In Milwaukee……the 7th Circuit holds that an individual debtor’s prior bankruptcy did not discharge liability on a personal guarantee for debts incurred after bankruptcy.
In Reinhart FoodService LLC v. Schlundt, 21-1027 (E.D. Wis. Oct. 27, 2022), a 7th Circuit case, District Judge Brett H. Ludwig of Milwaukee stepped into the middle of a split by holding that an individual debtor’s prior bankruptcy did not discharge liability on a personal guarantee for debts incurred after bankruptcy. Before ascension to Article III status in 2020, Judge Ludwig served three years on the bankruptcy bench.
Issued in favor of a particular supplier, the debtors had personally guaranteed any debt that might be owing by a restaurant they operated. The guaranty was “absolute, continuing and irrevocable.”
In a no-asset case, the debtors filed a chapter 7 petition and received a discharge in 2014. However, the debtors had not scheduled what was a $10,000 liability on the guaranty at the time of the chapter 7 filing. The supplier did become aware of the bankruptcy sometime after filing, according to the bankruptcy judge. The supplier did not file a proof of claim because none was required.
The restaurant incurred a $40,000 debt to the supplier in 2018 that was not paid. The supplier reopened the debtors’ chapter 7 case and filed an adversary proceeding to declare that the $40,000 debt on the guaranty was not discharged. The supplier conceded that the $10,000 debt was discharged.
Both sides moved for summary judgment. The bankruptcy court granted judgment in favor of the debtor, declaring in substance that all future liability on the personal guaranty had been extinguished by the 2014 discharge. Reinhart FoodService LLC v. Schlundt (In re Schlundt), 20-02091, 2021 BL 314402, 2021 Bankr Lexis 2265 (Bankr. E.D. Wis. Aug. 19, 2021). To read ABI’s report, click here.
The bankruptcy judge sided with the Sixth Circuit Bankruptcy Appellate Panel, which had held that a pre-petition guaranty is a contingent claim that is discharged in a later bankruptcy. The bankruptcy court also took counsel from Saint Catherine Hosp. of Ind. LLC v. Ind. Family and Soc. Servs. Admin., 800 F.3d 312 (7th Cir. 2015), where the Seventh Circuit adopted the so-called conduct test to determine whether a claim arose pre-petition or post-petition. In the bankruptcy court’s opinion, relevant conduct was the signing of the guarantee before the 2014 bankruptcy.
The supplier appealed and won in Judge Ludwig’s October 27 opinion.
Judge Ludwig trotted out the relevant statutes. Section 727(b) discharges “all debts that arose before” the order for relief. In turn, a “debt” means a liability on a claim under Section 101(12), and a “claim” under Section 101(5)(A) means a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.”
Judge Ludwig said that the $40,000 debt on the guarantee arose in 2018. Because “[t]here was no debt, claim or right to payment of any kind for this [$40,000] prior to 2018” and “[b]ecause the liability did not arise until four years after the [debtors] filed their bankruptcy petition,” he held that the debt had not been discharged in the 2014 bankruptcy, “consistent with the plain terms of Section 727(b).”
Judge Ludwig characterized the guarantee as a “contractual promise,” which he said was “not the same thing” as a “debt.” He went on to say that “the mere existence of a promise or a contract does not necessarily create a legal liability.” In that respect, he said that bankruptcy discharges debts, “not promises . . . that arose before the bankruptcy petition was filed.”
Citing Section 101(12), Judge Ludwig said that “a debt exists only when there is liability on a claim.” He added, “The mere existence of a promise or contractual provision does not, in and of itself, create legal liability or, accordingly, a debt.”
Judge Ludwig said that the $10,000 debt outstanding at the time of bankruptcy was discharged because it was an “existing liability” as of that time. But he said that “nothing in the Bankruptcy Code provides that the mere filing of a bankruptcy petition automatically terminates all of a debtor’s existing contractual obligations.”
Judge Ludwig rejected the debtor’s contention that obligations on the personal guarantee were “contingent” claims within the meaning of Section 101(5)(A) and were thereby discharged. From his point of view, “this stretches the meaning of a contingent claim almost beyond recognition.”
Ending his opinion, Judge Ludwig explained why Saint Catherine “does not compel the result” sought by the debtors. Laying out the Seventh Circuit case in detail, he said it involved “a unique Medicaid-reimbursement scheme, nothing like a pre-petition personal guarantee.” He said that none of the “general statements” in Saint Catherine about the “conduct test” required holding the debt to have been discharged.
Following the “plain text” of the Code and noting that the claim “depends almost entirely on post-petition conduct,” Judge Ludwig reversed the bankruptcy court with instructions to declare that the post-petition debt was enforceable.
–Rochelle’s Daily Wire, 11-3-22, ABI
