At least when Delaware law controls, suing an alter ego does not violate the discharge injunction protecting a corporate debtor, according to the Ninth Circuit Bankruptcy Appellate Panel.
The corporate debtor owned a partial interest in aircraft. The corporation filed a petition under Subchapter V of chapter 11. The entity that sold the aircraft to the corporate debtor had a claim for about $2 million.
The corporate debtor confirmed a plan that paid a small fraction of the seller’s claim. Before the corporate debtor received a discharge, the seller filed a lawsuit in federal district court against the individual who was the corporate debtor’s owner. The complaint alleged that the individual was the corporate debtor’s alter ego.
In his opinion for the BAP on June 2, Bankruptcy Judge Robert J. Faris said that the complaint did not name the corporate debtor as a defendant but did allege that the corporate debtor was liable for the underlying debt. The complaint had one cause of action alleging that the individual and the corporate debtor were alter egos.
After the corporation received a discharge, the corporate debtor filed a complaint in bankruptcy court alleging a violation of the discharge injunction under Section 524(a)(2). The debtor believed there was a discharge violation because it characterized the alter ego complaint as contending that the individual and the corporate debtor were one and the same.
Initially, Bankruptcy Judge M. Elaine Hammond of San Jose, Calif., denied the contempt motion, saying there was a “fair ground of doubt” about a discharge violation arising from the suit in district court. On the debtor’s motion for reconsideration, the bankruptcy judge expanded her conclusions by finding no discharge violation because the alter ego allegations did not violate the discharge injunction as to the corporate debtor.
The debtor appealed to the BAP.
Only the Debtor Was Discharged
The outcome turned on Section 524. Subsection (a)(2) says that the discharge “operates as an injunction against the commencement or continuation of an action . . . to collect, recover or offset any such debt as a personal liability of the debtor.” Subsection (e) says 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.”
“By the plain terms of the statute,” Judge Faris said, “the discharge only protects the debtor from personal liability” and “not any other person who is liable with the debtor.”
Parsing the complaint in district court, Judge Faris said that it did not name the debtor as a defendant and sought no relief against the debtor. He said that it “only seeks to hold [the nondebtor individual] liable for [the corporate debtor’s] debt.”
“Neither § 524(a)(1) nor (a)(2) prohibits this,” Judge Faris said. He buttressed his holding by quoting the Ninth Circuit for saying, “This court has repeatedly held, without exception, that § 524(e) precludes bankruptcy courts from discharging the liabilities of non-debtors.” Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F. 3d 1394, 1401 (9th Cir. 1995).
The alter ego claims were controlled by Delaware law. State law was to no avail, because Judge Faris said that Delaware law does not “deem the entities the same but [holds] one liable for the other’s debt.”
Furthermore, Judge Faris said that the discharge “does not extinguish the debt.” Instead, the debtor “continues to owe the full amount of the debt; the discharge injunction precludes collection of that debt from [the debtor], but not from anyone else.”
Similarly, Judge Faris rejected the idea that Section 524(e) only applies to guarantors or co-obligors, not to alter egos.
Finally, the debtor contended that taking discovery from the debtor would violate the discharge. Judge Faris responded:
But the discharge injunction only enjoins personal collection of a discharged debt and does not relieve a discharged debtor from all forms of imposition or inconvenience. We have repeatedly held that a discharged debtor’s obligation to participate in discovery is not an effort to personally collect a debt and does not violate the discharge injunction.
Judge Faris affirmed the bankruptcy court’s order denying the contempt motion.
Question
The Ninth Circuit is one of three circuits that categorically bar nonconsensual, nondebtor third-party releases in chapter 11 plans. Would the result be the same in circuits that permit nondebtor releases?
At least when Delaware law controls, suing an alter ego does not violate the discharge injunction protecting a corporate debtor, according to the Ninth Circuit Bankruptcy Appellate Panel.
The corporate debtor owned a partial interest in aircraft. The corporation filed a petition under Subchapter V of chapter 11. The entity that sold the aircraft to the corporate debtor had a claim for about $2 million.
The corporate debtor confirmed a plan that paid a small fraction of the seller’s claim. Before the corporate debtor received a discharge, the seller filed a lawsuit in federal district court against the individual who was the corporate debtor’s owner. The complaint alleged that the individual was the corporate debtor’s alter ego.
In his opinion for the BAP on June 2, Bankruptcy Judge Robert J. Faris said that the complaint did not name the corporate debtor as a defendant but did allege that the corporate debtor was liable for the underlying debt. The complaint had one cause of action alleging that the individual and the corporate debtor were alter egos.