Individual Subchapter V Debtor’s Liquidating Plan: Can Discharge Be Denied Under § 1141(d)(3)? (In re Lucido)

By: Donald L Swanson

Here’s a Bankruptcy Court opinion addressing a no-discharge claim under § 1141(d)(3) against an individual debtor who proposes a liquidating Subchapter V plan:  

• RGW Construction, Inc. v. Lucido (In re Lucido), Adv. No. 21-4031, Northern California Bankruptcy Court (issued 9/13/2023, Doc. 113).

The Issue

Here’s the issue:  How does the no-discharge provision of § 1141(d)(3)[fn. 1] apply to an individual debtor in Subchapter V?

§ 1141(d)(3) provides that confirmation of a plan “does not discharge debtor” when all three of the following elements exist:

• the plan liquidates “all or substantially all” of the estate’s assets;
• debtor “does not engage in business” after plan consummation; and
• debtor “would be denied a discharge” under § 727(a).

Notably for the third element and corporate debtors, § 727(a)(1) says says that only an individual can get a Chapter 7 discharge: “The court shall grant the debtor a discharge, unless—(1) the debtor is not an individual.”

Corporate v. Individual Debtors

Obviously, the primary thrust of § 1141(d)(3) is this: a corporate debtor will not receive a discharge under a liquidating plan.

But § 1141(d)(3) is trickier when the liquidating plan is for an individual, as explained by the In re Lucido opinion:

• Chapter 11 was originally designed for corporate debtors;
• so, it’s “easy to conclude” that a corporation will not engage in business when its assets are liquidated and the corporation is dissolved; but
• application of the “engage in business” element “to the sometimes, peripatetic[fn. 2] post-confirmation lives” of individuals “can be more difficult” (at 7, emphasis added).

Legal Standards

The In re Lucido opinion provides the following legal standards for analyzing a debtor’s right to a discharge under § 1141(d)(3):

• §1141(d)(3) may deprive a Chapter 11 debtor of a Chapter 11 discharge—even when a debtor’s Subchapter V plan is confirmed consensually;
• §1141(d)(3) is written in the conjunctive, so all three elements must be established by a preponderance of the evidence;
• courts make every effort to guard a debtor’s discharge; and
• challenges to an individual debtor’s discharge are narrowly construed.

First § 1141(d)(3) Element—Liquidation

The In re Lucido opinion finds that Debtor’s Subchapter V plan does liquidate “all or substantially all” estate assets:

• estate asset values total $4,130,092, of which $417,121 is exempt;
• so, the value of Debtor’s nonexempt assets is $3,712,971; and
• $3,400,289 (91.5%) of nonexempt assets are already liquidated.

The Bankruptcy Court concludes that liquidating 91.5% of nonexempt assets satisfies the first element of § 1141(d)(3):

• i.e., the plan liquidates “substantially all” estate assets.

Second § 1141(d)(3) Element—“Does Not Engage in Business”

The In re Lucido opinion finds that Debtor does “engage in business” after consummation of Debtor’s liquidating plan. 

Before filing Subchapter V bankruptcy, Debtor operates a drilling business. 

After filing bankruptcy, Debtor loses his contractor’s license to operate the business—so Debtor’s business is not the same as before filing bankruptcy.  However, this distinction between the nature of Debtor’s pre-bankruptcy and subsequent business activities is irrelevant because:     

• the statute requires one simple query (i.e., Will debtor “engage in business” after consummation of the plan?), and there are no modifiers or qualifiers on the type or form of business required;
• the statute is stated in present tense, is forward-looking, and simply requires that the debtor “engage in business” post-consummation; and
• the court declines to insert a business continuity requirement into the statute where none exists.

The Bankruptcy Code does not define “engage in business.”  But Black’s Law Dictionary defines “business” very broadly, as “[a] commercial enterprise carried on for profit; a particular occupation or employment habitually engaged in for livelihood or gain.”

Official Bankruptcy Forms limit the expansive definition by specifying five “business” categories:

1. sole proprietor or self-employed, either full-time or part time;
2. a member of a limited liability company (LLC) or limited liability partnership (LLP);
3. a partner in a partnership;
4. an officer, director, or managing executive of a corporation; and
5. an owner of at least 5% of the voting or equity securities of a corporation.

