Debtor Liability After Discharge Under Pre-Bankruptcy Guaranty? (Reinhart v. Schlundt)

Surprise? (Photo by Marilyn Swanson)

By: Donald L Swanson

Every now and then we get a bankruptcy opinion declaring a rule with broad application that, (i) may make sense is specific situations, but (ii) is a terrible result for others.

Here’s an Exhibit A opinion for such a proposition: Reinhart Foodservice LLC v. Schlundt, Case No. 21-cv-1027 in the U.S. District Court for Eastern Wisconsin, (Doc. 12, issued October 27, 2022).

The Facts

The Schlundt opinion cites these crucial facts:

  • In 2003, Debtor signs a continuing guaranty;
  • In 2014, Debtor receives a Chapter 7 bankruptcy discharge; and
  • In 2018, the guaranteed party creates a new debt that is covered by the language of Debtor’s 2003 guaranty.

The Question

The Schlundt opinion addresses this question:

  • Is Debtor liable under the 2003 guaranty for the 2018 debt, notwithstanding Debtor’s 2014 bankruptcy discharge.

The Practicalities

Before getting to the Court’s answer, let’s consider the practicality of the situation for other Chapter 7 debtors. Imagine these facts:

  • Debtor goes through the ordeal of a bankruptcy proceeding, receives a Chapter 7 discharge, and is getting on with life under the fresh start that bankruptcy provides; but
  • Years later, out of the blue and without debtor’s involvement or knowledge, a third person incurs a debt that, lo and behold, is covered by the language of a long-forgotten guaranty that Debtor signed before filing bankruptcy and scheduled in the bankruptcy; and
  • Surprise! Surprise! . . . Debtor’s bankruptcy fresh start is now destroyed by the actions of a third person—there is nothing good or fair or proper about such a result!

Now, back to the Schlundt opinion. 

The Ruling

The District Court finds that Debtor is liable for the $36,839.62 post-petition debt covered by a pre-petition guaranty, notwithstanding the intervening bankruptcy discharge. That’s because, the District Court declares, the debt is a post-bankruptcy debt, based on “the plain terms of Section 727(b).” 

The Analysis

Here is the District Court’s analysis:

  • Legal Standards.  Under § 727(b), the bankruptcy discharges “all debts that arose before the date of the order for relief under this chapter”;
    • “Debt” means “liability on a claim” (§101(12)), and “Claim” 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” (§101(5)(A)); and
    • Accordingly, the 2014 bankruptcy discharge extinguished only those debts, that “arose” before their bankruptcy filing date.
  • Facts. (i) Debtor guaranteed his restaurant business’ existing and future debts in 2003—more than ten years before filing bankruptcy, and (ii) the debt at issue arose between March and May 2018 when Debtor’s restaurant (an LLC entity) acquired $36,839.62 worth of goods and services from the guaranteed party.
  • Debtor’s argument is without merit. Debtor argues, wrongly, that the guaranteed debt must be deemed to have arisen when Debtor signed the guaranty in 2003. 
    • This argument confuses a contractual “promise” with a “debt,” which are not the same thing: a debtor’s discharge precludes enforcement of “debts”—not promises—that arose before the bankruptcy filing;
    • Nothing in the Bankruptcy Code provides that the mere filing of a bankruptcy automatically terminates all of a debtor’s existing contractual obligations;
    • Other courts have handled debts arising post-petition from pre-petition guaranties similarly (see In re Rosenfeld, 23 F.3d 833, 837 (4th Cir. 1994); In re Brand, 578 B.R. 729, 733-34 (D. Md. Sept. 19, 2017); In re Shaffer, 585 B.R. 224, 228-29 (Bankr. W.D. Va. 2018); In re Jordan, No. 04-11372-DHW, 2006 WL 1999117, at *3 (Bankr. M.D. Ala. June 15, 2006));
    • Debtor tries to characterize the $36,839.62 post-petition guaranteed debt as a liability on a “contingent” claim under § 101(5)(A)—but this stretches the meaning of a “contingent” claim almost beyond recognition; and
    • Neither Debtor nor the guaranteed party had any liability for the $36,839.62 at issue in 2014 (it was not even a glimmer on the horizon of anyone’s imagination), so there was nothing in 2014 that could have been discharged.

The Problems

There are two problems with the foregoing analysis.

–Technical Focus

The first problem is technical.  The words “debts that arose before” must focus on debts of the debtor, not on debts of the guaranteed party:

  • While it is true that the guaranteed party’s debt may have arisen after Debtor’s bankruptcy filing, Debtor’s obligation for that same debt actually arose back in 2003 at the signing of the guaranty; and
  • Without the signed guaranty, Debtor has no debt—so Debtor’s debt, if it exists at all, had to arise at the signing of the guaranty.

–Practical Confusion

The second problem is practical.  The Schlundt opinion confuses post-discharge actions by Debtor with post-discharge actions by others. This confusion is obvious from two items of rationale the Schlundt opinion provides.

The first item is this example in the opinion.  When a debtor files bankruptcy, with a credit card, the discharge will affect only those credit card charges incurred before the bankruptcy filing—the same debtor is not free to go on a post-bankruptcy spending spree using that same credit card and then have the new post-petition charges declared discharged. 

  • In this example, it is the very same person who receives the bankruptcy discharge and is engaging in the post-bankruptcy spending spree;
  • Accordingly, it makes no difference (in the example) whether the debtor is using a pre-bankruptcy credit card or a post-bankruptcy credit card—in all events, that debtor will be liable for the post-bankruptcy charges, regardless of a discharge in a prior bankruptcy; and 
  • In other words, this is a bad example that does not support the opinion’s conclusion.

The second item is this discussion in the opinion.  At the time of Debtor’s bankruptcy, the guaranty did not obligate Debtor to do anything—it was only later, when Debtor chose to have Debtor’s restaurant obtain additional credit from the guaranteed party that Debtor becomes exposed to liability, and there is nothing onerous or unfair about holding Debtor to that bargain based on Debtor’s own post-bankruptcy conduct.

  • Notice the point of this item: Debtor is the one who (through an LLC that Debtor owns and controls) incurs the new debt;
  • This is the same point as the credit card example: Debtor takes post-bankruptcy action that incurs new debt—and there is nothing onerous or unfair about making Debtor responsible for Debtor’s own actions; but
  • That is a far cry from punishing a debtor for post-bankruptcy conduct by someone else.

Both of these items illustrate the same problem.  The Schlundt opinion’s ruling and rationale would make all discharged debtors responsible for all post-bankruptcy transactions covered by a pre-bankruptcy guaranty—even when the debtor has no involvement in or knowledge of the incurring of the new debt.  This is a terrible result and bad bankruptcy policy.

Conclusion

Here’s hoping other courts reject this opinion and refuse to follow it.  

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

4 thoughts on “Debtor Liability After Discharge Under Pre-Bankruptcy Guaranty? (Reinhart v. Schlundt)

Add yours

  1. Note the district court judge in this case is a former bankruptcy judge. That doesn’t mean he’s infallible (I agree that this analysis isn’t persuasive or correct), but he has more insight into bankruptcy than a run-of-the-mill district court judge.

    Liked by 1 person

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