Debts that are nondischargeable as to individuals under Section 523(a) cannot be discharged by corporate debtors in Subchapter V of chapter 11, according to the Fourth Circuit.
Resolving what it called a “close” question, the Fourth Circuit believes that “fairness and equity” require making the debts nondischargeable since a small business debtor in Subchapter V has an easier road to confirmation given the absence of the absolute priority rule.
Corporations saddled with debts that would be nondischargeable under Section 523(a) must undergo the rigors of an “ordinary” chapter 11 case to discharge those debts, if the Fourth Circuit’s opinion is accepted nationwide.
The Judgment for Willful and Malicious Injury
A creditor won a $4.7 million judgment in state court for tortious interference with contract. More specifically, the jury found that the debtor had stolen customer information from the creditor.
The debtor filed a small business petition under Subchapter V of chapter 11, intending to discharge the judgment under Section 1192. The plan would have paid the creditor about 3% of its claim over five years.
Asserting that the judgment was not dischargeable under Section 523(a)(6) as a “willful and malicious” injury to its property, the creditor filed a complaint seeking a declaration that the judgment would not be discharged under Section 1192(2).
Deciding that the debt was dischargeable, the bankruptcy court dismissed the complaint in what Circuit Judge Paul V. Niemeyer called a “nicely crafted opinion.” The bankruptcy court authorized a direct appeal, which the Fourth Circuit accepted.
The ‘Discordant’ Statutes
The appeal called for an interpretation of two statutes which Judge Niemeyer called “a bit discordant — or perhaps more accurately, clumsy.”
Applicable only in Subchapter V cases, Section 1192 discharges debts, “except any debt . . . (2) of the kind specified in section 523(a) of this title.”
Section 523(a) provides that a “discharge under section . . . 1192 . . . does not discharge an individual debtor from any debt . . . (6) for willful and malicious injury by the debtor to another entity or to the property of another entity.”
In his June 7 opinion, Judge Niemeyer relied on a “textual review” along with “practical and equitable considerations” in holding that the debt was nondischargeable in Subchapter V despite “a certain lack of clarity in the relationship between § 1192(2) and § 523(a).”
Textual Analysis and Policy
Before focusing on dischargeability, Judge Niemeyer said that one of the “main features” of Subchapter V is the elimination of the absolute priority rule that otherwise governs confirmation of chapter 11 plans. It enables “the owners of a Subchapter V debtor . . . to retain their equity in the bankruptcy estate despite creditors’ objections,” he said.
Turning to dischargeability and focusing on Section 1192(2) alone, Judge Niemeyer said it “provides for the discharge of debts for both individual and corporate debtors.” [Emphasis in original.]
“Still,” Judge Niemeyer said, the question remains “whether the exception to such discharges — based on § 1192(2)’s reference to § 523(a) — applies to both individuals and corporations or to only individuals.”
To answer the question, Judge Niemeyer focused on Section 1192(2) because it “specifically” governs dischargeability in Subchapter V. He paraphrased the section by saying it excepts from discharge “‘any debt . . . of the kind specified in section 523(a).’” [Emphasis in original]. To his way of thinking, the use of the word “debt” was “decisive, as it does not lend itself to encompass the ‘kind’ of debtors discussed in the language of § 523(a).” [Emphasis in original.]
Judge Niemeyer concluded that “the combination of the terms ‘debt’ and ‘of the kind’ indicates that Congress intended to reference only the list of nondischargeable debts found in § 523(a).” [Emphasis in original.] He said that use of the words “of the kind” was statutory “shorthand to avoid listing all 21 types of debts.”
Judge Niemeyer held that “the debtors covered by the discharge language of § 1192(2) — i.e., both individual and corporate debtors — remain subject to the 21 kinds of debt listed in § 523(a).” [Emphasis in original.] He was persuaded in part by the idea that the specific governs the general.
Having construed the statutory language alone, Judge Niemeyer looked at similar provisions in the Code. He said it would be difficult to reconcile Section 523(a) with Section 1141(d)(6).
Judge Niemeyer also referred to Section 1228(a) of chapter 12 and its language “that is virtually identical” to Section 1192(2). Section 1228(a), he said, has been interpreted by two bankruptcy courts to mean that exceptions to discharge apply to both individual and corporate debtors.
Judge Niemeyer ended his opinion by discussing “fairness and equity” and the ability of a chapter 12 debtor to confirm a cramdown plan without satisfying the absolute priority rule. He said that “Congress understandably applied limitations on the discharge of debts to provide an additional layer of fairness and equity to creditors to balance against the altered order of priority that favors the debtor.”
Reversing and remanding, Judge Niemeyer said that a small business debtor “should not especially benefit from the discharge of debts incurred in circumstances of fraud, willful and malicious injury, and the other violations of public policy reflected in § 523(a)’s list of exceptions” when that debtor is immune from the absolute priority rule.
Questions
Congress decided to make virtually all debts dischargeable in chapter 11 because a finding of nondischargeability would injure the greater body of creditors. Similarly, Congress created Subchapter V because the rigors and expense of traditional chapter 11 was hurting creditors as well as the owners of small businesses.
Given the history and tradition of broad dischargeability in chapter 11, is the language in Section 1192 sufficiently clear to swim against the tide? Is the plain meaning of Section 523(a) overcome by the less than clear meaning of Section 1192(2)?
Debts that are nondischargeable as to individuals under Section 523(a) cannot be discharged by corporate debtors in Subchapter V of chapter 11, according to the Fourth Circuit.
Resolving what it called a “close” question, the Fourth Circuit believes that “fairness and equity” require making the debts nondischargeable since a small business debtor in Subchapter V has an easier road to confirmation given the absence of the absolute priority rule.
Corporations saddled with debts that would be nondischargeable under Section 523(a) must undergo the rigors of an “ordinary” chapter 11 case to discharge those debts, if the Fourth Circuit’s opinion is accepted nationwide.