Ninth Circuit BAP Holds that Debts of Corporate Sub V Debtors Can’t Be Nondischargeable

All six bankruptcy courts to confront the question have held that debts of corporate debtors in Subchapter V of chapter 11 cannot be nondischargeable under Section 523(a) in nonconsensual plans.

The Ninth Circuit Bankruptcy Appellate Panel has joined the horde by affirming Bankruptcy Judge Noah G. Hillen of Boise, Idaho, in holding that debts can be nondischargeable in Subchapter V only when the debtor is an individual.

The bankruptcy judges and the BAP are aligned against the Fourth Circuit, which held that corporate debtors in Subchapter V may not discharge debts “of the kind” specified in Section 523(a). Cantwell-Cleary Co. v. Cleary Packaging LLC (In re Cleary Packaging LLC), 36 F.4th 509 (4th Cir. June 7, 2022). To read ABI’s report, click here.

Bankruptcy Judge Craig A. Gargotta of San Antonio disagreed with Cleary and held that “corporate debtors proceeding under Subchapter V cannot be made defendants in § 523 dischargeability actions.” Avion Funding LLC v. GFS Industries LLC (In re GFS Industries LLC), 647 B.R. 337, 344 (Bankr. W.D. Tex. Nov. 10, 2022). To read ABI’s report on GFS, click here. The Fifth Circuit accepted a direct appeal in GFS in April. Briefing should be completed before September.

The Facts in the BAP

The July 6 BAP opinion by Bankruptcy Judge Scott H. Gan reads like an amicus brief submitted in the Fifth Circuit in support of the debtor. Judge Gan refutes the Fourth Circuit’s arguments, line by line, and concludes that dischargeability should be the same whether a corporate debtor is in “regular” chapter 11 or in Subchapter V.

The facts in the BAP case pull on the heartstrings in favor of nondischargeability, but the BAP resisted the urge to make bad law in a hard case.

The debtor allegedly suffered sexual harassment and discrimination at the hands of her corporate employer. She filed a complaint with the state employment commission and was awarded the right to sue after her former employer filed a chapter 11 petition and elected to proceed under Subchapter V.

The employee filed a claim accompanied by an adversary proceeding to declare the debt nondischargeable under Section 523(a)(6) as a willful and malicious injury. Judge Hillen dismissed the complaint for failure to state a claim.

Judge Hillen relied on his own previous decision in Catt v. Rtech Fabrications, LLC (In re Rtech Fabrications, LLC), 635 B.R. 559 (Bankr. D. Idaho 2021), and on Judge Gargotta’s GFS opinion. He was not persuaded by Cleary, nor was Judge Gan when the creditor appealed to the BAP.

The statutes are less than clear. 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 Gan said that Sections 523(a) and 1192 are “[f]acially” in “conflict.” The “better interpretation,” he said, “is that § 1192 reiterates § 523(a)’s application to debtors under subchapter V, and § 523(a) limits its applicability to individuals.” Among other things, he said that “nothing in § 1192 obviates the express limitation in the preamble of § 523(a) or otherwise expands its scope to corporate debtors.”

Noting that Congress amended Section 523(a) to add Section 1192 to the list of provisions to which it applies, Judge Gan said that accepting the Fourth Circuit’s reasoning would render the amendment surplusage.

Judge Gan differed with the Fourth Circuit’s idea that Section 1192, the more specific section, should control. He said that the canon of interpretation only governs when the statutes are irreconcilable, which they were not, in his view. And if they were irreconcilable, he saw Section 523(a) as being more specific, given that it applies in chapter 11 cases.

From a broader perspective, Judge Gan said that Subchapter V is part of chapter 11, “and its discharge provisions should be interpreted consistent with the overall statutory scheme in chapter 11.” He noted that Congress had narrowed the corporate discharge only once, in the amendment adding Section 1141(d), and only after eight years of deliberation.

Judge Gan said it was “improbable” that Congress would have enacted such a major change in dischargeability in a bill that was introduced and adopted within one month in 2019.

Judge Gan differed with the Fourth Circuit’s reliance on notions of fairness and equity to justify making debts nondischargeable in Subchapter V. Although the fairness idea was “plausible,” he said it did not “comport with the purpose of facilitating reorganization of small businesses.” Moreover, he said that making debts nondischargeable “is more likely to harm most general unsecured creditors by steering small businesses with nondischargeable debts toward liquidation.”

In sum, Judge Gan saw the policy considerations in Cleary as “unavailing.” He held “that § 1192 does not make debts specified in § 523(a) applicable to corporate debtors in subchapter V.”