Are Subchapter V Corporate Debtors Subject To The '523(a) Exceptions To Discharge?

• Published date: 19 June 2023
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Thompson Coburn LLP
• Author: Ms Katharine Clark, Joseph Orbach and Aleksandra Abramova

Background

Congress passed The Small Business Reorganization Act of 2019 (the "SBRA") for small businesses, currently defined as debtors with less than $7.5 million in debt. SBRA created a new Subchapter V, which can be used by both individual debtors or business entities, such as corporations, limited liability companies or partnerships (hereinafter "Business Entities"). While Congress intended to streamline and facilitate small business reorganizations, two recent cases discuss a little-noticed provision of Subchapter V that limits the ability of Business Entities to discharge certain kinds of debts in a Subchapter V plan.

SBRA added section 1192 of the Bankruptcy Code, which discusses a Subchapter V debtor's rights to discharge debts in a Subchapter V plan. This section says that a debtor may discharge debts that arose before confirmation of the plan except debts "of the kind specified in section 523(a) of [the Bankruptcy Code]." Section 523(a), of course, contains nineteen separate subsections describing debts that cannot normally be discharged ranging from debts arising out of domestic support obligations to debts incurred by violating federal election laws. While the majority of the debts described in Section 523(a) are unlikely to arise in a small business case, some of the other kinds of debts described in Section 523(a) occasionally do arise in small business cases: such as the debts obtained by fraud or a material misstatement in a financial statement.

Section 1192's discharge language differs from language in Section 1141(d), which governs discharges in regular Chapter 11 cases (i.e. Chapter 11 cases not filed under Subchapter V). Section 1142(d)(2) says individual debtors cannot receive a discharge of debts described in Section 523(a), but is silent on whether Business Entities can receive a discharge of the debts described in Section 523(a), leading the courts to conclude that a Business Entity may discharge otherwise non-dischargeable debts in its Chapter 11 plan. But Section 1192's language excepts debts of the kind specified in Section 523(a) from discharge without regard to whether the Subchapter V debtor is an individual or a Business Entity.

Recent cases have grappled with this apparent disconnect between Subchapter V's enhanced reorganization policy and Section 1192's discharge language, which is more restrictive than outside of Subchapter V. A detailed discussion of two such cases follows:

Fourth Circuit

In the case of Cantwell-Cleary...