If a corporate debtor under Subchapter V of chapter 11 confirms a consensual plan under Section 1191(a), there is no such thing as a nondischargeable debt under Section 523(a), for statutory reasons explained by Bankruptcy Judge Robert M. Matson of Albany, Ga.

In adopting the Bankruptcy Reform Act in 1978, Congress did away with nondischargeable debts for “ordinary” corporations in chapter 11. Why? Because a creditor with a nondischargeable debt in “old” Chapter XI under the former Bankruptcy Act could kill a plan, to the disadvantage of the larger creditor body that would benefit from reorganization.

Taking Judge Matson’s January 31 opinion as gospel, a creditor with a nondischargeable debt can kill a Subchapter V plan only if the creditor controls a class that votes against the plan, thereby forcing the debtor to confirm a nonconsensual, cramdown plan under Section 1191(b).

The Consensual Plan

The debtor leased its employees. The lessor paid the employees’ wages and could draw funds from the debtor’s bank account to cover payroll. Eventually, the lessor’s attempt to draw funds from the debtor’s bank account failed. 

According to the lessor, the debtor made intentionally false representations about the existence of funds in the account to cover the withdrawals. The representations proved false, because the lessor was stuck with $100,000 in bad debt. After the lessor filed suit in state court, the debtor filed a petition under Subchapter V.

However, the debtor did not schedule the lessor as a creditor. Unaware of the bankruptcy, the lessor obtained a default judgment in state court.

The lessor became aware of the bankruptcy when the debtor filed a suggestion of bankruptcy in state court. Because the lessor was unaware of the bankruptcy, the lessor had not filed a proof of claim before the bar date.

The lessor filed a complaint to except the debt from discharge under several subsections in Section 523(a). The debtor objected to confirmation of the debtor’s plan, but the objection was resolved in a stipulation with the debtor.

The debtor confirmed a consensual plan under Section 1191(a), evidently because the class including the lessor had voted in favor of the plan. Just after confirmation, the debtor filed a motion to dismiss the nondischargeability complaint.

Although courts are not in agreement, most courts have decided recently that a corporate debtor in Subchapter V can be saddled with a nondischargeable debt. Those cases, though, involved cramdown plans. To read some of the ABI reports on nondischargeability in Subchapter V, click here and here.

When Section 1141(d) Does and Does Not Apply

Addressing the merits of the motion to dismiss, Judge Matson didn’t leave the reader in suspense. He stated this holding: “[T]he discharge provisions of § 1192 (and thus the discharge exceptions on which [the lessor] relies) do not apply to a debtor whose plan was confirmed [as a consensual plan] under § 1191(a).”

Judge Matson then rummaged through several statutory provisions to explain how he arrived at his conclusion. He began by saying that a Subchapter V plan can be confirmed in two ways: (1) If the plan is consensual, it’s confirmed under Section 1191(a); and (2) if it’s nonconsensual or cramdown, it’s confirmed under Section 1191(b).

Generally speaking, the breadth of discharge is controlled by Section 1141(d). Broadly, it says that confirmation “discharges the debtor from any debt that arose before such confirmation.” The words “any debt,” Judge Matson said, mean that “confirmation of a Chapter 11 plan generally results in discharge of debts of the sort identified in § 523(a).”

However, there are exceptions in Section 1141(d). For example, Section 523(a) nondischargeability applies to individuals in chapter 11, and corporations that liquidate don’t receive a discharge. In addition, some types of debts owed to a governmental unit are not discharged. See Section 1141(d)(2), (3) and (6).

“[M]ost relevant to this case,” Judge Matson said, “§ 1141(d) does not apply when the debtor confirms a plan under § 1191(b), but rather § 1192 does.” He drew his conclusion from Section 1181(c), which says, “If a plan is confirmed under section 1191(b) of this title, section 1141(d) of this title shall not apply, except as provided in section 1192 of this title.”

Judge Matson translated the statutes into intelligible English as follows:

[T]he discharge provisions of § 1141(d) apply when the debtor confirms [a] consensual plan under § 1191(a) but do not apply when the debtor confirms a nonconsensual plan under § 1191(b). In those cases, § 1192 governs the debtor’s discharge instead of § 1141(d).

As authority for his conclusion, Judge Matson cited the Fifth Circuit and a decision by Bankruptcy Judge Joseph G. Rosania, Jr., of Denver. See In re GFS Indus., LLC, 99 F.4th 223, 227 (5th Cir. 2024); and In re Palmer Drives Controls & Sys., Inc., 657 B.R. 650, 654 (Bankr. D. Colo. 2024).

For failure “to state a claim upon which relief may be granted,” Judge Matson granted the debtor’s motion to dismiss the lessor’s dischargeability complaint, “[b]ecause § 1192, and by extension the exceptions to discharge, do not apply to the Debtor.”

Observations

Judge Matson’s decision inferentially explains why it makes sense to have nondischargeability in some Subchapter V cases.

Compared to “regular” chapter 11, corporate debtors in Subchapter V are relatively small. A corporate debtor cannot file in Subchapter V to discharge a nondischargeable debt if that’s the primary reason for chapter 11. In those circumstances, a creditor with a comparatively large nondischargeable debt likely would control a class, requiring confirmation of a cramdown plan where nondischargeability is a “thing.”

On the other hand, if the nondischargeable debt is small and does not control the class, the creditor with a nondischargeable debt should not be able to kill a chapter 11 case to the disadvantage of other creditors who are in favor of confirmation.