Academic journal article Washington and Lee Law Review

Archer V. Warner: Circuit Split Resolution or Contractual Quagmire?

Academic journal article Washington and Lee Law Review

Archer V. Warner: Circuit Split Resolution or Contractual Quagmire?

Article excerpt

I. Introduction

The Supreme Court's recent holding in Archer v. Warner (In re Warner)1 is an anticontractual decision that threatens the autonomy of parties to create valid settlement agreements that have lasting effect within bankruptcy courts. The linchpin of contract law is the freedom of parties to bargain for beneficial provisions. Thus, the public policy in favor of encouraging settlements not only recognizes the importance of encouraging contractual settlements but also the enforcement of valid agreements:2 "Because contract law presumes that parties will not consensually enter into a contract unless each party perceives a net benefit, courts enforce contracts absent good reason not to do so."3

Instead of upholding the basic tenets of contract law, Archer stated that bankruptcy courts should "look behind" privately contracted settlements to determine if the underlying and completely-released original debt was obtained by fraud.4 The factual scenario in Archer, however, did not involve any of the circumstances that typically cause courts to override a contract, such as unconscionability or duress. Yet the Supreme Court has crafted a decision that ultimately discards release provisions to which both parties have agreed. Thus, the question presented is whether Archer offers a compelling reason for allowing a bankruptcy court to derail the fundamental core of contract law, or if Archer only creates a contractual quagmire for creditors and debtors who desire to settle an alleged fraud claim.

Consider a situation in which A (a buyer) files suit against B (a seller) for fraudulent activity relating to a sale. Prior to litigation of the state court claim, A and B, both represented by counsel, agree to a settlement in which B agrees to pay a fixed sum in exchange for the buyer's complete release of all claims relating to the state court action. B makes a significant cash payment, and the rest of the settlement is secured by a promissory note. Neither an admission of liability nor a mention of fraud is included in the agreement. A dismisses the state fraud claim with prejudice. A's only source of remedy is the enforcement of the note because the settlement agreement expressly released all other claims relating to the state litigation. B defaults on the settlement payments. A attempts to enforce the settlement by using the released fraud claims. Although B objects to the resurrection of the claims, the court examines the circumstances behind the settlement agreement to determine if the original debt was fraudulent.

Under state contract law, examining the released original debt and underlying circumstances would be an outrage to the basic concept of novation,5 which is "[t]he act of substituting for an old obligation a new one that either replaces an existing obligation with a new obligation or replaces the original party with a new party."6 A novation immediately extinguishes the prior obligation, and "the obligee, therefore, has no right to enforce the original duty, even on breach by the obligor of the substituted contract."7 If the obligor breaches the novation, then the obligee is limited to "its remedies under the substituted contract that has replaced that duty."8

In the hypothetical, the settlement agreement is a novation because it completely substituted the earlier alleged tort debt with a new contractual obligation. Upon breach of the settlement, A no longer has the option to seek enforcement on the alleged tort debt. The prior obligation is nonexistent, and a proper state court decision would bar further litigation of the released fraud claim. Under the terms of the novation, A's remedy is limited to the enforcement of the promissory note as a contractual obligation.

Now, consider this revision to the hypothetical. B defaults on the payment of the settlement and files for bankruptcy. B seeks to discharge this debt in bankruptcy. The bankruptcy discharge relieves the debtor by "operat[ing] as an injunction against all efforts to recover debts owed prior to the filing of the bankruptcy case as a personal liability of the debtor. …

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