Appeals Courts Say Fraud Debts Can Survive Small Business Bankruptcies

Congress provided a streamlined mechanism for small businesses to reorganize when it enacted the Small Business Reorganization Act of 2019 and added Subchapter V to Chapter 11 of the Bankruptcy Code. Subchapter V gives small businesses relief from some of the more burdensome requirements of Chapter 11, including the absolute priority rule and the requirement to have at least one consenting class of impaired creditors to confirm a plan of reorganization.

In exchange for these benefits to small-business debtors, Congress may have put an arrow in the quivers of creditors by allowing them to object to the discharge of certain types of debts of corporate debtors, a remedy previously only applicable to debts of individuals. Nearly every lower court to consider this question has rejected it. So far, however, appeals courts have uniformly said that Section 1192 of the Bankruptcy Code exempts debts “of the kind specified in Section 523(a)” from discharge, regardless of whether the debtor is an individual or a corporation.

In a recent case, BenShot, LLC v. 2 Monkey Trading, LLC (In re 2 Monkey Trading, LLC), Case No. 23-12342 (11th Cir. July 9, 2025), the 11th U.S. Circuit Court of Appeals issued a 2-1 decision allowing creditors to challenge the dischargeability of certain debts in certain circumstances. The Court looked at what happens when a small business files for bankruptcy under Subchapter V and tries to get its repayment plan approved without all creditors agreeing, known as a “cramdown plan.” Writing for the majority, Judge Barbara Lagoa explained that in these situations, a specific part of the Bankruptcy Code, Section 1192, applies to determine which debts can be erased or “discharged.” Section 1192 says that most debts can be discharged, but not those listed in Section 523(a), which includes debts involving fraud or intentional harm. However, Section 523(a) usually only applies to individuals.

The BenShot majority points out that Section 1192 excludes debts “of the kind specified in Section 523(a)”, without saying that this only applies to individual debtors. The majority explains that “when Congress wanted to specify which kinds of debtors cannot discharge debts under Section 523(a), it has done so through express language in their respective sections.” Although the court acknowledged the decision was a “close call,” the 11th Circuit ultimately held that “based on the plain language of the statute” under Section 1192, “both individual and corporate debtors cannot discharge any debts of the kind listed in Section 523(a).”

This ruling is in line with recent decisions by the 4th and 5th Circuits but diverges from nearly every bankruptcy court, district court, and bankruptcy appellate panel that has addressed the issue. For comparison, see Cantwell-Cleary Co. v. Cleary Packaging, LLC (In re Cleary Packaging, LLC), 36 F.4th 509 (4th Cir. 2022), and Avion Funding, LLC v. GFS Industries, LLC (In re GFS Industries LLC), 99 F.4th 223 (5th Cir. 2024), which agree with the 11th Circuit decision, versus Lafferty v. Off-Spec Sols., LLC (In re Off-Spec Sols., LLC), 651 B.R. 862 (B.A.P. 9th Cir. 2023), which reached a different conclusion.

What does this mean for creditors of small business debtors in Subchapter V? The threat of nondischargeability is a powerful tool to bring to the negotiating table. Subchapter V is designed to be flexible and promote consensus that enables small businesses to obtain fresh starts. However, the subchapter isn’t designed to allow these debtors to steamroll their creditors. Creditors in the 4th, 5th, and 11th circuits that have arguments their debts may be nondischargeable under Section 523(a) can use nondischargeability as one of many levers of influence they can pull to negotiate their best outcome in Subchapter V cases.

Our Bankruptcy, Restructuring, and Creditors’ Rights team is ready and able to help both creditors and debtors navigate insolvency and bankruptcy cases. If you are a large or small business facing financial difficulty or a creditor owed money from a business that has filed a bankruptcy case, we are here to help you through the process.