Judge Gargotta Splits with the Fourth Circuit on Nondischargeability in Subchapter V

To justify holding that “corporate debtors electing to proceed under Subchapter V of Chapter 11 are not subject to complaints to determine dischargeability pursuant to § 523(a),” Bankruptcy Judge Craig A. Gargotta of San Antonio issued a 25-page, line-by-line refutation of the recent, contrary holding by the Fourth Circuit in Cantwell-Cleary Co. v. Cleary Packaging LLC (In re Cleary Packaging LLC), 36 F.4th 509 (4th Cir. June 7, 2022).

Resolving what it called a “close” question, the Fourth Circuit held in June that “fairness and equity” required making the debts nondischargeable for a corporation, since a small business debtor in Subchapter V has an easier road to confirmation given the absence of the absolute priority rule. To read ABI’s report on Cleary, click here.

Judge Gargotta’s Facts

Judge Gargotta’s debtor was a corporation in Subchapter V of chapter 11. A secured lender filed a complaint contending that its claims were nondischargeable under Sections 523(a)(2)(A), 523(a)(2)(B), 1141(d) and 1192.

The lender’s complaint alleged that the debtor made a misrepresentation by not disclosing that bankruptcy was imminent. The complaint also asserted that the debtor failed to disclose that the debtor had other, more senior lenders.

The debtor responded with a motion to dismiss for failure to state a claim under Rule 12(b)(6), based on the idea that corporations in Subchapter V of chapter 11 are allowed to discharge debts that would be nondischargeable by individual debtors in Subchapter V. The debtor won dismissal of the complaint in Judge Gargotta’s November 10 opinion.

The Statutory Language

The question before Judge Gargotta came down to this: Is Section 523(a) applicable to corporate debtors in Subchapter V?

Of pertinence to the case at hand, Section 523(a) says, “A discharge under section 727, 1141, 1192, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt” for money obtained by false pretenses or fraud.” [Emphasis added.]

Governing discharge for Subchapter V debtors, Section 1192 states that “the court shall grant the debtor a discharge of all debts provided in section 1141(d)(1)(A).” Subsection (2) of Section 1192 goes on to say that a discharge in Subchapter V does not cover “any debt . . . of the kind specified in section 523(a) of this title.”

Finally, Section 1141(d)(1)(A) says that a “discharge under this chapter [11] does not discharge a debtor who is an individual from any debt excepted from discharge under section 523 of this title.” [Emphasis added.]

Judge Gargotta summarized the interplay among the sections as follows:

[T]he language of § 1192(2) does not intend to except from discharge any debts that § 523(a) does not already except. Because § 523(a) unequivocally applies only to individuals, the language of § 1192(2) does not empower § 523(a) to cast a wider net than the text of § 523(a) permits. Had Congress included a phrase in § 1192(2) explicitly stating that the list found in § 523(a) applies to all debtors proceeding in Subchapter V, then the interpretation would be straightforward. Congress’s choice not to insert this language is instructive.

In drafting Section 1192, Judge Gargotta said that Congress knew how to distinguish dischargeability based on the nature of the debtor but “did not make this distinction in § 1192(2).”

Judge Gargotta said that “interpreting § 523 as excepting from discharge debts of corporate debtors in Subchapter V would be to ignore the import of § 1192 into § 523(a).” He went on to say that “corporate debtors proceeding under Chapter 11 historically have been immune to dischargeability actions under § 523(a).” He added, “For Congress to suddenly depart from this well-established principle when it enacted Subchapter V defies reason.”

Adding “§ 1192 into § 523 demonstrates that Congress intended § 1192(2) to limit the § 523 exceptions in Subchapter V to individuals only,” Judge Gargotta said. “This conclusion is mandated by the canon of statutory construction against surplusage.”

“In sum,” Judge Gargotta said, “the statutory language along with the broader Chapter 11 statutory scheme mandate this Court’s holding that corporate debtors proceeding under Subchapter V cannot be made defendants in § 523 dischargeability actions.”

JRB Distinguished

The lender threw New Venture Partnership v. JRB Consolidated, Inc. (In re JRB Consolidated, Inc.), 188 B.R. 373, 374 (Bankr. W.D. Tex. 1995), into Judge Gargotta’s face.

In JRB, a different bankruptcy judge in the same district had held in 1995 that similar language in Chapter 12 made debts nondischargeable as to corporate debtors, not only individual debtors. JRB had been cited approvingly by the Fourth Circuit in Cleary.

Judge Gargotta said that Chapter 12’s incorporation of Section 523 is “broader.” He also noted that unlike chapter 12 cases, “Subchapter V is not its own chapter of bankruptcy, but rather is a subchapter of Chapter 11.”

Cleary and Other Cases

The case before him was an issue of first impression in the Fifth Circuit, Judge Gargotta said. He cited four bankruptcy courts that confronted the same question, and all held that corporate debtors in Subchapter V cannot be saddled with nondischargeable debts.

However, one of the four cases was reversed by the Fourth Circuit in Cleary. So, Judge Gargotta set about rebutting the six arguments on which the Fourth Circuit primarily relied. He saw Cleary as “frustrat[ing] the entire Chapter 11 statutory scheme.”

Dismissing the lender’s nondischargeability complaint, Judge Gargotta said that he “disagrees” with Cleary “and joins [his] sister bankruptcy courts in holding that corporate Subchapter V debtors should not be subject to § 523 dischargeability actions.”

For debtor’s counsel facing the same issue, Judge Gargotta has written the brief for you.