Rochelle's Daily Wire

Taking sides with the only other court of appeals to decide the question, the Fifth Circuit reversed the bankruptcy court on direct appeal and held that debts of corporate debtors in Subchapter V of chapter 11 can be nondischargeable under Section 523(a) in nonconsensual plans.

Beyond the language of the statutes, the Fifth Circuit saw Subchapter V as an example of congressional compromise. In return for omitting the absolute priority rule from Subchapter V, the New Orleans-based appeals court followed the Fourth Circuit by saying that Congress, as a compromise, made some debts nondischargeable as to corporate debtors.

The Nondischargeability Complaint

The 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, because the debtor made a misrepresentation by not disclosing that bankruptcy was imminent.

In response to the complaint, the debtor filed a motion to dismiss for failure to state a claim under Rule 12(b)(6), contending that corporations in Subchapter V of chapter 11 may discharge debts that would be nondischargeable by individual debtors in Subchapter V.

The Fourth Circuit had already decided the issue in Cantwell-Cleary Co. v. Cleary Packaging LLC (In re Cleary Packaging LLC), 36 F.4th 509 (4th Cir. June 7, 2022), by holding that debts described in Section 523(a) can be nondischargeable as to corporate debtors, not just individual debtors, if the plan is nonconsensual. To read ABI’s report on Cleary, click here.

Line by line, the bankruptcy court refuted Cleary’s reasoning and granted the motion to dismiss. Avion Funding LLC v. GFS Industries LLC (In re GFS Industries LLC), 647 B.R. 337 (Bankr. W.D. Tex. Nov. 10, 2022). To read ABI’s report, click here. The bankruptcy court authorized a direct appeal, which the Fifth Circuit accepted and held oral argument on December 5.

The Statutory Language

On the merits, Circuit Judge Stuart Kyle Duncan began his April 17 opinion by saying that “the dischargeability of its debts is governed by § 1141(d)” if “a debtor’s bankruptcy plan is confirmed as a consensual plan under § 1191(a).” However, he said that the debtor’s “plan was confirmed as a nonconsensual plan under § 1191(b), so the dischargeability of its debts is governed by § 1192.”

Quoting Section 1192, Judge Duncan went on to say that confirmation discharges all debts in Section 1141(d)(1)(A) except, among other things, those “of the kind specified in section 523(a) of this title.”

Judge Duncan identified a “textual conundrum,” given that the preamble to Section 523(a) reads, “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 . . . .” [Emphasis in opinion.] He said that the preamble was “critical” to the bankruptcy court’s conclusion that nondischargeability in Subchapter V applies only to individual debtors.

For Judge Duncan, “placing controlling weight” on the word “‘individual’ in § 523(a) disregards the plain language of § 1192(2).” He noted that Section 1192 deals with the discharge of debts of a “debtor,” and that the word “debtor” in Subchapter V refers to “a person.” In turn, “person” is defined in Section 101(41) to mean both an individual and a corporation.

“[P]utting all this together,” Judge Duncan concluded that “§ 1192 applies to both individual and corporate debtors.”

Next, Judge Duncan focused on the statutory language in “§ 1192[, which] excepts from discharge “any debt . . . of the kind specified in section 523(a).” [Emphasis in original.] He then said, “We must apply this precise language as written.”

For Judge Duncan, “the most natural reading of § 1192(2) is that it subjects both corporate and individual Subchapter V debtors to the categories of debt discharge exceptions listed in § 523(a).” Like the Fourth Circuit “correctly reasoned,” he said that “the reference to ‘kind[s]’ of debt in § 1192 serves as ‘a shorthand to avoid listing all 21 types of debts’ in § 523(a), ‘which would indeed have expanded the one-page section to add several additional pages to the U.S. Code.’” Cleary, supra, 36 F.4th at 515.

In addition, he said that Section 1192(2) is “the more specific provision” that should govern the more general.

Like the Fourth Circuit, Judge Duncan said that nondischargeability “gains greater force when we situate § 1192 in the larger context of the Bankruptcy Code . . . . Even traditional Chapter 11 proceedings distinguish discharges for individual and corporate debtors.” In addition, he said that Section 1192 is “virtually identical” to Section 1228(a), which courts have interpreted as allowing nondischargeability complaints as to corporate farmers.

“[M]ore importantly,” Judge Duncan said, the debtor “misunderstands the compromises Congress made in Subchapter V,” by which he was referring to the omission of the absolute priority rule in Subchapter V cases. “To counterbalance that benefit to debtors,” he said, “Congress excepted from discharge ‘any debt . . . of the kind specified in section 523(a).’”

Believing that accepting the debtor’s arguments would “rewrite that compromise,” Judge Duncan reversed and remanded, holding “that 11 U.S.C. § 1192(2) subjects both corporate and individual Subchapter V debtors to the categories of debt discharge exceptions listed in § 523(a).”

Observation

So far, eight lower courts, including the Ninth Circuit Bankruptcy Appellate Panel, have disagreed with Cleary and the result reached by the Fifth Circuit. To read ABI’s report, click here.