Recent Developments Affecting Lenders

This month we (a) highlight an emerging split among the courts regarding the eligibility of companies in bankruptcy to receive loans under the Paycheck Protection Program, (b) review some recent bankruptcy court guidance concerning how to avoid violating the automatic stay, and (c) provide an update regarding the impact of COVID-19 on litigation in Virginia’s state and federal courts.

Courts Split on PPP Loans to Companies in Bankruptcy

In a fast-emerging area of the law, the courts are reaching different conclusions about whether loans under the Paycheck Protection Program (“PPP”) are available to companies in bankruptcy. For example, on June 22, 2020, the Fifth Circuit Court of Appeals overruled a bankruptcy court’s injunction requiring the SBA to handle a PPP application filed by a Chapter 11 debtor. The SBA had refused the application based on an SBA regulation that “[i]f [an] applicant … is the debtor in a bankruptcy proceeding, … th[at] applicant is ineligible to receive a PPP loan” (hereinafter the “Eligibility Rule”). The Fifth Circuit based its decision on precedent that injunctions against the SBA are prohibited by the terms of the federal Small Business Act (the “Act”).¹

Similarly, on June 8, 2020, the Bankruptcy Court for the District of Maryland declined to issue an injunction requested by a Chapter 11 debtor. The Debtor argued that the Eligibility Rule is arbitrary and capricious, but the court held that the Act precluded an injunction based on that argument.² Other courts have also come down on the side of the Eligibility Rule.³

Yet, other courts have reached polar opposite conclusions. For example, on June 8, 2020, the Bankruptcy Court for the Middle District of Florida ruled that (a) the Act does not prohibit it from issuing an injunction, and (b) it would issue an injunction because the Eligibility Rule is “arbitrary and capricious” and exceeded the SBA Administrator’s authority.⁴ Further, on May 1, 2020, the Bankruptcy Court for the District of New Mexico, writing that the Eligibility Rule is “inexplicable and highhanded”, reached essentially the same conclusion and also held that a PPP loan is a “grant” within the meaning of Bankruptcy Code § 525 (which prohibits government discrimination against companies in bankruptcy with respect to grants and certain other government benefits).⁵ Other courts have also ruled against the Eligibility Rule.⁶

None of the cases to date are binding in Virginia, but this issue is arising frequently, so stay tuned for further developments.

Bankruptcy Court Opinion Provides Guidance to Creditors on Automatic Stay

Another source of disagreement among the courts concerns the extent of a creditor’s duty when it learns of a bankruptcy filing after taking possession or control of property in which the debtor has an interest (e.g., a piece of collateral) but before disposing of the property. Some courts take the view that the creditor has an affirmative duty to release the property, failing which the creditor violates the automatic stay. Other courts have held that there is no duty to return the debtor’s property and that the creditor can maintain the status quo without violating the stay. A recent opinion from the Bankruptcy Court for the Eastern District of Virginia requires release of the debtor’s property and shows the peril a creditor faces if it does not act promptly to either release the property or protect its rights in the bankruptcy court.

In In re Nimitz,⁷ the creditor was in the midst of collecting its judgment through a state-court wage garnishment when the debtor filed bankruptcy and informed the creditor of the filing. The creditor (a law firm, no less) took the view that it was not required to terminate the garnishment and that it would simply wait for two weeks until the state court hearing on the garnishment, at which time the state court could decide what to do.

The bankruptcy court stated that while a creditor is entitled to adequate protection of any interest it has in property and “may have legitimate reasons for resisting a turnover of property to the debtor - when a vehicle, for example, is uninsured”, “it is incumbent upon the creditor to move for adequate protection promptly.” In other words, simply maintaining the status quo until the state court hearing was not acceptable.

Further, the court noted that the law firm had not demonstrated an interest in the garnished funds that was superior to the debtor’s right to claim an exemption in the funds. In other words, even if the law firm had moved promptly for adequate protection, it did not have an interest that was entitled to protection.

