The United States Bankruptcy Court for the District of Maryland became the first court to grapple with the issue of whether corporate debtors in Subchapter V of Chapter 11 (“Subchapter 5”) may discharge debts that would not be discharged under Section 523(a) in Gaske v. Satellite Rests. Inc., Case No. 21-00012. Judge Maria Ellena Chavez-Ruark applied the plain language of Section 523(a) and Section 1192 of the Bankruptcy Code in holding that the non-dischargeability provisions of 523(a) apply only to individual debtors in Subchapter V cases.
Subchapter V, codified in Sections 1181-1195 of the Bankruptcy Code, was adopted by the Small Business Reorganization Act of 2019, and became effective in February 2020. It was enacted to provide a more efficient, streamlined and cost-effective reorganization procedure for small businesses. It was further expanded under the CARES Act to permit debtors with up to $7.5M in debt to elect to file their case under Subchapter V. Since the statute’s enactment, Courts across the country have been administering more and more Subchapter V cases as debtors look to bankruptcy as a result of the Covid-19 pandemic.
Section 523(a) provides that a discharge obtained under the various Bankruptcy Code discharge sections including Section 1192 “does not discharge an individual debtor from any debt” that falls under the enumerated categories, including a debt that is based upon money or credit obtained by “actual fraud” or a debt “for willful and malicious injury by the debtor to another entity or to the property of another entity.” 11 USC 523(a)(2)(a) and (a)(6).
In Gaske, several former employees filed a lawsuit asserting claims under the Fair Labor Standards Act. The suit was stayed when the restaurant corporation (the “Debtor”) filed a petition under Subchapter V. The employees subsequently filed a complaint seeking a determination that the debts owed to them were non-dischargeable as actual fraud and/or a debt for a willful or malicious injury as detailed in Section 523. The employees argued that the debts arose from the Debtor’s false pretenses or actual fraud which resulted in willful and malicious injury. The employees argued for the expansion of Section 1192 in application of Section 523(a) to non-individual debtors like the corporate Debtor.
The Debtor proposed its Subchapter V plan under Section 1192, which invoked the specific cramdown provisions of Section 1191(b). Section 1192 provides:
“If the plan of the debtor is confirmed under section 1191(b) of this title [the cramdown provision], as soon as practicable after completion by the debtor of all [plan] payments …, the court shall grant the debtor a discharge of all debts provided for in section 1141(d)(1)(A) of this title, and all other debts allowed under section 503 of this title and provided for in the plan, except any debt … of the kind specified in section 523(a) of this title.
The Debtor filed a motion to dismiss claiming that the section 523 exceptions to discharge apply only to an individual debtor in Subchapter V under the plain language of the statute and arguing that corporate debtors in Subchapter V receive the same broad discharge as larger corporate debtors in traditional Chapter 11 cases.
The Bankruptcy Court analyzed sections 1192 and 523 and reiterated that section 1192 does not discharge an individual debtor from any debt. In fact, the statute makes no reference to non-individuals. The Court then looked to other jurisdictions that have held that Section 523 does not apply to corporate debtors, albeit prior to the enactment of Subchapter V. In re MF Glob. Holdings, Ltd., No. 11-15059(MG), 2012 Bankr. LEXIS 897, 2012 WL 734175, at *3 (Bankr. S.D.N.Y. Mar. 6, 2012); Williams v. Sears Holding Co., No. 06-PWG-455-M, 2008 WL 11424255, at *4 (N.D. Ala. Mar. 28, 2008); Garrie v. James L. Gray, Inc., 912 F.2d 808, 812 (5th Cir. 1990).
Judge Ruark granted the Debtor’s motion to dismiss, holding that “the plain language of Section 523(a) is unequivocal and confirms that the exceptions to a debtor’s discharge, including a discharge under Section 1192, apply only to an individual.” Furthermore, Judge Ruark found the Debtor’s reliance on treatises such as Collier and Norton to be unpersuasive despite their conclusions that Section 523(a) does apply to non-individual debtors proceeding under subchapter V and seeking discharge under Section 1192 because these treatises failed to examine the plain language of Section 523(a).
The Court also examined the congressional intent of Subchapter V and noted that the statute’s purpose was to streamline the bankruptcy process. Nothing in the legislative history or commentary of Section 1192 supported the conclusion that Congress intended to expand the application of Section 523(a) to non-individual debtors. In addition, such a holding would not serve to improve efficiency, which was the primary intent behind the enactment of Subchapter V.
This latest ruling concerning the application and administration of a Subchapter V case under Chapter 11 is an important reminder that courts are examining novel issues in harmonizing various sections of the Bankruptcy Code with Subchapter V. Parties considering bankruptcy, and eligible for Subchapter V, should carefully examine statutory language and the intent behind the most recent code provisions to anticipate legal disputes that are likely to arise.