Does Subchapter V Allow Corporations to Discharge Debts Based on Fraud?
The Small Business Reorganization Act of 2019 created Subchapter V, designed to allow small companies to reorganize without Chapter 11’s usual expenses, delays and complex procedures. Subchapter V applies to both individual and corporate debtors, but not always equally to both. Federal courts are in conflict over the ability of corporations to discharge certain types of debts in Subchapter V.
Section 523(a) of the Bankruptcy Code provides that an individual debtor cannot discharge — among other specified debts — a debt for money, property, services or other benefits obtained by false pretenses, fraud or other materially false statements made with intent to deceive. However, there is no comparable code provision relating to corporations, which means that under Chapter 11, a corporation can discharge debts even if based on fraud or misrepresentation.
But suppose a corporation, instead of using Chapter 11, opts to file under Subchapter V, which is available if their debt ceiling is below $7.5 million? Subchapter V includes Section 1192(2), which creates an exception to discharge for “any debt … of the kind specified in section 523(a).” The Fourth Circuit Court of Appeals, in Cantwell-Cleary Co., Inc., v. Cleary Packaging, has held that Congress, in placing this provision in section 1192(2), was only using it as shorthand, rather than having to itemize all the types of debts listed in section 523(a). As such, the court concluded that the provision applies to both corporate and individual debtors, even though section 1192(2) does not specifically address the type of debtor involved.
Yet, at least six bankruptcy courts — in Florida, Idaho, Maryland, Michigan and Texas — have held the opposite way. The Florida court observed that Congress, in enacting Subchapter V, amended section 523(a) to make its exceptions apply to section 1192(2) discharges. Since section 523(a) specifically references “individual debtor,” while section 1192(2) does not reference individuals or corporations, the language in section 523(a) controls, the Florida court held. The Texas bankruptcy court noted that since Subchapter V is a subsection of Chapter 11, it cannot “cast a wider net” than the main chapter.
Until there is a consensus among federal courts, the question of corporate eligibility for discharge of fraud-related debt is likely to be decided regionally. Courts in the Fourth Circuit, which includes Maryland, Virginia, West Virginia, North Carolina and South Carolina, are likely to follow the Cantwell-Cleary case, while those in the other districts will follow their precedents. There has not been a case on the issue decided in California.
While the law evolves, Subchapter V remains a powerful remedy for smaller companies to gain control of their debt and to reemerge as viable entities. An attorney skilled in business debt reorganizations can analyze your situation and advise you on the best path to take.
The Law Offices of Michael Jay Berger in Beverly Hills firm helps businesses like yours dealing with the weight of excessive debt. Call today 310-271-6223 or contact me online to schedule a free initial consultation.