The court wrote that a “a creditor’s intransigence in returning property to the debtor … cannot diminish the debtor’s right to be free from an exercise of control over her property” under the automatic stay. It therefore concluded that the law firm had violated the automatic stay. The court also viewed its ruling as being dictated by a 2014 opinion of the U.S. District Court for the Eastern District of Virginia, which held that a creditor “has an affirmative duty … to discontinue any proceeding … if the proceeding (a) jeopardizes or threatens in any way the integrity of the bankruptcy estate, or (b) exposes the debtor to harassment or coercion or otherwise inhibits the debtor’s ‘breathing spell from [her] creditors.’”

By refusing to release the garnishment despite its knowledge of the bankruptcy filing, the law firm committed a “willful” violation of the automatic stay, even though it did not specifically intend to violate the stay. The law firm thereby exposed itself to claims for the debtor’s actual damages and attorney fees, plus punitive damages. Fortunately for the law firm, the court did not find that creditor’s actions were an “egregious violation of the automatic stay” or that the creditor had acted with “malevolent intent”, so the court denied the debtor’s request for punitive damages. The court also found that the debtor did not prove any damages beyond the attorney fees she incurred in securing release of the garnishment, so the law firm was ordered to pay those attorney fees, but nothing more.

The takeaway is simple: if a creditor takes possession or control of property and then learns that a debtor in bankruptcy has an interest in the property, the creditor must promptly either surrender the property or seek adequate protection of its interest in the property from the bankruptcy court. Failure to do one of these things exposes the creditor to potentially substantial damages.

COVID-19 Impacts the Courts

Virginia’s Circuit Courts and General District Courts

COVID-19 has impacted Virginia’s state courts in unprecedented ways. To minimize the health risks to litigants, judges, courthouse staff, and the general public, the Supreme Court of Virginia (the “Supreme Court”) has issued a series of orders in which it declared a judicial emergency, extended or tolled certain case deadlines, and set forth mandatory guidelines for the courts.

1. Judicial Emergency Orders

On March 16, 2020, the Supreme Court entered the first order declaring a judicial emergency (the “First Order”). The First Order covered through April 6, 2020, and suspended all non-essential, non-emergency proceedings in all circuit and general district courts, as well as tolled and extended all deadlines for a period of twenty-one days. The First Order also required all courts to implement certain safety measures, including but not limited to continuing all jury trials and limiting courtroom attendance.

The Supreme Court has since entered five extension orders and two clarification orders, the last two of which were entered on June 22, 2020. The current judicial emergency period runs through July 19, 2020, but could be extended.

2. Tolling of Deadlines / Discovery Exception

The Supreme Court’s orders have contained slight variances in applicability and exceptions for specified deadlines. Notably, on May 6, 2020, the Supreme Court entered the fourth order modifying and extending the declaration of judicial emergency through June 7, 2020 (the “Fourth Order”). While the Fourth Order continued to toll all statutes of limitation and other case-related deadlines through the end of the judicial emergency period, it created an exception for a variety of discovery-related deadlines, such as responding to requests for admissions, interrogatories, and requests for production of documents. As a result, if a defendant is served with a complaint and discovery requests during the judicial emergency period, the defendant must respond to the discovery in a timely manner even though it does not need to file a responsive pleading until after the emergency period has ended. This allows a plaintiff to make progress toward resolving its case notwithstanding the judicial emergency.

The time to respond to non-discovery matters, such as filing responsive pleadings, does not begin to run again under the current order (entered on June 22, 2020, the “Sixth Order”) until July 19, 2020.

As the Supreme Court has noted throughout its orders, clerks’ offices remain open, operational, and continue to accept filings, both physical and electronic. However, because the Sixth Order continues to stay all case-related deadlines aside from discovery, some litigants have chosen to delay filing new cases for strategic purposes. Otherwise, defendants have well over the 21 days typically afforded to file a responsive pleading.

3. Case Backlog

Litigants also face potential delays in both hearings and trials. Certain larger jurisdictions in the Commonwealth have not yet noted a discernible case backlog, but the Supreme Court has provided statistics indicating that the pandemic’s effect on the pace of litigation may be long-lasting.

