No D/C of Post-D/C Transaction Based on Pre-Bankruptcy Guaranty

Posted by NCBRC - November 2, 2022

A post-discharge liability arising out of pre-petition personal guaranty was not discharged in the debtors’ bankruptcy where the debt was based on transactions occurring four years after the debtors received their discharge. Reinhart Foodservice, LLC v. Schlundt, No. 21-1027 (E.D. Wisc. Oct. 27, 2022).

In 2003, ten years before he and his wife filed for bankruptcy, David Schlundt entered into a service agreement with Reinhart Foodservice, LLC, under which Reinhart supplied goods and services for Mr. Schlundt’s restaurant, and Mr. Schlundt personally guaranteed the obligations under the contract. When the Schlundts filed for bankruptcy, David Schlundt continued to operate the restaurant and the debtors did not list Reinhart as a creditor. The trustee determined the debtors had no non-exempt assets, and the court granted their discharge.

Four years later, David Schlundt closed the restaurant owing Reinhart $36,839.62. He refused to pay the debt arguing that it was discharged in his bankruptcy. Reinhart moved to reopen the bankruptcy and sought a ruling that the debt was not discharged. The bankruptcy court found the case was governed by Saint Catherine Hospital of Indiana, LLC v. Indiana Family and Social Services Administration, 800 F.3d 312 (7th Cir. 2015), which compelled the conclusion that the debt was discharged.

Reinhart appealed to the district court.

On appeal, the court framed the question as “whether a 2014 bankruptcy discharge order can extinguish a debt from the sale of goods and services in 2018 based solely on the fact that the promise to guarantee such a debt was made in 2003, prior to the bankruptcy.”

Section 727(b) provides that a bankruptcy discharge applies to debts arising before the “date of the order for relief.” Section 101(12) defines “debt” as “liability on a claim,” and section 101(5)(A) defines a “claim” as a “right to payment” which may be contingent. Under this statutory construct, the court found “the Schlundts’ 2014 bankruptcy discharge order extinguished all debts, but only those debts, that arose before January 17, 2014, the date they filed their joint bankruptcy petition.”

The court went on to find that the debt here was incurred when the transactions giving rise to it took place—four years post-discharge—rather than as of the pre-bankruptcy date David Schlundt made the personal guaranty. “At that point, but no earlier, Reinhart had both a $36,839.62 claim against [the restaurant] for those goods and services and a contingent claim against Schlundt, subject to the contingency that Schlundt’s liability would be triggered only if [the restaurant] ‘failed to pay.’ There was no debt, claim or right to payment of any kind for this $36,839.62 prior to 2018. Because the liability did not arise until four years after the Schlundts filed their bankruptcy petition, the debt was not subject to the Schlundts’ earlier bankruptcy discharge, consistent with the plain terms of Section 727(b).”

The court found the Schlundts’ argument to the contrary confused a contractual “promise” with a “debt.” As the court made clear, “A debtor’s discharge precludes enforcement of ‘debts’—not promises—that arose before the bankruptcy petition was filed.” While bankruptcy debtors often enter bankruptcy with promises, discharge releases debtors only from debts. The court pointed to credit cards as examples of contracts where the cardholder’s promise to pay for purchased goods does not give rise to a debt until good are actually purchased.

The court rejected the debtors’ argument that the debt was “contingent” at the time they filed for bankruptcy comparing the connection between the promise and debt in this case to the connection between Herbert Hoover’s presidential election and the Big Bang. For practical purposes, the debtors incurred no legal liability until they purchased Reinhart’s goods and services in 2018, four years after they obtained their discharge.

The court went on to consider the bankruptcy court’s finding that the case was governed by Saint Catherine Hospital of Indiana. Saint Catherine was a chapter 11 case involving a scheme under which the hospital owed Medicaid reimbursements in the form of a Hospital Assessment Fee (HAF) for the years 2012 and 2013 as determined by the Indiana Family and Social Services Administration. When Saint Catherine Hospital filed for bankruptcy in 2013, it argued that the portion of the debt for that year was a pre-petition debt subject to discharge. The Seventh Circuit agreed. It held that the conduct giving rise to the debt occurred pre-petition and that “[i]t did not matter that payment of the HAF was contingent on the hospital’s post-petition continued operations; ‘the creditor was aware of [the exact amount of] its claims against [the debtor] . . . well before it filed for bankruptcy.’”

Unlike in Saint Catherine, “neither Reinhart nor the Schlundts had any idea of the amount that would be owed to Reinhart in 2018, prior to the Schlundts’ bankruptcy filing in 2014. Indeed, they could not have known because the legal liability did not exist.”

The court reversed and remanded.

Schlundt ED Wisc Oct 2022


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