On a question where the courts are split, Bankruptcy Judge Beth E. Hanan of Milwaukee extrapolated from Seventh Circuit authority to hold that a discharge terminates liability that arises after filing on a personal guaranty.
The debtor had issued a personal guaranty of debts owing by his restaurant to a particular supplier. The guaranty provided that it was “absolute, continuing and irrevocable.”
The debtor filed a chapter 7 petition and received a discharge in 2014. It was a no-asset case. The debtor did not schedule what was a $10,000 liability on the guaranty at the time of the chapter 7 filing. However, the supplier did become aware of the bankruptcy sometime after filing.
The supplier conceded that the $10,000 debt was discharged, Judge Hanan said in her August 19 opinion.
The restaurant incurred a $40,000 debt to the supplier in 2018 that was not paid. The supplier reopened the debtor’s chapter 7 case and filed an adversary proceeding seeking a declaration that the $40,000 debt on the guaranty was not discharged.
Both sides moved for summary judgment, but Judge Hanan came down in favor of the debtor by holding in substance that all future liability on the personal guaranty had been extinguished by the 2014 discharge.
The outcome turned on Section 727(b), which discharges “all debts that arose before” the order for relief. In turn, a “debt” means a liability on a claim under Section 101(12), and a “claim” under Section 101(5)(A) means a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.”
Judge Hanan said the courts are split on whether a personal guaranty survives discharge. That is, does a personal guaranty fall under the definition of a “claim?”
One group of courts hold that discharge does not extinguish personal liability for post-petition extensions of credit covered by a guaranty.
Other courts, including the Sixth Circuit Bankruptcy Appellate Panel, hold that a pre-petition guaranty is a contingent claim that is discharged in a later bankruptcy, Judge Hanan said.
To divine the answer, Judge Hanan turned to the nearest Seventh Circuit authority, Saint Catherine Hosp. of Ind. LLC v. Ind. Family and Soc. Servs. Admin., 800 F.3d 312 (7th Cir. 2015). There, the Seventh Circuit adopted the so-called conduct test to determine whether a claim arose pre-petition or post-petition.
The Seventh Circuit said that “the date of a claim is determined by the date of the conduct giving rise to the claim.” Id. at 315. The Seventh Circuit rejected the so-called accrual theory that relies on state law to decide when a claim arose, Judge Hanan said.
Judge Hanan said that the Seventh Circuit and other courts found the conduct test “to be most consistent with the Bankruptcy Code’s broad definitions of claim and debt,” thus capturing “a larger number of claims (i.e., contingent and unmatured).” In turn, finding claims to arise at the earliest time possible best serves the policy goals of the Bankruptcy Code, the Seventh Circuit said.
Judge Hanan acknowledged courts’ criticism of the conduct test as potentially discharging claims that a creditor does not know exist. To avoid due process problems, courts have narrowed the conduct test to require a pre-petition relationship through which the creditor would have known a claim to exist by the exercise of reasonable due diligence.
Even if the relationship test applied, Judge Hanan said it was satisfied by the supplier’s pre-petition relationship with the debtor.
Judge Hanan held that “signing the contract was the conduct giving rise to the claim, the debt under [the debtor’s] personal guaranty was contingent on a future default, and therefore the debt was dischargeable as part of the debtors’ 2014 bankruptcy discharge.”
Finally, Judge Hanan denied the supplier’s motion to amend the complaint by adding a claim under Section 323(a)(3). In a no-asset case without a bar date, that section provides that claims that were not scheduled are discharged unless they fell under Section 523(a)(2), (4) or (6).
In the case before her, there was no fraud, so the supplier could not replead to state a claim under Section 523(a)(2), (4) or (6), which all require some form of fraud or willful and malicious injury.
On a question where the courts are split, Bankruptcy Judge Beth E. Hanan of Milwaukee extrapolated from Seventh Circuit authority to hold that a discharge terminates liability that arises after filing on a personal guaranty.
The debtor had issued a personal guaranty of debts owing by his restaurant to a particular supplier. The guaranty provided that it was “absolute, continuing and irrevocable.”
The debtor filed a chapter 7 petition and received a discharge in 2014. It was a no-asset case. The debtor did not schedule what was a $10,000 liability on the guaranty at the time of the chapter 7 filing. However, the supplier did become aware of the bankruptcy sometime after filing.
The supplier conceded that the $10,000 debt was discharged, Judge Hanan said in her August 19 opinion.