As the Supreme Court notes in its Fourth Order, the backlog of cases in Virginia’s courts continues to grow due to the effective stay on litigation. From March 16, 2020, through May 1, 2020, the general district courts and the circuit courts continued approximately 413,000 and 135,000 cases, respectively.

According to the Supreme Court’s calculation, in the eight weeks since May 1, 2020, approximately 480,000 and 152,000 more cases have been added to the general district court and circuit court backlogs, bringing the respective totals since the beginning of the emergency period to 893,000 and 287,000. The practical effect of these backlogs is that, even once courts return to business as usual, the speed of litigation will continue to be hampered by the sheer volume of cases circulating through the court system.

Despite the continuing health crisis, courts have begun to hold hearings and, in some cases, have held telephonic or video conference hearings where feasible. The availability of electronic means of conducting hearings varies across the Commonwealth depending on each court’s capabilities. However, courts are still required to prioritize emergency matters and all jury trials are postponed through at least July 19.

For those cases involving contracts that lack a jury-waiver provision, the freeze on jury trials could substantially delay the trial. The Chief Justice has created a Jury Task Force comprised of judges and administrative personnel that, in collaboration with the Virginia Department of Health, must determine best practices on how to safely resume jury trials. The Sixth Order further requires that all circuit courts develop a plan for their circuit to safely conduct jury trials whether in their existing courtrooms or alternate available space.

Federal District Courts and Bankruptcy Courts

On May 26, 2020, the United States District Court for the Eastern District of Virginia (“EDVA”) entered an order setting forth guidelines for its phased expansion of court operations. In its order, the EDVA explained that beginning on June 11, 2020 in-person proceedings would resume and civil jury trials are postponed until further notice.

On June 8, 2020, the United States District Court for the Western District of Virginia (“WDVA”) entered a similar order setting forth guidelines for its first phase of reopening. In its order, the WDVA stated that beginning June 29, 2020, in-person proceedings would resume and civil jury trials may resume August 31, 2020. Unlike Virginia state courts, there is no tolling of any deadlines or statutes of limitations in Virginia federal courts.

The Bankruptcy Courts have also implemented protocols to limit in-court hearings and also otherwise limit the spread of COVID-19. In the Bankruptcy Court for the Eastern District of Virginia, the Court has ordered that until further notice all hearings will be conducted remotely by Zoom or other means unless the presiding judge makes an exception in a particular instance. Likewise, in the Bankruptcy Court for the Western District of Virginia, all hearings before Judge Connelly are being held by video until further notice or unless otherwise ordered, and hearings before Judge Black are being held by video or telephone through at least July 2020. The remote hearings, including hearings in which witness testimony is presented, have so far proceeded without difficulty, and other court functions have also continued to operate smoothly.

1 The case is In re Hidalgo County Emergency Service Foundation, Case No. 20-40368 (5^th Cir. June 22, 2020).

2 The case is iThrive Health, LLC v. Carranza, 2020 Bankr. Lexis 1509 (Bankr. D.Md. June 8, 2020).

3 For example, Fox Valley Pro Basketball Inc. v. S.B.A., 2020 U.S. Dist. Lexis 105355 (E.D. Wis. June 16, 2020), and Penobscot Valley Hospital v. Carranza, 2020 Bankr. Lexis 1464 (Bankr. D. Me. June 3, 2020).

4 The case is Gateway Radiology Consultants, P.A. v. Carranza, 2020 Bankr. Lexis 1508 (Bankr. M.D.Fla. June 8, 2020).

5 The case is Roman Catholic Church of the Diocese of Santa Fe v. United States SBA, 2020 Bankr. Lexis. 1211 (Bankr. D.N.M. May 1, 2020).

6 For example, Springfield Hosp., Inc. v. Carranza, 2020 Bankr. Lexis 1667 (Bankr. D.Vt. June 22, 2020), and Skefos v. Carranza, 2020 Bankr. Lexis 1479 (Bankr. W.D.Tenn. June 2, 2020).

7 2019 Bankr. Lexis 3798 (Bankr. E.D.Va. December 11, 2019).