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Nov. 22, 2022

Free and Clear of Post-Petition Guarantor Liability—Not So Fast: A Bankruptcy Discharge May Not Apply to Post-petition Claims Arising Under Pre-petition Contracts

By Lee B. Hart

A somewhat common question that arises after a bankruptcy discharge is granted is whether post-petition liabilities are discharged under pre-petition agreements, like guaranties. To describe the issue in more digestible language, let’s say that the owner of a small business guarantees the business’s most important vendor to garner more favorable terms for the business. The owner files personal bankruptcy and receives a discharge, but the vendor keeps shipping to the business. Later, the business fails to pay. Can the vendor look to the guarantor to satisfy these debts? On the one hand, the debts relate to post-petition deliveries, and in that sense (assuming no prepayment), they are not covered by the discharge. On the other hand, the owner’s obligations relate to the guaranty, which is a pre-petition contract, which typically would be covered by the discharge.

This tension was the dispute covered in Reinhart Foodservice LLC v. David S. Schlundt, et al. (In re Schlundt), 2:21-cv-01027, 2022 WL 15523157 (E.D. Wis. Oct. 27, 2022) (the “Schlundt Decision”). In a decision that should come as good news for trade vendors, landlords and others, the District Court held that, under the specific facts, post-petition liabilities arising under a pre-petition guaranty were not discharged by the guarantor’s bankruptcy.

The dispute at issue in the Schlundt Decision focused on the following facts: in 2003, David Schlundt’s restaurant signed a food supply agreement with a vendor, which Schlundt personally guaranteed.  Years later, Schlundt filed a personal Chapter 7 bankruptcy, and in 2014, received a personal discharge (the restaurant did not file). Personal bankruptcy notwithstanding, the vendor continued to ship to the restaurant, which closed in 2018.  At the time of closing, the restaurant owed the vendor $36,839.62 for food and other services delivered in 2018. The question for the courts was whether the bankruptcy discharge – granted in 2014 – discharged debts incurred in 2018 under a guaranty executed in 2003. 

In the Schlundt Decision, the District Court began with the text of 11 U.S.C. § 727(b), which prescribes the scope of bankruptcy discharge. The Court reasoned that the discharge precludes the enforcement of “debts,” not promises, and that the “debt” did not arise until the goods and services were delivered to the restaurant. Focusing on the “conduct test,” the District Court held that, because the conduct giving rise to the claim (as opposed to the promise) arose post-petition, these 2018 debts against Schlundt were not discharged, even though they were under a pre-petition guaranty. Bolstering the decision was the District Court’s citation of authority noting that guaranties are continuing promises to guarantee ongoing debts as they arise, with each future obligation constituting a separate and distinct transaction. 

The District Court reconciled the Schlundt Decision with the Seventh Circuit’s decision in Saint Catherine Hospital of Indiana, LLC v. Indiana Family and Social Services Administration, 800 F.3d 312 (7th Cir. 2015). At issue there was an assessment calculated and administered by the State of Indiana under a statute meant to increase reimbursement to hospitals providing care to patients under Medicaid.  The fee was assessed and calculated pre-petition but owed post-petition. Triangulating on the fact that the entirety of the fee was calculated pre-petition based on pre-petition performance and financials, the Court held the debt to be pre-petition, even though much of it was payable post-petition. The District Court in the Schlundt Decision therefore viewed Saint Catherine as consistent, since the conduct giving rise to the debt occurred pre-petition, rather than post-petition, as in Schlundt

Whether a debt constitutes a pre-petition or post-petition obligation is crucial not only for discharge purposes but also for knowing your rights during the bankruptcy case. Bankruptcy lawyers at Nelson Mullins regularly deal with these and similar issues in matters around the country. Please call us if we can be of service.