February 1, 2023
By: William L. Hallam
In its January 18, 2024 opinion in In Re Hilgartner, the United States Court of Appeals for the Fourth Circuit exhibited deference to U.S. Supreme Court precedent by forcefully rejecting an argument that the Fourth Circuit itself had previously accepted.
Lee Andrew Hilgartner assaulted Ysuko Yagi. After Yagi sued Hilgartner, the parties entered into a settlement agreement under which Hilgartner agreed to pay Yagi $415,000 in installments. After paying Yagi $185,955, Hilgartner defaulted under the settlement agreement. Yagi sued Hilgartner for the remaining balance due. Two days before a scheduled hearing on Yagi’s motion for a default judgment against him, Hilgartner filed for bankruptcy.
Yagi filed an adversary proceeding against Hilgartner in which she asserted that Hilgartner’s debt to her was not dischargeable under Bankruptcy Code Section 523(a)(6). That section provides that claims arising from “willful and malicious injury” are not dischargeable.
Hilgartner argued that the settlement agreement had converted Yagi’s claim for willful and malicious injury into a contractual claim for money and that such a claim was dischargeable. The Bankruptcy Court rejected Hilgartner’s argument, as did the District Court on appeal. The case was then appealed to the Fourth Circuit.
The Fourth Circuit agreed with the lower courts. It said:
In Archer v. Warner, 538 U.S. 314 (2003), the Supreme Court rejected an argument nearly identical to Hilgartner’s. That case involved a debt under an agreement settling a lawsuit for fraud. And while a debt for money obtained by fraud is excepted from discharge, see 11 U.S.C. § 523(a)(2)(A), the debtor argued-like Hilgartner here-that his debt was dischargeable, because it was for breach of the settlement agreement rather than for the underlying fraud. His settlement agreement, in other words, had “replaced” his non-dischargeable debt for fraud with a dischargeable debt for breach of contract. Archer, 538 U.S. at 318. The Supreme Court disagreed. The Bankruptcy Code, it explained, required it to “look behind” the settlement “to determine whether it reflected settlement of” an otherwise non-dischargeable claim. Id. at 320. If it did, then the settlement debt was non-dischargeable, even though collection on that debt sounded in contract rather than tort. Id. at 320-21.
The Fourth Circuit concluded that “Archer governs here.”
What the Fourth Circuit does not mention is that the Supreme Court in Archer reversed the Fourth Circuit’s own decision in which it had agreed with the debtor that the creditor’s non-dischargeable claim was converted into a dischargeable breach of contract claim by the parties’ settlement agreement. In its prior decision, the Fourth Circuit said, “The Archers would have us hold that courts must determine whether the underlying factual basis for the settlement agreement consisted of fraud; however, under the novation theory, courts need only address the validity and completeness of the bargained for agreement and release.”
Perhaps hoping that the Fourth Circuit’s pre-disposition to favor the debtor in Archer before being reversed by the Supreme Court would make it receptive to arguments for distinguishing the Supreme Court’s decision, Hilgartner argued that Archer did not control because: (a) fraud debts like those involved in Archer arose under a different subsection of Bankruptcy Code Section 523 than Hilgartner’s debt to Yagi; and (b) the settlement agreement in Archer resolved pending litigation while his agreement with Yagi preempted a lawsuit.
Hilgartner made no headway with either argument. On the first, the Fourth Circuit said that each use of “the debt” in Bankruptcy Code Section 523 “serves the identical function of introducing a category of nondischargeable debt.” Because of the presumption that “equivalent words have equivalent meaning when repeated in the same statute,” the Fourth Circuit concluded that “There is no textual basis for limiting Archer to the specific subsection under which it was decided.”
On Hilgartner’s second argument, the Fourth Circuit said that “the statutory question is whether debt embodied in a settlement agreement is “a debt for” the underlying tort claim, and whether the agreement comes before or after litigation has no obvious bearing on that point.” It concluded that “What matters is the ‘true nature’ of the debt [citation omitted] not the form of legal instrument in which it is reflected.”
In its prior decision accepting the argument that the contractual obligation replaced the tort obligation and resulted in a dischargeable debt, the Fourth Circuit had opined that if settlements did not convert non-dischargeable tort debts into dischargeable contractual debts, the incentive to settle would be gone. In practice, however, until the Supreme Court reversed, it was the Fourth Circuit’s approach that was the disincentive to settle. It made no sense for creditors holding non-dischargeable claims to agree to accept less than full payment in installments when the debtor could then file for bankruptcy and discharge the debt while paying little, if anything. The Supreme Court’s approach, now embraced by the Fourth Circuit, of focusing on the “true nature” of the debt, rather than on a technical contract interpretation spares parties to a settlement from being caught in a legal “gotcha.”