none of the PPP, Section 7(a) of the Small Business Act, or (at the time) the SBA’s own guidance had so contemplated.The SBA’s responsive brief asserted that the SBA violated neither section 525 of the Bankruptcy Code nor its own authority. The SBA argued that section 525(a) has been narrowly construed by courts and does not apply to lending or loan guarantees; rather, section 525(c) applies and only in the context of student loans and grants, not the PPP. Second, the SBA argued that the bankruptcy exclusion was within its broad grant of authority—authority that was expanded under the CARES Act—and that, while nothing in the CARES Act expressly excludes debtors in a

hey argue that this prohibition simply makes no sense.Second, debtors have argued that the SBA's actions violate section 525(a) of title 11 of the U.S. Code, 11 U.S.C. § 101, et seq. (Bankruptcy Code). As relevant here, section 525(a) states that a governmental unit:... may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise or other similar grant to, condition such a grant to, discriminate with respect to such a grant against, deny employment to, terminate the employment of, or discriminate with respect to employment against a person that is or has been a debtor under this title ... or another person with whom such bankrupt or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title ..., has been insolvent before the commencement of the case under this title, or during the case but before the debtor is granted a discharge, or has not paid a debt that is dischargeable in the case under this title ...See 11 U.S.C. § 525(a). While the PPP is on its face a loan program, the loans are being made available on an unsecured basis to any applicant that purports to fulfil the criteria.

Following the issuance of the Interim Rules, numerous debtors have sought to challenge the SBA’s position. For example, some debtors have dismissed their Chapter 11 cases in order to procure PPP loans. [3] Other debtors [4]have sued the SBA over whether the government can lawfully withhold stimulus funds from debtors in Chapter 11 cases. In general, the debtors’ position is that 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,” [5]and further, that the SBA’s policy is in violation of 11 U.S.C. § 525(a). [6]Section 525(a) of the Bankruptcy Code prohibits discrimination by the government against a debtor based upon its status as a debtor in bankruptcy.

The Court also held that the CARES Act’s eligibility requirements do not include creditworthiness, instead, the PPP Loans are available regardless of financial distress. Given the obvious purpose of PPP Loans, the Court found it arbitrary and capricious for the SBA to add a creditworthiness test to the eligibility requirements for a PPP Loan.Exceeded SBA’s Authority The Court also found that the SBA was tasked only with issuing “regulations to carry out this title…” and had exceeded its authority under this direction by rewriting the eligibility requirements and prohibiting bankruptcy debtors from obtaining PPP Loans.Discriminatory Treatment 11 U.S.C. § 525(a) provides protection against a governmental unit denying or discriminating against a person that is or has been a debtor under the Bankruptcy Act in applying for a license, permit, charter, franchise, or other similar grant. The Court found that a PPP Loan is not a typical loan but is instead a government grant or support program.

In response to those actions, the SBA aggressively defended its authority to issue the Bankruptcy Exclusion and extolled the alleged public policy virtues of precluding bankruptcy debtors from the benefits of PPP funding. The outcomes of the lawsuits varied significantly: some courts declined to enforce the Bankruptcy Exclusion because they found that either the SBA exceeded its rulemaking authority or the exclusion violates the anti-discrimination provisions of 11 U.S.C. § 525; other courts sided with the SBA; and a number of courts allowed debtors to take advantage of certain loopholes affecting the Bankruptcy Exclusion, such as by permitting debtors to voluntarily dismiss their cases in order to apply for PPP funding and then reopen the previously dismissed case. (See our related alert here.)Debtors initially thought they had obtained a victory when the Consolidated Appropriations Act of 2021 (CAA) was signed into law on December 27, 2020.

National Labor Relations Act of 1935: Covers virtually all private-sector employers, and protects the rights of their employees to engage in "concerted activity" for the purpose of self-organizing, forming, joining, or assisting labor organizations, and to engage in "mutual aid or protection" – whether a union is involved or not – for the purpose of trying to improve wages, hours, and other working conditions. Employers that interfere with, restrain, or coerce employees in the exercise of such rights commit an "unfair labor practice".U.S. Bankruptcy Code, 11 U.S.C. §525, "Protection against discriminatory treatment": Provides in part that "No private employer may terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor under this title, a debtor or bankrupt under the Bankruptcy Act, or an individual associated with such debtor or bankrupt, solely because such debtor or bankrupt -- (1) is or has been a debtor under this title or a debtor or bankrupt under the Bankruptcy Act; (2) has been insolvent before the commencement of a case … or during the case …; or (3) has not paid a debt that is dischargeable … or that was discharged under the Bankruptcy Act."Title III of Consumer Credit Protection Act ("CCPA"): Prohibits employers from terminating an employee because, in whole or in part, the employee’s earnings have been subjected to garnishment for any one debt.

Second, the court concluded that the rule exceeded SBA’s authority under the CARES Act because Congress’s intent explicitly prohibited them from making this restriction. Third, the court held that rule was discriminatory in violation of 11 U.S.C. § 525(a) because it discriminates against grant recipients because they are debtors. As such, the court held that the organization was entitled to PPP funding and struck down the SBA’s rule.Agency Pronouncements & GuidanceGuidance Under Section 6033 Regarding the Reporting Requirements of Exempt Organizations, 85 Fed. Reg. 31959 (May 29, 2020)This new guidance from the IRS applies to reporting regulations under IRC § 6033 that are generally applicable to organizations that are tax exempt under Section 501(a).

PPP Loans Now Available to Certain DebtorsUnder regulations adopted by the SBA in response to the CARES Act, businesses in bankruptcy were disqualified from receiving PPP loans. The SBA regulations spawned an avalanche of litigation which challenged them on grounds that they were unlawfully discriminatory under 11 U.S.C. §525(a), see e.g. In re Springfield Hospital, Inc., 618 B.R. 70, 80-93 (Bankr. D. Vt. June 22, 2020), appeal pending Nos. 20-3902, 20-3903 (2d Cir.), or were arbitrary and capricious or exceeded the SBA’s rulemaking authority.