602-322-4000

The recent State of Arizona Declaration of Emergency *COVID-19* and Executive Order 2020-07 issued by Governor Douglas A. Ducey on March 11, 2020, forced the Arizona economy into a screeching halt. To provide a robust and integrated response to successfully combat the COVID-19 outbreak, the Governor shut down schools, non-essential functions, non-essential businesses1, including the closure of sporting events, casinos, restaurants, hotels, and churches. The designated non-essential businesses, many of which were small businesses, were for all practical purposes required to close. Normal life as we knew it, was essentially stopped from March 31, 2020 until May 4, 2020, as the population stayed home to “flatten the curve” and to stop the spread of a deadly virus. Arizona is now slowly opening up under Governor Ducey’s Executive Order 2020-18 titled “Stay Healthy, Return Smarter, Return Stronger”.

While the success of this drastic response to the COVID-19 Pandemic will be debated and evaluated in the future, it is already apparent this has had a devastating impact on the Arizona economy, the Arizona healthcare system, and Arizona non-essential businesses. It is predicted that many Arizona small businesses will be severely crippled or not survive the COVID-19 Pandemic. The “new normal” economy is unfolding for Arizona businesses and the rules for operating in the new normal economy will certainly be a challenge until effective treatments or a vaccine for COVID-19 is developed.

It is clear that many Arizona businesses (large and small) are struggling to reopen and will be facing possible bankruptcy in the near term2. According to Amy Quackenboss, Executive Director of the American Bankruptcy Institute, “Mounting financial challenges may result in more households and companies seeking the shelter of bankruptcy.” According to the CBS News, 722 companies already filed for bankruptcy protection throughout the United States in May 2020.

There are two federal options that may help to save small businesses from bankruptcy during the gradual, phased opening of the Arizona economy:

  1. The Paycheck Protection Program (PPP); and
  2. A reorganization under new Subchapter V to Chapter 11 of the Bankruptcy Code.

Small business owners facing economic challenges should consider each option individually or in combination.

ENVIRONMENTAL ISSUES AND BANKRUPTCY

Many businesses (large and small) have environmental programs, environmental reporting, environmental permits, or environmental liabilities that are significant expenses to the daily cost of doing business. Typical examples are routine compliance and monitoring requirements, environmental training, waste-water discharge permits, hazardous waste compliance programs, and air quality equipment that either has ongoing maintenance or reporting expenses.

Despite the COVID-19 Pandemic shutdown, environmental statutes and regulations require compliance by the Environmental Protection Agency (“EPA”) or the various state environmental agencies. If a company receives a PPP loan, that money cannot be used for environmental issues. If a company elects to file a plan under Subchapter V to Chapter 11 bankruptcy provisions, the small business debtor will have to address environmental issues with either federal or state environmental agencies related to the restructuring plan.

During the economic shutdown, the Department of Justice (“DOJ”), EPA and the Arizona Department of Environmental Quality (“ADEQ”) have emphasized existing or promulgated new Policy Statements which provide some guidance and limited protections for small businesses from Environmental Enforcement under certain conditions during these tough times.

DEPARTMENT OF JUSTICE

The DOJ has previously issued a directive titled “Enforcement Principles and Priorities” dated March 12, 2018. This directive for the Environmental and Natural Resources Division (“ENRD”) states the following Enforcement Principle #3 which I believe would be relevant to environmental compliance issues during the COVID-19 Pandemic:

Exercising Pragmatic Decisionmaking. The sound exercise of enforcement discretion is a defining responsibility for ENRD, and is one that will be governed by the law, the facts of the case, and common sense. Decisions by ENRD attorneys to bring federal cases must spring from an independent and searching review of the facts and the law and a sound and careful consideration of relevant factors, including the strength of the evidence; the basis of assertion of federal jurisdiction; the nature, importance and impact of the violations; the environmental and law enforcement benefits expected to be gained through enforcement action; and the objectives and priorities of the referring agency. With regard to evidence, environmental cases often involve complex scientific or technical issues. In such contests, ENRD attorneys must be careful to rely upon sound scientific data and evidence.

Even though many cases are complex, ENRD enforcement attorneys should always be mindful of pragmatic concerns. And when choosing which violations of law to pursue and how to pursue those violations, our attorney should weigh whether the contemplated enforcement action is calculated to achieve a just result.”

ENVIRONMENTAL PROTECTION AGENCY

On March 26, 2020, the EPA issued a new Enforcement Memorandum titled “COVID-19 Implications for EPA’s Enforcement and Compliance Assurance Program.” This Memorandum recognizes the significant issues concerning environmental compliance and recognizes that “the consequences of the COVID-19 Pandemic may constrain the ability of regulated entities to perform routine compliance monitoring, integrity testing, sampling, laboratory analysis, training and reporting or certification.” EPA will likely delay enforcement on the issues during the COVID-19 Pandemic. EPA will expect facilities to take reasonable measures to resume compliance activities as soon as possible. EPA shall coordinate with the DOJ to exercise enforcement discretion where appropriate. Generally, when Consent Decrees are involved, small businesses should use the Notice Procedures indicating a situation of force majeure during the time of non-compliance.

