A panel of the Ninth Circuit ruled, unsurprisingly, that an individual ineligible for a discharge in chapter 7 cannot obtain a discharge in chapter 11 by being employed in an unrelated business after confirmation. However, the opinion is difficult to parse because the appeals court talks about discharging a debt when the issue is denial of discharge.
The two owners of a business were saddled with a judgment in state court for fraud and misrepresentation. If they were to file chapter 7 petitions, they evidently believed they would be denied discharges under Section 727(a). So, they filed chapter 11 petitions.
The cases were consolidated, and the chapter 7 trustee confirmed a liquidating chapter 11 plan where all of the debtors’ nonexempt assets were sold along with the assets of their jointly owned business.
The judgment creditor filed a nondischargeability complaint under Section 523(a)(3), contending that it had not been given timely notice of the bankruptcy. Had the creditor succeeded, the debt would have been excepted from discharge under Section 1141(d)(2), which applies only to individual chapter 11 debtors. However, the bankruptcy court dismissed the complaint for having missed the filing deadline.
So, the judgment creditor filed another complaint, this time seeking to deny discharge under Section 1141(d)(3). That section, which applies to both corporate and individual debtors, provides that a debtor does not receive a discharge if the plan liquidates “all or substantially all of the property of the estate,” the debtor “does not engage in business after consummation of the plan,” and the debtor would be denied a discharge under Section 727(a) if the case were in chapter 7. The conditions are laid out in subsections (d)(3)(A), (B) and (C), respectively.
On summary judgment, the bankruptcy court “denied a discharge of the . . . debt” to the judgment creditor, according to the September 14 opinion by Circuit Judge Andrew D. Hurwitz. However, the opinion of the bankruptcy court shows that the bankruptcy judge denied the debtors’ discharges under Sections 1141(d)(3) and 727(a).
The district court affirmed.
On appeal to the circuit, Judge Hurwitz said that the debtors conceded that “they would not have been entitled to a discharge of the [debt on the judgment] had they sought relief in chapter 7,” thus satisfying the requirement in Section 1141(d)(3)(C) regarding denial of discharge in chapter 7. Although Judge Hurwitz was referring to discharging a particular debt, he evidently meant to say the debtors would have been denied a discharge of all debts under Section 727(a).
The debtors argued, though, that they were entitled to chapter 11 discharges because the other conditions in Section 1142(d)(3)(A) and (d)(3)(B) had not been met.
Judge Hurwitz quickly concluded under Section 1141(d)(3)(A) that the plan liquidated substantially all of the estate property, because it was denominated as a “liquidation plan,” and the debtors did not retain any estate property.
Attempting to salvage their discharges, the debtors were left to argue under Section 1141(d)(3)(B) that they were engaged in business after consummation of the plan. Judge Hurwitz said that the third and final element was “less clear cut” when applied to an individual rather than a corporate debtor.
One debtor was employed part time by the plan administrator, and the other began working for an unrelated business. The bankruptcy court followed a nonprecedential opinion from the Fourth Circuit and concluded that the debtors had not continued their prepetition business and thus were not entitled to discharges.
Judge Hurwitz upheld the result in bankruptcy court for a different reason. He said the debtors “did not engage in any business” [emphasis in original] because they “were simply employees in businesses owned or operated by others.”
Judge Hurwitz said that “no court has ever read Section 1141(d)(3)(B) as being satisfied by mere employment.” Allowing “a liquidating chapter 11 debtor to obtain a discharge for debts incurred by fraud simply by accepting employment after plan consummation would effectively vitiate Section 727(a),” he said.
Judge Hurwitz concluded the opinion by saying that the debtors were “not entitled to a discharge of the . . . debt” to the judgment creditor. The opinion would have been easier to understand had the court said that the bankruptcy court properly denied the debtors’ discharges.
The holding is important in bankruptcy practice, but the opinion uses dischargeability nomenclature when dealing with discharge. Before official publication, the court may wish to consider modifying the opinion by clarifying the references to discharge and dischargeability.