Although the Fifth Circuit is among the most restrictive courts of appeals when it comes to non-debtor, third-party releases, the New Orleans-based court once again held that a chapter 11 plan can reduce the amount of a non-debtor guarantor’s liability to a creditor.
A couple owned a corporation that operated a grocery store. The couple owned the real estate occupied by the grocery store. The store borrowed $325,000. The couple personally guaranteed the debt and secured the debt with a mortgage on the store and a mortgage on their home.
The grocery store filed a chapter 11 petition and confirmed a plan that called for surrendering the store and its contents to the lender in return for a $225,000 reduction in the couple’s debt on their personal guarantee. The lender had an unsecured claim for the $100,000 deficiency.
After confirmation, the lender evidently decided that the store was not worth $225,000. The lender apparently believed it would have a larger recovery by asserting a claim against the couple for the entire $325,000.
So, the lender began foreclosure proceedings against the couple’s home. The couple filed their own chapter 11 petition in response.
Overruling the lender’s objection, the bankruptcy court confirmed the couple’s chapter 11 plan and held that their debt to the lender had been reduced to $100,000. The district court affirmed, ruling that the lender could not relitigate the debt that had been reduced to $100,000 in the grocery store’s confirmed chapter 11 plan.
Circuit Judge Gregg Costa affirmed once again in an opinion on November 12.
According to Judge Costa, the grocery store’s plan lifted the automatic stay by allowing the lender to foreclose. He found no provision in the plan conditioning the reduction in the guarantee on the lender’s taking title to the store, either by foreclosure or voluntary transfer.
Judge Costa said that the lender could not “upend the arrangement by ignoring the [store’s] obligation and going after the [couple] for the entire debt.”
Even so, the lender argued in the circuit court that Section 524(e) barred the couple from using the grocery store’s plan to reduce their obligations on the guarantee. The section provides that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”
Citing two earlier decisions by the Fifth Circuit, Judge Costa responded by saying:
But discharge is not the issue here. The [grocery store’s] bankruptcy plan does not discharge the [debt to the lender] or the [the couple’s] obligations under it . . . . [A] partial release of liability for the secured portion of the debt is not a discharge.
To understand the principle, Judge Costa said, “imagine that the bankruptcy court had ordered the [grocery store] to turn over cash instead of real estate.” If the lender had received cash, he said, “No one would view an order requiring the [the grocery store’s] estate to pay [the lender] $250,000 in cash as eliminating a guaranty.”
Judge Costa held that a “bankruptcy plan, then, can limit a creditor’s claim against third-party guarantors — not by discharging the guaranty but by determining the source and value of payments satisfying the guaranteed debt.”
Judge Costa buttressed his conclusion by alluding to the preclusive effect of the grocery store’s chapter 11 plan under Section 1141(a), which says that “the provisions of a confirmed plan bind the debtor . . . and any creditor . . . whether or not . . . such creditor . . . has accepted the plan.”
Judge Costa quoted the Collier treatise, which says Section 1141(a), like res judicata, “precludes parties from raising claims or issues that they could have or should have raised before confirmation.” 8 Collier on Bankruptcy § 1141.02 (16th ed. 2021).
Had there been a post-confirmation default by the grocery store under its plan, Judge Costa said that the default “would not void the credit but would instead give rise to a new and separate claim against the [the grocery store] for noncompliance with the plan.”
Judge Costa upheld the judgment, calling the lender’s theory “a collateral attack on the [grocery store’s] bankruptcy plan’s disposition of the secured debt.”
Although the Fifth Circuit is among the most restrictive courts of appeals when it comes to non-debtor, third-party releases, the New Orleans-based court once again held that a chapter 11 plan can reduce the amount of a non-debtor guarantor’s liability to a creditor.
A couple owned a corporation that operated a grocery store. The couple owned the real estate occupied by the grocery store. The store borrowed $325,000. The couple personally guaranteed the debt and secured the debt with a mortgage on the store and a mortgage on their home.
The grocery store filed a chapter 11 petition and confirmed a plan that called for surrendering the store and its contents to the lender in return for a $225,000 reduction in the couple’s debt on their personal guarantee. The lender had an unsecured claim for the $100,000 deficiency.
After confirmation, the lender evidently decided that the store was not worth $225,000. The lender apparently believed it would have a larger recovery by asserting a claim against the couple for the entire $325,000.
So, the lender began foreclosure proceedings against the couple’s home. The couple filed their own chapter 11 petition in response.