ARIZONA DEPARTMENT OF ENVIRONMENTAL QUALITY

In a similar declaration, the ADEQ has issued a “Memorandum of Compliance and Enforcement Implementation” during COVID-19 (March 31, 2020). This ADEQ Memorandum compares the ADEQ’s existing implementation of enforcement of non-compliance and compares to the EPA’s March 26, 2020, Memorandum. In all practical applications, EPA and ADEQ are consistent in their enforcement approach during the COVID-19 Pandemic. The ADEQ Memorandum provides:

“The ADEQ approach to compliance management has historically focused on compliance assistance and informed enforcement reserving escalated enforcement and penalties for only the most severe non-compliance.”

I recommend informing ADEQ of any environmental compliance issues during these tough times to assure enforcement discretion.

PAYCHECK PROTECTION PROGRAM

Fortunately for many Arizona businesses, Congress passed the Coronavirus Aid, Relief and Economic Security (“CARES”) Act on March 27, 2020, and established the Paycheck Protection Program (“PPP”)3. The purpose of the PPP was to provide loans to small businesses affected by the government shutdown to borrow money to assist and retain the employees and to stay in business until the economy gets back on track. The PPP was designed to keep workers off the state unemployment programs by lending money to the employers to pay employees. The PPP authorizes up to $659 billion to be used by employers and under specific conditions, the loan will be forgiven. There are no personal guarantee requirements.

To have the loans forgiven, companies must keep their employees on payroll as before the shutdown and at the same wages. In general, the Small Business Administration (“SBA”) has some issues with the PPP rollout, but it has been generally successful in keeping workers on the payroll and off the unemployment line.4

Who Can Apply for a PPP Loan?

  • The following entities may be eligible:
    Any small business that meets SBA’s size standards (either the industry based sized standard or the alternative size standard)
  • Any business, 501(c)(3) non-profit organization, 501(c)(19) veterans organization, or Tribal business concern (15 U.S.C. 657a(b)(2)(c)) with the greater of:
    • 500 employees, or
    • That meets the SBA industry size standard if more than 500
  • Any business with a NAICS Code that begins with 72 (Accommodations and Food Services) that has more than one physical location and employs less than 500 per location
  • Sole proprietors, independent contractors, and self-employed person

What Can I Use the Loans For?

  • Payroll costs, including benefits
  • Interest on mortgage obligations received before February 15, 2020
  • Rent under lease agreements in force before February 15, 2020
  • Utilities for which service began before February 15, 2020

Note that you will owe the loan money when your loan is due if you use the proceeds for anything other than payroll costs, mortgage interest, rent, and utilities. You must use at least 60% of the loan in payroll costs to avoid repayment obligations. It has been reported recently by The New York Times that $130 billion in PPP funds have yet to be issued and is still available to applicants.

Here is a link to the SBA’s PPP application for a loan.

Here is a link to the SBA’s Application for PPP Loan Forgiveness. 

SUBCHAPTER V TO CHAPTER 11 OF THE BANKRUPTCY CODE

For businesses, large and small, that are in peril of failure, they should also consider a relatively new provision in Chapter 11 of the Bankruptcy Code. The possibility of Bankruptcy Court supervision can help companies restructure their debt, restructure their business, and emerge from Chapter 11 either more competitive or at least able to survive. Chapter 11 allows a business to continue operating under existing management while restructuring the debt and paying it off over a period of time. Historically, a traditional Chapter 11 bankruptcy has been expensive and it does require a reorganization plan to be approved by the creditors.

What is commonly referred to as a “Fast Pass” or “Subchapter V” bankruptcy to Chapter 11, is a new streamlined plan and confirmation process to better enable small businesses to survive bankruptcy, lower legal costs, and retain control of the business operations. Subchapter V creates special rules for small businesses which makes it easier for them to reorganize:

  1. Debtor elects to Subchapter V provision in the initial petition.
  2. A bankruptcy trustee is appointed to provide assistance and oversight so that the debtor stays on track with the reorganization as planned. No Creditor’s Committees are approved.
  3. The debtor has ninety (90) days to propose a plan of reorganization.
  4. If the reorganization plan is “fair and equitable”, creditors’ objections can be overruled by the bankruptcy judge. All projected disposable income for 3-5 years has to be used to pay creditors.
  5. The CARES Act increased the maximum amount of debt a small business could have from $2,725,625 to $7,500,000. (Only for cases filed after the CARES Act and expires after one year when it reverts back to $2,725,625.)
  6. PPP loans are excluded from the debtor’s current monthly income and disposable income under the requirements for a “Reorganization Plan”.

