The creditors, an LLC and its wholly owned subsidiary, are involved in the fire protection industry. The debtor was a “direct competitor” with the creditors. The creditors employed several individuals (each, an “employee” and, collectively, the “employees”), who signed non-disclosure, non-compete, and non-solicitation agreements. The creditors alleged that several of the employees, in coordination with the debtor, engaged in a scheme to steal its confidential information, trade secrets, and customers. The debtor and its related entity (collectively, the “debtors”) each filed for subchapter V Chapter 11 bankruptcy, and the court jointly administered the cases. The debtors proposed joint reorganization plans, and the creditors, which asserted a general unsecured claim, opposed the plan. Additionally, the creditors initiated an adversary proceeding to object to the discharge of its general unsecured claim under 11 U.S.C. § 523(a)(6). The debtor filed a motion to dismiss under Fed. R. Civ. P. 12(b)(6), arguing that (1) 11 § 523(a) “only exempts from discharge debts against individual debtors and not corporate debtors in Subchapter V,” (2) the creditors failed to demonstrate that it “acted with a culpable state of mind,” and (3) the claims cannot be dealt with in an adversary proceeding.
In Marmic Fire & Safety Co. v. ETG Fire, LLC (In re ETG Fire, LLC), Adv. Pro. No. 24-1225 TBM, 2025 WL 915381, 2025 Bankr. LEXIS 671 (Bankr. D. Colo. Mar. 20, 2025) (opinion not yet released for publication), the court denied the motion to dismiss. First, the court addressed whether the debt was nondischargeable under section 523(a)(6). The court noted that there is a split on whether section 523(a)(6) applies to subchapter V corporate debtors whose reorganization is nonconsensual. The issue “arises mainly from differing interpretations of the interplay between the text of Section 1192(2) and the preamble of Section 523(a).” “Section 1192(2) makes no distinction between individual and corporate debtors.” However, section 523(a) specifically states that section 1192 “does not discharge an individual debtor” from debts arising from “willful and malicious injury by the debtor to another entity.” Code section 523(a)(6). The court was convinced that the only two Courts of Appeal cases to decide the issue had held that section 1192(2) applied to both individual and corporate debtors. Avion Funding v. GFS Indus., LLC (In re GFS Indus., LLC), 99 F.4th 223, 228 (5th Cir. 2024); Cantwell Cleary Co., Inc. v. Cleary Packaging, LLC (In re Cleary Packaging, LLC), 36 F.4th 509, 517 (4th Cir. 2022) (“In short…§ 1192(2)'s cross-reference to § 523(a) does not refer to any kind of debtor addressed by § 523(a) but rather to a kind of debt listed in § 523(a). By referring to the kind of debt listed in § 523(a), Congress used a shorthand to avoid listing all 21 types of debts…[t]hus, we conclude that the debtors covered by the discharge language of § 1192(2) — i.e., both individual and corporate debtors — remain subject to the 21 kinds of debt listed in § 523(a)”). The debtor argued that the other circuits were mistaken and urged the court to consider a bankruptcy appellate court’s holding that “Section 523(a) unambiguously applies only to individual debtors…[because nothing in § 1192 obviates the express limitation in the preamble of § 523(a)…[and] [i]nterpreting § 1192 to extract from § 523(a) only the list of nondischargeable debts, without its limitation to individuals, would render the amendment surplusage.” Lafferty v. Off-Spec Sols., LLC (In re Off-Spec Sols., LLC), 651 B.R. 862, 867 (9th Cir. BAP 2023). The court disagreed and found the arguments of Cleary Packaging more persuasive. Specifically, that “the more specific provision of the Bankruptcy Code which addresses both individual and corporate debtors, should govern over the more general preamble of Section 523(a).” Further, the court adopted the Fourth and Fifth Circuit opinions completely, stating that the analysis “is so clear and compelling that, as a matter of judicial humility, the Court refrains from restating the same thing again.” Second, the court addressed whether the creditors had sufficiently stated a claim for willful and malicious injury under section 523(a)(6). The debtor argued that the intent of a corporate debtor’s employees should not be imputed to the corporation because section 523(a)(6) “requires conduct and intent ‘by the debtor’ to establish nondischargeability.” However, the court disagreed and found that “a corporate entity’s intent may be determined by imputing to the entity the acts and intentions of the corporate entity’s management and senior employees, acting within the scope of such agents’ employment, in the entity’s interest.” Here, there was evidence that two agents of the debtor had “participated in a scheme” to use confidential information and trade secrets to injure the creditors; thus, the court denied the motion to dismiss. Finally, the court dismissed the debtor’s final argument, stating that although “the debt may be in dispute (and subject to a claims objection),” that alone does not warrant a dismissal of the adversary proceeding. Ultimately, the court denied the debtor’s motion to dismiss in its entirety.
By Hayden Mariott, [email protected]
Edited By Callighan Ard, [email protected]