The outer limits of dischargeability - when is a claim a claim in bankruptcy?

• Author: Williamson, Michael G.

The scope of what may be considered a "claim" in bankruptcy has vital importance to the operation of the Bankruptcy Code. In many respects, the claim is the atom around which much of the Bankruptcy Code is structured. For example, an entity does not qualify as a "creditor" in bankruptcy unless it holds a claim. (2) Further, the discharge provisions of the Bankruptcy Code apply only to a "debt"--defined as a "liability on a claim" in Bankruptcy Code [section]101(5). Accordingly, obligations that do not fall within the bankruptcy definition of a claim are not subject to discharge and survive bankruptcy. Thus, while the relief available to a debtor in bankruptcy is extensive, it is not without limits. This article explores this limitation in the context of two types of such obligations that fall beyond the outer limits of dischargeability in bankruptcy--environmental obligations and contractual obligations not to compete.

The Code Definition

In [section]101(5), the Bankruptcy Code defines a claim as follows:

(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or

(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.

This definition is easily applied to the simple case of a money obligation owed by the debtor to a creditor. Under part (A) of the definition, the creditor to whom the money is owed has a right to payment under nonbankruptcy law and thus holds a claim. The application of the definition is not quite as clear, however, when the debtor has breached a duty that would entitle the person to whom the duty is owed to an equitable remedy under nonbankruptcy law. A breach of performance that cannot be adequately redressed by the payment of money, and thereby lacks an adequate remedy at law, warrants an equitable remedy. If the equitable remedy gives rise to a claim under subsection B of the definition of a claim, then the obligation may be discharged in bankruptcy. However, if the equitable remedy does not qualify as a claim under [section]101(5)(B), then it is not a debt for purposes of bankruptcy, and the obligation survives bankruptcy unaffected by the debtor's discharge. (3) In such cases, the party to whom the obligation is owed may enforce the obligation under applicable nonbankruptcy law.

There are two principal examples of obligations of a debtor that may fall outside the definition of a claim and, therefore, are not affected by the debtor's discharge. The first is a debtor's obligations under state or federal environmental regulations. The second is a debtor's obligations under a noncompete clause in an employment contract. These two obligations illustrate the outer limits of dischargeability in bankruptcy and are the focus of this article.

Legislative History

A brief examination of legislative history will be helpful to understanding the scope of a claim in bankruptcy. Under the Bankruptcy Act of 1898, creditors were not allowed to participate in a bankruptcy for purposes of distribution unless their claims were "allowed." If a claim was not allowed, then it was not discharged. A claim was only allowed if it was "provable." As a result, the debtor would effectively be denied a "fresh start" in cases where a creditor held a significant nonprovable claim that would be unaffected by the debtor's discharge.

When enacting the Bankruptcy Code of 1978, Congress removed the concept of provability from the definition of a claim in favor of the broader definition of the term found in [section]101(5). (4) The legislative history indicates that Congress intended that "all legal obligations of the debtor, no matter how remote or contingent," would be included in the bankruptcy. (5) Consistent with this intent, the Supreme Court has unequivocally adopted a broad interpretation of the [section]101(5) definition, declining to limit the definition as long as the creditor has a right to payment under nonbankruptcy law. (6)

The breadth of the definition, however, is not limitless. This is particularly true with regard to subsection B. To have a claim under [section]101(5)(B) there must be an "equitable remedy" that arises from a "breach of performance" that gives rise to a "right to payment." The existence or absence of an equitable remedy is relatively straightforward; it depends on relevant nonbankruptcy law. Equally settled is the proposition that a breach of performance can stem from both contractual and statutory obligations. (7) The controversy in this area surrounds the right to payment element of the subsection B definition of a claim.

By its terms, [section]101(5)(B) excludes a right to an equitable remedy for breach of performance where there is no concomitant right to payment. Such a right is not a claim in bankruptcy and, as such, is not subject to discharge in bankruptcy. (8) However, the legislative history indicates that equitable remedies that can be adequately satisfied in the alternative by a right to payment were meant to be included as claims. (9) If the right to payment is an "alternative" to...