Fourth Circuit rules are no panacea for dishonest debtors

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In 2019, Congress enacted the Small Business Reorganization Act. This legislation created a new type of Chapter 11 reorganization under which certain businesses with total debt below a certain threshold (currently $7.5 million) could reorganize. These provisions, known as Subchapter V, have eliminated certain requirements for the confirmation of a reorganization plan and include other changes to make the reorganization of small businesses faster and less costly.

However, sub-chapter V also modified the provisions relating to the forgiveness of debts. In a traditional corporate reorganization under Chapter 11, a broad discharge is available for virtually all debts. Subchapter V includes a specific provision in § 1192(2) which excludes from discharge debts “of the kind specified in § 523(a)”. Section 523(a) in turn provides that a bankruptcy court discharge “does not release an individual debtor” from certain types of debts, including debts for “willful and malicious injury by the debtor to another entity or property of another entity.”

In In re Cleary PackagingNo. 21-1981, 2022 WL 2032296 (4th Cir. June 7, 2022), the United States Court of Appeals for the Fourth Circuit considered the applicability of Section 1192(2) in the case of a debtor company and concluded that the types of debts specified in § 523(a) cannot be discharged without the consent of the creditor concerned.

Clear packaging involved a creditor who held a judgment of more than $4 million for willful interference with contracts and tortious interference with business relationships. The creditor filed a complaint seeking to have the judgment determined to be a debt for “willful and malicious injury” and therefore not dischargeable. The bankruptcy court dismissed the suit on the grounds that the exceptions to discharge set out in section 523(a) apply only to individual debtors.

On a direct appeal to the Fourth Circuit, the appeals court overturned the bankruptcy court’s decision. Crucial to this decision is the wording of § 1192(2), which refers to debts “of the type specified in section 523(a) of this title.“That meant Congress was referring to types of debts, not type of debtor. The Fourth Circuit also drew on similar language contained in Chapter 12 of the bankruptcy code which is used to reorganize the debts of family farmers and fishers. Several courts have interpreted Chapter 12 as prohibiting the non-consensual discharge of debts of a type specified in Section 523(a). Finally, the Fourth Circuit recognized the difference between Subchapter V and a traditional Chapter 11 reorganization where the overriding priority rule must be followed and found that the application of release limitations to corporate debtors reflected a sense of balance and fairness.

The Fourth Circuit is the first appellate court to rule on this important issue and is likely to be a persuasive authority in courts outside its jurisdiction, at least until other appellate courts rule on it. the question. Debtors facing similar judgments or debts under § 523(a) should consider whether Subchapter V is a viable vehicle for reorganization. Creditors holding such judgments or other debts should be aware of the potential need to file a lawsuit to determine discharge within the time period provided by Rule 4007.

Copyright ©2022 Nelson Mullins Riley & Scarborough LLPNational Law Review, Volume XII, Number 178

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