Can a nondischargeability suit survive after a claim is deemed “satisfied in full” under a confirmed plan?  The Tenth Circuit recently considered this question in Bank of Commerce & Trust Co. v. Schupbach (In re Schupbach).  The court held that such a claim cannot survive where a plan is confirmed without objection or appeal regarding the treatment of the claim, emphasizing in its opinion the importance of resolving conflicts within the confines of the bankruptcy case and preserving issues for appeal. 

Key Takeaways

  • Never underestimate the binding power of a confirmed plan, even in the face of a pending adversary proceeding. When in doubt, parties should raise their objections in the confirmation process.
  • Don’t assume that an issue can be raised for the first time before the appellate court. Preserve all issues by raising them initially with the lower court.

Background: Two Plans and the Power of a Confirmation Order

Two individual debtors had a business of buying, renovating, renting, and reselling homes through an LLC.  The LLC obtained bank loans that were secured by mortgages on properties owned by the LLC and personally guaranteed by the debtors.  After the individual debtors and their LLC filed chapter 11 cases in the United States Bankruptcy Court for the District of Kansas, the bank filed identical proofs of claim in each case seeking payment of approximately $750,000.  The claims stated that, based on appraisals, the total value of the collateral securing the bank’s claim was in excess of $1.3 million.

During the bankruptcy cases, the bank filed an adversary proceeding in the individual debtors’ chapter 11 case alleging that a portion of their guaranty was nondischargeable because the debtors obtained it under false pretenses in violation of section 523(a)(2) of the Bankruptcy Code and willfully and maliciously misappropriated it under section 523(a)(6).  The bankruptcy court dismissed the 523(a)(2) claim as untimely, but refused to dismiss the bank’s claim under section 523(a)(6).  After the bankruptcy court ruled against the bank on the merits of its section 523(a)(6) claim, the bank appealed from the untimeliness ruling.

In the meantime, the bankruptcy court confirmed a plan in the LLC’s case.  That plan – filed by the bank and other creditors – gave the bank possession of the collateral securing its loan.  The bankruptcy court later confirmed the individual debtors’ plan, which treated the bank’s unsecured guaranty claim as satisfied in full by the transfer of the collateral under the LLC plan.  The bank did not object to the individual debtors’ plan and did not appeal from the confirmation order.

Dismissal of the Dischargeability Appeal

Given the chain of events, the debtors then successfully moved before the Tenth Circuit Bankruptcy Appellate Panel to dismiss the bank’s appeal, leading the bank to appeal to the Tenth Circuit.  In affirming the BAP’s decision, the Tenth Circuit first noted that a case becomes moot when “an event occurs while [it] is pending on appeal that makes it impossible for the court to grant any effectual relief whatever to a prevailing party.”  In the bankruptcy context, a confirmation order moots the litigation of any issue necessarily determined by the order.  Here, the individual debtors’ plan treated the bank’s claim as fully satisfied under the LLC plan, and the bank did not object to the individual debtors’ plan or appeal from the order confirming such plan.  Consequently, no case or controversy existed regarding its claim.

The Bank Fights Back

The bank posed a number of arguments as to why its nondischargeability claim was not mooted by the confirmation order.  The court highlighted that underlying all of these arguments was the bank’s belief that it was actually undersecured by $350,000 based on the liquidation value of the assets, as well as the bank’s claim that it chose to forego a valuation fight during the debtors’ confirmation proceedings in favor of litigating the issue in the nondischargeability case.

Jurisdiction and Issue Preclusion

First, the bank argued that its appeal divested the bankruptcy court of jurisdiction over the question of whether the bank’s claim was fully secured.  Although the Tenth Circuit agreed that the question of federal court jurisdiction may be raised at any time, it did not reach the question because the bank never appealed from the confirmation order.  The time to file such an appeal under Rule 8002 of the Federal Rules of Bankruptcy Procedure had expired, and the court decided that it would not allow the bank to “reopen [the] question in a collateral attack upon an adverse judgment.”  The bank also argued that the bankruptcy court’s valuation was not binding in the nondischargeability case because the doctrine of issue preclusion only applies when an issue underlying a judgment is actually litigated, and valuation was never an issue in the bankruptcy case.  The circuit court similarly rejected this argument because the bank only raised it for the first time on appeal.

Findings of Fact and the Scope of the Plan

In addition to its arguments regarding jurisdiction and issue preclusion, the bank argued that the BAP impermissibly made factual findings in dismissing the appeal.  The Tenth Circuit rejected this argument, stating that the bank cited no authority for its proposition that an appellate court could not make factual determinations in finding an appeal moot.  The court cited to the U.S. Supreme Court’s decision in Heitmuller v. Stokes in holding that “it has long been the rule” that facts relevant to a mootness determination may be proved by extrinsic evidence.  The court also noted that, in any event, the BAP’s analysis in this case involved only a legal assessment of the confirmation order and related mootness implications.

Finally, the bank argued that the individual debtors’ plan only determined the amount of the bank’s claim for the purposes of voting and distribution and that the confirmation order did not have any effect on the nondischargeability claim.  The court was not persuaded, holding that the value of the collateral as set forth in the plan would have been subject to any amended proof of claim the bank filed.  In other words, the bank had the opportunity to challenge the debtors’ valuation of the collateral and failed to exercise it.  Additionally, the bank did not cite any provision of the individual debtors’ plan that would limit the treatment of its claim in this way.  Even if the bank did so, the court stated that the bank failed to show that valuation could be litigated in the nondischargeability case on remand from the BAP because the bank never presented the issue as one to be tried.

Conclusion

The Schupbach case offers some important reminders for claimants in bankruptcy cases.  Specifically, it demonstrates how a court may treat an issue in the context of an adversary proceeding that a claimant had ample opportunity to address within the bankruptcy case.  It also brings to light the importance of preserving issues for appeal: although many of the bank’s arguments may not have prevailed for other reasons, most were rejected by the appellate court simply because they had not been asserted in the lower court.