Case law uniformly holds that a debtor working as a mere employee is not in “business” for purposes of §1141(d)(3)(B).

In applying these legal standards, the Bankruptcy Court finds that Debtor does continue generating income by providing “self-employed independent” consulting services out of his union hall.  Such consulting services:

• involve all phases of the drilling business, such as inspecting drilling sites and advising potential bidders—these are activities for which Debtor is well-suited by background and experience and which do not require a contractor’s license; and 
• create earnings for Debtor, which are reported as 1099 income for taxes and on Debtor’s monthly operating reports and provide the bulk of Debtor’s non-rental, post-petition income.

Additionally, Debtor’s plan proposes that Debtor will:

• expand his consulting services;
• continue working out of the union hall; and
• start to receive social security.

The Bankruptcy Court concludes that Creditor fails to meet its burden of proving that Debtor “does not engage in business” after plan consummation.

Third § 1141(d)(3) Element—Discharge Denial Under § 727

Following a lengthy analysis (on pages 11 to 22), the In re Lucido opinion concludes that creditor “has failed to sustain its burden to prove, by a preponderance of the evidence,” that Debtor “would be denied a discharge under §727(a) in a chapter 7 case.”

Accordingly, the Bankruptcy Court rules in Debtor’s favor on the basis of this third element “alone.”

Q&A

What follows are some obvious questions about the § 1141(d)(3) claim in In re Lucido and a probable answer.

–Questions

Why bother with § 1141(d)(3) in an individual’s case?

When would a § 1141(d)(3) claim even be relevant in an individual’s case?

For starters, if a creditor establishes a § 727 against an individual debtor, the debtor does not get a discharge under any circumstances—and the other two elements of § 1141(d)(3) are irrelevant and immaterial.

By contrast, in pursuing a § 1141(d)(3) no-discharge claim against an individual debtor:

• all three elements must be established—liquidation, no further business, and no-discharge under § 727; and
• if any one of those three elements is not established, the debtor gets a discharge.

That means, unless a § 727 violation is established for an individual debtor, the debtor gets a discharge under § 1141 upon confirmation of a Chapter 11 plan—regardless of the other two elements in § 1141(d)(3).

So . . . why would a creditor, in an individual Chapter 11 case, even argue about the first two elements of a no-discharge claim under § 1141(d)(3)?

• Why bother—since it all comes down to § 727 issues in all events for the individual debtor?
• Wouldn’t it be better, and more efficient, to focus exclusively on § 727—and forget about the other two elements in § 1141(d)(3) for an individual debtor?

–Answer?

Presumably, the answer to such questions, in the In re Lucido case, arise from these facts:

• June 30, 2021, is the deadline established in the In re Lucido case for filing a complaint objecting to Debtor’s discharge under § 727 (Doc. 3 says, “Last day to oppose discharge or dischargeability is 6/30/2021”);
• that deadline expires without Creditor filing a complaint;
• on July 20, 2021, Debtor files a proposed liquidating Subchapter V plan;
• on August 3, 2021, Creditor files its Complaint to deny Debtor’s discharge under § 1141(d)(3), based on Debtor’s proposed liquidating plan; and
• Debtor’s act of proposing the liquidating plan gives creditor a second shot at pursuing a § 727 no-discharge claim—this time, under § 1141(d)

Conclusion

Here’s a suggestion:

• when the deadline for filing a § 727 claim has not-yet expired, don’t even bother asserting a § 1141(d)(3) no-discharge claim against an individual debtor—focus exclusively on § 727 instead; but
• after expiration of the § 727 filing deadline, a liquidating plan might allow for a belated shot at pursuing a § 727 claim under § 1141(d)(3).

————–

Footnote 1.  11 U.S.C. § 1141(d)(3) provides: “(3) The confirmation of a plan does not discharge a debtor if—(A) the plan provides for the liquidation of all or substantially all of the property of the estate; (B) the debtor does not engage in business after consummation of the plan; and (C) the debtor would be denied a discharge under section 727(a) of this title if the case were a case under chapter 7 of this title.”

Footnote 2.  “Paripatetic” means “traveling from place to place, in particular working or based in various places for relatively short periods.”

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