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For cannabis firms, challenges emerge for denials of PPP loan forgiveness

The Small Business Administration has sought to make cannabis firms and those businesses that supply them ineligible for its loans, but some believe there may be a legal way to challenge that policy. (BridgeTower Media)

The Small Business Administration has sought to make cannabis firms and those businesses that supply them ineligible for its loans, but some believe there may be a legal way to challenge that policy. (BridgeTower Media)

Given the haste with which it was rolled out in response to the COVID-19 pandemic, a few Paycheck Protection Program recipients profiting from the cannabis industry, at least indirectly, no doubt slipped through the cracks.

Those businesses may face some challenges as they apply to have their loans forgiven due to their connection to what the federal government still considers illicit activity.

The easiest solution to that dilemma would be simply to give the money back, and some attorneys say they would counsel their clients to do just that.

But at least one lawyer believes that such companies might also want to consider mounting a challenge under the Administrative Procedures Act, given what is a rapidly — if erratically — evolving body of case law that may have application beyond the cannabis industry.

Businesses engaged directly in the marijuana trade in states where sales are legal, may not have dared apply for PPP loans, given that the Borrower Application Form asked them to certify that “[t]he Applicant is not engaged in any activity that is illegal under federal, state or local law.”

But the door was arguably left cracked open for “indirect” marijuana businesses, such as businesses that provide testing services, or sell or install grow lights or other specialized equipment, or businesses that sell ancillary products, such as pipes and other smoking devices.

The Small Business Administration would say that such businesses, too, are ineligible for PPP loans, pointing to a regulation it adopted in 1996, 13 C.F.R. §120.110, which in subsection (h) prohibits “businesses engaged in any illegal activity” from participating in any of the SBA’s business loan programs. Those programs include those under §7(a) of the Small Business Act — of which the PPP is now a part.

The SBA has subsequently published guidance further clarifying that it meant to sweep up in the prohibition “businesses that derive revenue from marijuana-related activities or that support the end-use of marijuana.”

But there is some tension between such limitations on access to SBA funding and Congress’ apparent desire when passing the CARES Act to make relief from the COVID-19 pandemic widely available.

While cannabis has not been at the heart of any of the early cases, decisions have begun to bubble up from the federal courts involving businesses also normally blocked from accessing SBA funds.

Perhaps most on point are cases involving adult entertainment business, like strip clubs. As with marijuana businesses, under 13 C.F.R. §120.110(p), certain sexually oriented businesses are prohibited from participating in SBA lending programs.

However, those businesses have gone into federal court to challenge their denial of access to PPP funds using the APA, which prohibits agencies from taking action “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right.”

Under the first step of the two-step framework set forth in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., courts are to ask whether “Congress has directly spoken to the precise question at issue.”

In DV Diamond Club of Flint, LLC, et al. v. United States Small Business Administration, U.S. District Court Judge Matthew J. Leitman of the Eastern District of Michigan framed the question as: “May the SBA exclude from eligibility for a PPP loan guarantee a business concern that (1) during the covered period (2) has less than 500 employees or less than the size standard in number of employees established by the Administration for the industry in which the business operates?”

Leitman then answered that question in the negative.

When it created the PPP program, Congress was aware that the SBA had historically declared certain classes of businesses ineligible for SBA lending, and yet it made loans available to “any business concern,” Leitman reasoned.

“While Congress may once have been willing to permit the SBA to exclude these businesses from [the SBA’s] lending programs, that willingness evaporated when the COVID-19 pandemic destroyed the economy and threw tens of millions of Americans out of work,” Leitman wrote. “Simply put, Congress did not pick winners and losers in the PPP.”

But confronted with a near identical issue in the Western District of New York, U.S. District Court Judge Lawrence J. Vilardo ruled in the opposite direction in Pharaoh’s GC, Inc. v. United States Small Business Administration.

After noting the split among courts on whether the SBA’s eligibility requirements for a PPP loan contradict the plain text of the CARES Act, Vilardo sided with those who had held that the SBA did not exceed its authority in barring certain organizations from obtaining PPP loans.

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