Reversing the bankruptcy court, a district judge in Chicago decided that corporate debtors in Subchapter V of chapter 11 can be saddled with nondischargeable debts.

In his November 14 opinion, District Judge Manish S. Shah followed the Fourth and Fifth Circuits and agreed with a different bankruptcy judge in Chicago, while disagreeing with the Ninth Circuit Bankruptcy Appellate Panel and eight bankruptcy courts.

A creditor held a judgment for more than $3 million against a corporation and its owner. The corporation filed a petition under Subchapter V of chapter 11. The judgment creditor responded with an adversary proceeding seeking a declaration that the debts owing to it were nondischargeable under Section 523(a)(2)(A), (a)(2)(B) and (a)(6).

Believing that nondischargeability does not apply to corporate debtors in Subchapter V just like in “regular” chapter 11, the bankruptcy court granted the debtor’s motion to dismiss the complaint for failure to state a claim. See Chicago & Vicinity Laborers’ District Council Pension Plan v. R&W Clark Construction Inc. (In re R&W Clark Construction Inc.), 656 B.R. 628 (Bankr. N.D. Ill. Feb. 8, 2024). To read ABI’s report on R&W, click here.

The creditor appealed to the district court and won a reversal.

Sections 1192 and 523(a)

Apart from a court’s concept of policy, the outcome turns on the interpretation of Sections 1192 and 523(a). Applicable to nonconsensual plans, Section 1192 provides that “the court shall grant the debtor a discharge of all debts provided in section 1141(d)(1)(A) of this title . . . except any debt — . . . (2) of the kind specified in section 523(a) of this title.” [Emphasis added.]

Section 523(a) provides that a “discharge under section . . . 1141 . . . does not discharge an individual debtor” from 19 types of debt. [Emphasis added.]

Believing there is no nondischargeability for corporations in Subchapter V, the bankruptcy court was persuaded by the Ninth Circuit Bankruptcy Appellate Panel’s decision in Lafferty v. Off-Spec Sols., LLC (In re Off-Spec Sols., LLC), 651 B.R. 862 (B.A.P. 9th Cir. 2023), appeal dismissed per stipulation, 23-60034, 2023 WL 9291577 (9th Cir. Nov. 12, 2023). To read ABI’s report on the BAP opinion, click here.

Concluding that nondischargeability did not apply to corporate debtors in Subchapter V, the BAP saw Section 523(a) and its limitation to individual debtors as being more specific and therefore controlling.

The bankruptcy court declined to follow Cantwell-Cleary Co. v. Cleary Packaging LLC (In re Cleary Packaging LLC), 36 F.4th 509 (4th Cir. June 7, 2022), where the Fourth Circuit held that corporate debtors in Subchapter V may not discharge debts “of the kind” specified in Section 523(a). To read ABI’s report, click here. Subsequently, the Fifth Circuit came down the same way in Avion Funding LLC v. GFS Industries LLC (In re GFS Industries LLC), 99 F.4th 223 (5th Cir. April 17, 2024). To read ABI’s report, click here.

Notably, Chicago Bankruptcy Judge Deborah L. Thorne of Chicago decided in July that the Fourth and Fifth Circuits had the right idea. She ruled that corporate debtors in Subchapter V are subject to complaints for nondischargeability. See Christopher Glass & Aluminum Inc. v. Premier Glass Services LLC (In re Premier Glass Services LLC), 661 B.R. 939 (Bankr. N.D. Ill. July 31, 2014). To read ABI’s report, click here.

Section 1192 Controls

Ruling on the appeal, District Judge Shah decided that Section 1192(2) was “unambiguous” in that it “grants a debtor, either individual or corporate, discharge of all debts except for debts ‘of the kind specified in section 523(a).’” On the other hand, he found “trouble” in the preamble to Section 523(a), which says, “A discharge under section . . . 1192 . . . of this title does not discharge an individual debtor from” 19 types of debt. [Emphasis added.] Judge Shah devoted 10 pages to explaining why the preamble to Section 523(a) is not controlling.

“When § 1192 refers to the kinds of debt specified in § 523(a),” Judge Shah said, “it is referring to the enumerated debts, not the preamble’s reference to types of debtors.” The judge said that his conclusion was “bolstered” by bankruptcy courts in Texas and Georgia that had decided in 1995 and 2009 that “virtually identical” language in chapter 12 opens the door to nondischargeability for corporations, not only individual debtors.

Judge Shah saw Congress as having “made a choice to change bankruptcy proceedings for small business debtors and chose to treat individual and corporate debtors the same. To hold that § 523(a) only applies to individuals discharging debt under § 1192 ignores the purposeful change Congress made to the statutory language.”

Reversing the bankruptcy court, Judge Shah held that the “‘most natural reading’ of § 1192(2) applies the exceptions to discharge in the paragraphs of § 523(a) to both corporate and individual debtors.”