Are the Nondischargeability Provisions of Section 523(a) of the Bankruptcy Code Applicable to Corporate Debtors Under Subchapter V of the Small Business Reorganization Act?
The Small Business Reorganization Act of 2019 (the “Act”) was passed by Congress and signed into law in August of 2019. Subchapter V, codified in Sections 1181-1195 of the Bankruptcy Code, was adopted by the Act, and became effective on February 19, 2020.
Subchapter V was designed to stream line the chapter 11 plan confirmation process for small business debtors. It made significant changes to chapter 11 reorganization for small businesses, including, most significantly, the elimination of the absolute priority rule, now allowing equity owners to retain their equity interests even though creditors are paid less than the full amount of their claims.
Questions emerged, including, particular to this blog, whether the dischargeability exceptions enumerated in Section 523(a) of the Bankruptcy Code apply to corporate debtors proceeding under Subchapter V.
The Act added Section 1192 of the Bankruptcy Code, which provides, in relevant part, that in the case of a nonconsensual plan, the bankruptcy court shall grant the debtor a discharge of all debts … except any debt “of the kind specified in section 523(a) of [title 11]” (emphasis added). Notably, Section 1192 does not differentiate between an individual and corporate debtor.
As of this writing, three reported bankruptcy level decisions exist interpreting the discharge provision under Section 1192(2) of the Bankruptcy Code. Two of the three reported decisions were issued by the United States Bankruptcy Court for the District of Maryland, which held, in both cases, that the discharge exceptions enumerated in Section 523(a) of the Bankruptcy Code do not apply to a corporate debtor proceeding under Subchapter V.
In reaching its conclusion, the Bankruptcy Court relied on the introductory paragraph to Section 523, which provides, in relevant part, that a discharge under section 727, 1141, 1192, 1228(a), 1228(b) or 1328(b) of Title 11 does not discharge an individual debtor from any debt enumerated in Section 523(a). 11 U.S.C. §523 (emphasis added). Relying on principles of statutory construction, the Bankruptcy Court held that the language in the introductory paragraph of Section 523 limits the application of Section 523 to individual debtors. As such, the Bankruptcy Court dismissed creditor Cantwell-Cleary Co., Inc.’s complaint against Cleary Packaging, LLC (the debtor), which sought a determination that its pre-petition judgment against Cleary Packaging be declared non-dischargeable pursuant to Section 523(a)(2) and/or (a)(6) of the Bankruptcy Code.
Cantwell-Cleary noted a direct appeal to the United States Court of Appeals for the Fourth Circuit. Several parties filed amicus briefs in support of Cantwell-Cleary’s position, including the Department of Justice, Tax Division, the Public Justice Center and others. Oral argument is scheduled to be conducted in the Fourth Circuit Court of Appeals on March 10, 2022.
In its appeal, Cantwell-Cleary argued, among other things, that the plain language of Section 1192 excepts from discharge debts of the kind specified in Section 523(a), irrespective of whether that debtor is an individual or corporation. Relying on decision law in the Chapter 12 context, which served in part as the framework for Subchapter V, Cantwell-Cleary argued, among other things, that Section 523(a) does not define the breadth of a discharge; the breadth of the discharge is defined by Section 1192 of the Bankruptcy Code, which does not distinguish between individual and corporate debtors.
The outcome of the appeal will provide necessary clarity as to whether a corporate debtor proceeds under Subchapter V or under traditional chapter 11 and, in a case where a debtor proceeds under Subchapter V, the rights of creditors to object to the dischargeability of a corporate debtor’s debts under Subchapter V. Reversal of the Bankruptcy Court’s decision will, in this author’s view, preserve the fundamental principal that a discharge be reserved for the honest but unfortunate debtor, irrespective of whether the debtor is an individual or a corporation. This issue is especially important under Subchapter V, where the absolute priority rule has been abrogated, permitting equity interest holders to retain their equity interests despite creditors receiving, as is often the case, a small fraction of what they are owed.
There are no circuit level decisions answering this question. Accordingly, the decision of the Court of Appeals will provide important guidance.
 See Gaske v. Satellite Restaurants Inc. Crabcake Factory USA (In re Satellite Restaurants Inc. Crabcake Factory USA), 626 B.R. 871 (Bankr. D. Md. 2021) (vacated after underlying bankruptcy case was dismissed during appeal) and Cantwell-Cleary Co., Inc. v. Cleary Packaging, LLC (In re Cleary Packaging, LLC), 630 B.R. 466 (Bankr. D. Md. 2021), on appeal to the United States Court of Appeals for the Fourth Circuit, Case No. 21-1981. The United States Bankruptcy Court for the District of Idaho, relying on the Satellite Restaurants and Cleary Packaging decisions, found that the discharge exceptions to Section 523(a) do not apply to corporate debtors proceeding under Subchapter V. See In re Catt v. Rtech Fabrications, LLC et al. (In re Rtech Fabrications, LLC), No. 21-07002, 2021 WL 4204800 (Bankr. D. Idaho Sep, 15, 2021). 
In re Cleary Packaging, LLC, Case No. 21-10765 / Adv. No. 21-00056). See also Cantwell-Cleary Co., Inc. v. Cleary Packaging, LLC, 630 B.R. 466 (Bankr. D. Md. 2021). 
Notably, courts have found that the discharge exceptions in Section 523(a) apply to corporations under Chapter 12, where the absolute priority rule has similarly been abrogated. Southwest Georgia Farm Credit, ACA v. Breezy Ridge Farms, Inc. (In re Breezy Ridge Farms, Inc.), No. 09-1011, 2009 WL 1514671 at *3 (Bankr. M.D. Ga. May 29, 2009). Though Subchapter V and Chapter 12 are not identical, Subchapter V starts with chapter 11 as its base and draws on, among other things, the structures of chapter 12. See In re Trepetin, 617 B.R. 841, 848 (Bankr. D. Md. 2020).
Disclaimer: The opinions raised in this blog are solely those of the author. The information contained in this blog is general in nature and is not offered, and cannot be considered as legal advice for any particular situation.