Many of the nuances of the Fast Pass or Subchapter V Bankruptcy program can be reviewed in the Handbook for Small Business Chapter 11 Subchapter V Trustees, U.S. Department of Justice (February 2020) found at:
https://www.justice.gov/ust/file/subchapterv_trustee_handbook.pdf/download.

There has always been tension between (1) the Bankruptcy Code’s policy of discharging debts and a “fresh start”; and (2) the environmental laws to protect public health and safety. Generally, claims which arise before the date of the Bankruptcy Court order confirming a reorganization plan are, in theory, and practice, discharged by the Bankruptcy Court. Environmental liabilities are one of the few exceptions to discharge ability under the Bankruptcy Code. See Midlantic National Bank v. New Jersey Dept. of Envtl. Prot., 474 U.S. 494 (1986), In re: Chateaugay Corp., 944 F.2d 997 (2d Cir. 1991), and Mark IV Industries, Inc. v. New Mexico Env. Dept., 452 B.R. 385 (S.D.N.Y. 2011). Environmental issues common in bankruptcy proceedings are a liability for Superfund sites and environmental liabilities associated with transactions of real property or business.

CONCLUSION

Arizona is now slowly opening up under Governor Ducey’s Executive Order 2020-18 titled “Stay Healthy, Return Smarter, Return Stronger”. The “new normal” economy is unfolding for Arizona businesses, and the rules for operating in the new normal economy will certainly be a challenge until effective treatments or a vaccine for COVID-19 is developed. It is clear that many Arizona businesses (large and small) are struggling to reopen and will be facing possible bankruptcy in the near term.
In order for small businesses to survive, they should consider (1) the SBA’s PPP loan program and (2) a possible “Fast Pass” reorganization under Subchapter V to Chapter 11 of the Bankruptcy Code. Under the PPP loan provisions, 60% must be used for employee retention and 40% can be used for mortgage, rent, and utilities (but not environmental costs). If a company elects to utilize and file a plan under Subchapter V to Chapter 11 bankruptcy provisions, the small business debtor will have to address environmental issues with either federal or state environmental agencies related to the restructuring plan. During the economic shutdown, the DOJ, EPA, and the ADEQ have existing or new Policy Statements which provide some guidance and limited protections for small businesses from Environmental Enforcement under certain conditions during these difficult times.

It might be time to add a Bankruptcy Lawyer and an Environmental Lawyer to your speed dial for business as we reopen under the “new normal” economy!

Jerry D. Worsham II
The Cavanagh Law Firm, P.A.
1850 N. Central Avenue, Suite 2400
Phoenix, AZ 85004
(602) 322-4040
JWorsham@cavanaghlaw.com

Jerry D. Worsham II is a shareholder with the firm. Mr. Worsham has extensive practice in environmental compliance and litigation, natural resource development. His experience includes approvals and permits for natural resource development; litigation defense on numerous cases involving the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA); Climate Change including comment on issues and regulation development; compliance with the Resource Conservation and Recovery Act (RCRA); civil and criminal liability defense on environmental matters; ASTM Phase I and Phase II Environmental Site Assessments coordination; emergency incident responses; Prospective Purchaser Agreement negotiations; creation of Conservation Easements; and due diligence associated with mergers, acquisitions, and initial public offerings. Mr. Worsham reviews and comments on federal, state, and local laws, rules, and regulations on a regular basis and represents clients before federal and state environmental agencies.

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1. Although the legal profession was deemed to be an essential business under the umbrella “Professional and Personal Services,” many law firms switched to either a temporary or permanent remote practice model while working from home.

2. Bankruptcy provides a process to resolve a debtor’s prebankruptcy liabilities and affords the debtor a “fresh start” by discharging debtor of liability for actual and contingent claims arising before the bankruptcy petition was filed (prepetition claims) through a process of liquidation or reorganization of the debtor’s assets and allocation of assets among creditors. Under Chapter 7, the debtor’s nonexempt assets are liquidated and the proceeds are used to pay creditor’s claims. See 11 U.S.C. §§ 704, 726. Under Chapter 11, a debtor will remain in possession of its assets and use those assets to produce income to be distributed under a plan to the creditors. 11 U.S.C. § 1141(d)(1)(A). In either case, to the extent that there are not sufficient assets to pay the claims, the debts are discharged.

3. In addition, Congress passed the PPP Flexibility Act on June 4, 2020, which expanded the program benefits to small businesses from $349 billion in forgiveness loans to add an additional $310 billion.

4. According to the most recent announcement from the Bureau of Labor Statistics, the current “seasonally adjusted” unemployment rate for May 2020 (released June 5, 2020) is 13.3% down from 14.7% in April 2020. Non-farm payroll employment increased by 2.5 million jobs in May 2020.