Personal Guaranty of Commercial Lease Held Discharged in Guarantor's Bankruptcy

Three years after the debtor's bankruptcy case, the salon entity exercised an option for a five-year extension on the lease. The extension was executed by the debtor on behalf of the salon, but the debtor did not execute a new guaranty. The salon vacated the property prior to the end of the lease term. The landlord filed suit against the debtor in Ohio state court. The complaint asserted, among other things, that the personal guaranty remained enforceable. In his answer, the debtor asserted "discharge in bankruptcy" as an affirmative defense. The landlord continued the state court action. The debtor moved to reopen the bankruptcy case and initiated an adversary proceeding, asserting his guaranty had been discharged in his prior bankruptcy case, and the landlord and its attorneys (defendants) willfully violated the discharge injunction by continuing the state court action with knowledge of the bankruptcy.

The defendants filed a motion for summary judgment, claiming the discharge injunction did not affect the guaranty because it was "resurrected" by, among other things, the subsequent lease extension. The Bankruptcy Court denied the defendants' motion. After trial, the Bankruptcy Court ruled that the guaranty was a contingent claim that had been discharged in the bankruptcy case and the defendants willfully violated the discharge injunction. After a separate hearing, the Bankruptcy Court awarded the debtor compensatory damages of $10,720 as a result of the defendants' willful violation of the discharge injunction. The defendants appealed to the bankruptcy appellate panel.

Guaranty Discharged But No Willful Violation

The court considered whether the debtor's personal guaranty was discharged in his bankruptcy case. The issue was whether the guaranty was a prepetition debt that existed at the time of the bankruptcy case. The Bankruptcy Code definition of "debt" is a "liability on a claim." The term "claim" is 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," 11 U.S.C. Section 101(5)(A). Courts generally define the term "claim" broadly.

Two lines of cases have developed on whether a prepetition guaranty falls within the scope of the definitions of "debt" and "claim," and subject to discharge. The first line holds that "absent an affirmative action by the debtor to terminate the guaranty, the guaranty may be enforced as to obligations incurred post-petition." A second line of cases holds that a prepetition guaranty is a contingent claim and subject to discharge. The courts in the second line rely on the plain text of the Bankruptcy Code. Here, the court agreed with this reasoning and further observed that the landlord could have required the debtor to sign a new guaranty when the debtor executed the lease extension or required the debtor to reaffirm the guaranty in the bankruptcy case pursuant to Section 524 of the Bankruptcy Code. Since neither had occurred, any debt owed on account of the guaranty was discharged in the debtor's bankruptcy case, and the filing of the state court action violated the discharge injunction.

The court next turned to whether the defendants had willfully violated the discharge injunction by initiating and continuing the state court action despite knowing of the debtors' prior bankruptcy case and discharge. The court noted, "The discharge injunction operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor." A creditor may be held in contempt and sanctioned if its violation of the discharge injunction was willful. While there was no controlling Sixth Circuit decision, the court noted the historical standard for "willful" employed by lower courts is "when the creditor deliberately acted with actual knowledge of the bankruptcy case." Under that standard, a creditor's good faith belief that its actions were lawful was irrelevant. The Bankruptcy Court ruled the defendants had notice of the debtor's prior bankruptcy case and still pursued the state court action.

However, the Supreme Court recently issued a ruling in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019) that a creditor may only be held in contempt for violation of the discharge, "if there is no fair ground of doubt as to whether the order barred the creditor's conduct." As such, if a creditor has a good faith, reasonable belief that its actions do not violate the discharge order, then sanctions are not appropriate. In this case, the court reasoned that the defendants' actions were not willful under this new standard because a clear split of authority existed regarding whether a pre-petition guaranty is discharged in bankruptcy, and there was no controlling Sixth Circuit law on the issue. Consequently, "there was an objectively reasonable basis for the defendants to have concluded that filing the state court action might be lawful." The court reversed the Bankruptcy Court's finding of willfulness and award of sanctions.

Conclusion

Courts continue to be divided on whether a personal guaranty is discharged in the individual guarantor's bankruptcy case. As such, landlords should be guided accordingly, and not assume the guaranty will continue to be enforceable post-bankruptcy absent some affirmative undertaking by the guarantor. Also, given the Supreme Court's recent ruling in Taggart, practitioners will need to see how courts interpret the standard for willful violation of the discharge injunction. In this case, the court found that an objective belief that a court might rule in its favor was enough to avoid a contempt ruling and sanctions. Some things just never come to closure.

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Andrew C. Kassner is co-chair of Faegre Drinker Biddle & Reath and a member of the firm's board. He can be reached at [email protected] or 215-988-2554. Joseph N. Argentina Jr. is a senior attorney in the firm's corporate restructuring practice group in the Philadelphia and Wilmington, DE, offices. He can be reached at [email protected] or 215-988-2541.