Business Law

Bankruptcy Discharge Applies to Pre-Petition Guarantee Obligations Arising After the Debtor’s Discharge

The following is an update analyzing a recent case of interest.

Applying 7th Circuit precedent, a Bankruptcy Court in the Eastern District of Wisconsin (the “Court”) ruled that obligations of a debtor created by a personal guaranty of an LLC’s debt signed years before the debtor’s chapter 7 petition was filed were discharged despite the fact that the debts which the creditor sought to collect under the guaranty arose after the debtor’s discharge.  Reinhart FoodService, LLC v. Schlundt (In re Schlundt), 2021 WL 3700401 (Bankr. E.D. WI, Aug. 19, 2021).  To view the opinion, click here.

FACTS

From 2003 to 2018, debtor David Schlundt was the owner and sole member of The Refuge, LLC, which operated a restaurant in Antigo, Wisconsin.  The Refuge entered into a supply agreement with Reinhart FoodService, LLC under which Reinhart provide food and restaurant supplies.  In 2003 the debtor signed an Individual Personal Guaranty whereby he personally guaranteed prompt payment of any obligation of The Refuge.  The guaranty was an “absolute, continuing and irrevocable guaranty for such indebtedness of the Company [The Refuge].”

The debtor filed chapter 7 in 2014 but did not schedule any debt to Reinhart in Schedule F.  The case was a no asset case and no claims bar date was set by the court. The debtor received his discharge in April 2014.  Whether and when Reinhart learned of debtor’s bankruptcy was an open question, not resolved by the Court, as notice and knowledge were ultimately not relevant in a no asset case where no claims bar date was set.  Meanwhile, The Refuge kept operating and incurring debt with Reinhart, some of which remained unpaid when The Refuge went out of business in 2018.  Under the guaranty, the debtor was liable for this unpaid debt.  In December 2019 Reinhart filed a motion to reopen the debtor’s bankruptcy in order to pursue an adversary in which it asserted that the post petition unpaid debt was owed by the debtor and, under sections 523(a)(3) and 727(b) of the Bankruptcy Code, was not discharged in the prior chapter 7.

In the adversary, Reinhart filed a summary judgment motion, asserting as a matter of law that the accrued debt was not discharged because the debt arose after the case was discharged and closed.  The debtor opposed, arguing that the debt was created by the prepetition guaranty and the liability thereunder was discharged in the chapter 7.  The Court applied the “conduct test” adopted by the 7th Circuit and concluded that the debt was discharged.  In addition, because the case was a no asset case for which no claims bar date had been set, section 523(a)(3) did not apply to extend the debtor’s liability, despite his failure to schedule Reinhart as a creditor.

REASONING

The court recognized that two views had developed in case law on whether liability created by a guaranty executed prepetition survived the discharge if the relevant charges were incurred post discharge.  After surveying the cases on both sides of the issue, the Court determined that the conduct test adopted in the Seventh Circuit compelled its conclusion that the debt was discharged.

The Court disposed quickly of the section 523(a)(3) argument.  That section says no discharge of a debt occurs if the creditor’s claim was not scheduled in time to file a proof of claim in the bankruptcy case.    Seventh Circuit precedent holds that in a no asset case with no claims bar date, the exception to discharge of section 523(a)(3) does not apply because no claims are ever filed.

Under the conduct test, “the date of a claim is determined by the date of the conduct giving rise to the claim.”  This test is meant to cast a broad impact, in keeping with the fresh start policy behind a chapter 7 discharge.  The Court had no problem finding that the execution of the guaranty in 2003 was the conduct which gave rise to the Reinhart claim.  The guaranty itself spoke to future and contingent claims, not accrued at the time of the execution but certain to occur as the relationship between the parties extended into the future, just as happened here.  The document on its face created the claims and the conduct was therefore in 2003.  The Court also remarked that even if it had applied the alternative “relationship” test, it still would have concluded the debt was discharged.  No doubt, the relationship between the debtor and Reinhart had arisen long before the petition date and this same relationship applied to the guaranteed debt.

Not only did the Court deny Reinhart’s summary judgment motion, but it ruled as a matter of law and undisputed facts affirmatively for the debtor, granting judgment in his favor.  The debt was discharged.

AUTHOR’S COMMENTS

As noted by the Court, this issue splits the bankruptcy courts, without binding precedent in most circuits.  Without a circuit split, the tussle will not be resolved soon by the Supreme Court.  Whether a jurisdiction applies the conduct test or the relationship test, how a court rules really seems to come down to the specific facts of each case more than the standard set by precedent.  The standard of appellate review would be abuse of discretion, so as long as the trial court recognizes which approach is favored in a circuit, the ruling will probably be unassailable on appeal.

One practice tip for creditors:  what the creditor did here – reopen the case and ask the court to determine whether this debt was discharged before charging ahead with collection efforts – was indeed wise rather than risk a violation of the discharge injunction.  With the Supreme Court’s Taggart standard in place – that a creditor cannot be in contempt for pursuing a discharged debt if it had an objectively reasonable belief such pursuit was not barred by the discharge inunction – no creditor who asks a court what it can do will ever be found in contempt, even if that lower court’s determination is later found faulty on appeal.

The Commercial Finance Newsletter is written by an ad hoc group of the California Lawyers Association (CLA) Business Law Section.  This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., ret.) a member of the ad hoc group.  The opinions expressed herein are solely those of the author.  The opinions expressed herein are solely those of the author.  Thomson Reuters holds the copyright to these materials and has permitted the Commercial Transactions Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.

This ebulletin was prepared by Walter K. Oetzell, Walter K. Oetzell, APC, wkoetzell@oetzelllaw.com.

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