Taking sides with the results reached in the Fourth and Fifth Circuits, Bankruptcy Judge David W. Hercher of Portland, Ore., decided that the types of debts described in Section 523(a) can be nondischargeable for corporations in Subchapter V.

Although sitting in the Ninth Circuit, Judge Hercher disagreed with the Ninth Circuit Bankruptcy Appellate Panel, which ruled one year ago that there’s no such thing as a nondischargeable debt for a corporation in Subchapter V. See Lafferty v. Off-Spec Solutions LLC (In re Off-Spec Solutions LLC), 651 B.R. 862 (B.A.P. 9th Cir. July 6, 2023). To read ABI’s report, click here.

Like a district court opinion, a BAP opinion is not binding on a bankruptcy judge in the same circuit unless the decision was made in the same case.

The Dischargeability Complaint

The creditor filed a complaint against a corporate debtor in Subchapter V of chapter 11. The complaint made two claims. One claim sought a declaration that the debt was nondischargeable under Section 523(a)(2) as having arisen from fraudulent misrepresentations. The second claim was for a money judgment arising from breach of contract.

The debtor moved to dismiss both claims. In his opinion on June 11, Judge Hercher dealt only with the motion to dismiss the nondischargeability claim and ruled in favor of the creditor by denying the motion to dismiss.

Before turning to the case before him, Judge Hercher laid out the similarities and differences regarding dischargeability in chapters 7, 11, 12 and 13. If the plan in Subchapter V is accepted by all classes, he said that all debts are discharged because Section 1141(d) applies and discharges virtually all debts when the debtor is a corporation.

In the case before him, the plan was a so-called cramdown plan confirmed over the objection of a creditor class. Therefore, discharge was governed by Section 1192. After confirmation and the completion of plan payments, the section provides that “the court shall grant the debtor a discharge of all debts provided in section 1141(d)(1)(A) of this title, and all other debts allowed under section 503 of this title and provided for in the plan, except any debt — . . . (2) of the kind specified in section 523(a) of this title.” [Emphasis added.]

Applicable to Subchapter V cases, Section 523(a) provides that a “discharge under section . . .  1141 . . . of this title does not discharge an individual debtor from any debt” described in the following 20 subparagraphs.

Throughout the opinion, Judge Hercher referred to the phrase a “discharge under section . . .  1141 . . . of this title does not discharge an individual debtor” in Section 523(a) as the “preamble.”

Analysis of the BAP and the Circuit Opinions

The debtor naturally urged Judge Hercher to follow Off-Spec, while the creditor wrapped itself in the flags flown by the Fourth and Fifth Circuits. See Cantwell-Cleary Co. v. Cleary Packaging LLC (In re Cleary Packaging LLC), 36 F.4th 509 (4th Cir. June 7, 2022); and 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 reports, click here and here.

Judge Hercher described the Fourth Circuit in Cleary as holding that debts of corporate debtors in Subchapter V can be nondischargeable because the phrase “of the kind specified in section 523(a)” refers to the type of debt, not the type of debtor. He also mentioned how the Fourth Circuit adopted the positions of bankruptcy courts in two chapter 12 cases in 1995 and 2009 as having held that identical language in chapter 12 can give rise to nondischargeable debts of corporate debtors. He also observed that the Fourth Circuit saw nondischargeability as an offset to the easier confirmation of Subchapter V plans.

In GFS, Judge Hercher said that the Fifth Circuit “echoed the reasoning of the Fourth.”

In Off-Spec, Judge Hercher described the BAP as seeing no conflict between Sections 523(a) and 1192 and deciding that Section 523(a) and its limitation to individual debtors was more specific and should control. He also cited the BAP for saying that the two lower courts’ decisions on chapter 12 were “wrong.”

Judge Hercher’s Analysis

Judge Hercher decided that “debts of the kind” “refers to types of debt, not types of debtors.” He therefore concluded that “the plain meaning of 1192(2) is that the discharge under a subchapter V plan confirmed nonconsensually excepts the debts listed in the 523(a) debt-type list — even when the debtor is not an individual.”

To his way of thinking, “the 523(a) preamble — and its application only to the discharge of a debtor who is an individual — has no role in the discharge-narrowing work of the cross-references in the second category of discharge sections, including 1192(2).”

If Congress had meant for nondischargeability to apply in Subchapter V only to individuals, Judge Hercher said “it could easily have said so clearly and expressly by excepting in 1192(2) either ‘any debt — (2) of an individual debtor of the kind specified in section 523(a)’ or as it did in 1141(d)(2), ‘any debt — (2) excepted from discharge under section 523.’”

Judge Hercher found no reason to adopt any policy arguments made by the circuits and the BAP because “the meaning of 1192(2) is clear both in isolation and when considered with other Code sections.”

Parting Company with the Circuits

Although concurring in the outcome reached in the two circuits, Judge Hercher found two of the circuits’ “rationales” to be “questionable.”

First, Judge Hercher said that the “general-versus-specific rationale” does not apply because the statutes are not in conflict, since they can be read “in harmony.” Second, he did not believe that Congress was following the two lower courts’ chapter 12 cases because they were “nonprecedential, unpublished trial-court decisions,” making it “unlikely that Congress was aware of them.”

Denying the debtor’s motion to dismiss the nondischargeability complaint, Judge Hercher predicted that the Ninth Circuit would follow the Fourth and Fifth Circuits to avoid creating a split of circuits.

Updates

In Off-Spec, the creditor appealed to the Ninth Circuit, but the parties later withdrew the appeal.

In the case before Judge Hercher, his order denying the motion to dismiss may not be a final order subject to appeal. With regard to jurisdictional issues in a similar circumstance, see Kiviti v. Bhatt, 80 F.4th 520 (4th Cir. 2023). To read ABI’s report on Kiviti, click here.