The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
The Bankruptcy Appellate Panel for the Ninth Circuit (the BAP) published a recent opinion to confirm that the discharge injunction does not protect a debtor’s alter egos. In re RS Air, LLC, 651 B.R. 538 (B.A.P. 9th Cir. 2023).
To view the opinion, click here.
RS Air is a Delaware limited liability company whose primary purpose is to provide transportation services to Stephen Perlman, its founder and sole member. Perlman is the trustee of his trust, the Perlman Trust (the Trust). NetJets Aviation, Inc. and related entities are in the business of selling and leasing fractional interests in private jets. RS Air purchased a 6.25% interest in two aircraft from NetJets. NetJets sued RS Air in Ohio, asserting breaches by RS Air under the agreements, and RS Air counterclaimed. Just before trial in Ohio, RS Air filed a Subchapter V chapter 11 in California.
NetJets filed a $2.133 million proof of claim and unsuccessfully moved to dismiss the subchapter V case. It also filed a motion requesting standing to assert alter ego claims against Perlman and the Trust, which the bankruptcy court denied. The BAP in a prior appeal vacated that denial, noting an error in the bankruptcy court’s interpretation of Delaware law on veil-piercing, but remarked in that ruling that once RS Air’s plan was confirmed, any party could assert the alter ego claims. In the meantime, the bankruptcy court confirmed a chapter 11 plan that would pay NetJets a pro-rata share of a $100,000 contribution from Perlman.
After confirmation but before RS Air’s discharge, NetJets filed a new complaint in Ohio against Perlman and the Trust which did not name RS Air but sought a declaration that the defendants were the alter egos of RS Air and liable to it for about $1.8 million. After discharge, RS Air filed a motion for contempt, asserting that NetJets violated the discharge injunction by seeking to collect the “discharged debt” from alleged alter egos because “the Defendants are all one and the same.” NetJets opposed the motion, arguing that Bankruptcy Code § 524(e) expressly limited the discharge to the debtor only, not other parties such as Perlman and the Trust.
The bankruptcy court denied the motion for contempt. It later specified, when ruling on a motion for clarification, that NetJets did not violate the discharge injunction by seeking to collect the debt from the alleged alter egos. RS Air appealed to the BAP, which affirmed.
The BAP applied de novo review to the unambiguous language of § 524. By its plain terms, § 524 only protects the debtor from “personal liability”, using that term twice is § 524(a)(2). This restriction is emphasized by the equally plain language of § 524(e), which provides the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”
It then reviewed the application of those sections in Ninth Circuit and BAP cases, which support the concept that only actions which seek to recover a debt as a personal liability are barred; where the action is to collect from a collateral source, even naming the debtor nominally is not forbidden. RS Air was not a named defendant in the Ohio action. That it might have to participate in third-party discovery is not a discharge violation. Importantly, the BAP emphasized that “the discharge does not extinguish the debt; instead, it protects only the debtor from personal liability on that debt.” Blixseth v. Credit Suisse, 961 F. ed. 1074, 1082 (9th Cir. 2020).
In response to RS Air’s argument that “the defendants are all one and the same.” the BAP observed that it misunderstood veiling-piercing analysis under Delaware law. Under that law, “although the alter ego doctrine requires a showing that the entities operated as a single economic entity,” the result is not that they are deemed to be the same but rather that one could be held liable for the other’s debt.
After distinguishing the authorities which RS Air relied on to assert its position, the BAP affirmed that the discharge injunction did not protect Perlman and the Trust from liability.
We may have all assumed this outcome to be proper under the Ninth Circuit’s strict reading of § 524(e), but it is reassuring to have BAP authority spelling it out. A significant takeaway from this decision is the reminder that a discharge does not extinguish the debt. It merely prevents collection of that debt as a personal liability of the debtor.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.). Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.