Appeals Court Rules That a Discharge Injunction Bars a Fraudulent Transfer Claim Based on a Non-Dischargeable Debt
A discharge of debt in bankruptcy “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. . . .” 11 U.S.C. § 524(a)(2). Certain debts, however, including debts “for violation of . . . any of the State securities laws,” are not subject to discharge. See 11 U.S.C. § 523(a)(19). A discharge injunction does not bar the collection of such debts. Does a discharge injunction bar a fraudulent transfer action, when that action is brought based on an underlying non-dischargeable debt? In a recent decision, the United States Court of Appeals for the Eleventh Circuit considered this issue, and concluded that the discharge injunction barred a fraudulent transfer action under the Alabama Uniform Fraudulent Transfer Act (“AUFTA”), because the fraudulent transfer claim gave rise to a separate liability from the underlying non-dischargeable debt. SuVicMon Development, Inc. v. Morrison, 991 F.3d 1213 (11th Cir. March 25, 2021).
The plaintiffs here, three corporations, originally brought suit in state court in 2006 against Charles M. Morrison, Sr. for common-law fraud and violations of the Alabama Securities Act. In 2012, they amended their complaint to add claims for fraudulent transfer against Morrison and his sons, alleging that Morrison had transferred property in an effort to defraud his creditors. Morrison filed for chapter 7 bankruptcy in August 2018, but the bankruptcy court permitted the state-court action to go forward while staying the execution of any judgment. The state court ultimately entered judgment against Morrison on the common-law fraud and Alabama Securities Act claims, and entered judgment for Morrison and his sons on the fraudulent transfer claims. The plaintiffs appealed the judgments on the fraudulent transfer claims. In November 2019, the bankruptcy court ruled that the state court judgment on the securities fraud claims was a non-dischargeable debt for violation of state securities laws, and the plaintiffs moved for the bankruptcy court to allow them to proceed with their appeals of the fraudulent transfer claims notwithstanding the discharge injunction Morrison had obtained. The bankruptcy court ruled in December 2019 that the discharge injunction barred the plaintiffs from proceeding on their fraudulent transfer claims against Morrison. The district court affirmed, and the plaintiffs appealed to the Eleventh Circuit.
The plaintiffs argued that the fraudulent transfer action was an action to collect on a non-dischargeable debt, and was therefore not subject to the discharge injunction. The Eleventh Circuit rejected this argument. The Eleventh Circuit explained that a fraudulent transfer action is a distinct cause of action with its own particular elements. It noted that under the AUFTA, while the remedy may be avoidance of the transfer, compensatory and punitive damages are sometimes also available. A fraudulent transfer claim, therefore, as a distinct cause of action, gives rise to a distinct debt, notwithstanding that it must be based on an underlying claim of a creditor. The underlying debt being non-dischargeable does not mean that the debt corresponding to the fraudulent transfer claim is non-dischargeable.
The Eleventh Circuit distinguished a fraudulent transfer action from modes of execution on a judgment, which, it reasoned, do not give rise to distinct debts. Modes of execution and associated proceedings, the Eleventh Circuit explained, are based simply on an underlying judgment and the identification of property subject to execution, without requiring allegations of wrongdoing or misconduct by the debtor, and are generally in rem. A fraudulent transfer action, by contrast, can be brought as an in personam action, does not require an underlying judgment but merely an underlying claim, and depending on the remedy, may itself require the creditor to levy execution after judgment. Further, in a fraudulent transfer action, a creditor is not always limited to recovering the amount of the underlying claim.
The Eleventh Circuit also rejected the plaintiffs’ second argument that they should be able to proceed nominally against Morrison, without seeking any direct recovery from him, to facilitate obtaining recovery from his sons. The Eleventh Circuit held that there were two prerequisites before a plaintiff can proceed nominally against a debtor to collect from a third party: first, the debtor’s status as a defendant must be necessary for recovery against the third party, and second, it must be sufficiently certain that maintaining suit against the debtor would not place any economic burden on the debtor. Here, the court held that neither prerequisite was met: the AUFTA permitted plaintiffs to bring suit against the transferees directly, and the suit had the potential to impose an economic burden on Morrison.
The Eleventh Circuit thus affirmed the district court.