By holding that “actual fraud” includes fraudulent transfer schemes, the Supreme Court has clarified that the exceptions to discharge for individual debtors are broader than the United States Court of Appeals for the Fifth Circuit had opined.
On May 16, 2016, the Supreme Court of the United States handed down its opinion in Husky International Electronics, Inc. v. Ritz, Case No. 15-145.
Lee Ritz, Jr. was a director and part owner of Chrysalis Manufacturing Corp. During the course of its operations, Chrysalis incurred debt to Husky International Electronics, Inc. Unfortunately, Ritz siphoned assets away from Chrysalis that could have been used to satisfy the Chrysalis debt to Husky, and he transferred those assets to other entities in which he held an ownership interest.
Husky sued Ritz on a state law theory that he was personally liable on the debt owed to it by Chrysalis, and Ritz filed an individual chapter 7 bankruptcy case in response. Husky then brought an adversary proceeding against Ritz, seeking a determination that Ritz’s liability for the debt to Husky was nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A), which excepts from discharge any debts:
for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by . . . false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition[.]
The district court and United States Court of Appeals for the Fifth Circuit found that Ritz’s debt to Husky—incurred through Ritz’s fraudulent transfers—did not arise from “actual fraud” within the meaning of the statute; they found that a necessary element of “actual fraud” under Bankruptcy Code § 523(a)(2)(A) is a misrepresentation from debtor to creditor, and Ritz had not made any such misrepresentation. Therefore, according to the reasoning applied by those courts, Ritz’s debt to Husky was held to be dischargeable.
The Supreme Court granted certiorari and, through a majority opinion written by J. Sotomayor, reversed (J. Thomas dissented).
The majority took particular aim at the circuit court’s requirement that the fraud at issue involve an affirmative misrepresentation by the debtor to the creditor causing harm. Emphasizing that:
the historical meaning of “actual fraud” provides [strong] evidence that the phrase has long encompassed the kind of conduct alleged to have occurred here: a transfer scheme designed to hinder the collection of debt,
the Court rejected the appellate court’s narrow approach.
The Court also rejected the circuit court’s focus on a requirement of “inducement,” which the circuit court (and J. Thomas, in dissent) found was grounded in the “obtained by” language in the statute. Focusing on the fraudulent transfer context, the Court stated, “In such cases, the fraudulent conduct is not in dishonestly inducing a creditor to extend a debt. It is in the acts of concealment and hindrance.” The Court concluded:
Because we must give the phrase “actual fraud” in 11 U.S.C. § 523(a)(2)(A) the meaning it has long held, we interpret “actual fraud” to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.
The Takeaway
By holding that “actual fraud” includes fraudulent transfer schemes, the Supreme Court has clarified that the exceptions to discharge for individual debtors are broader than the United States Court of Appeals for the Fifth Circuit had opined. As a result, in circumstances where personal liability can be imposed upon corporate insiders for fraudulent transfers and other types of conduct designed to hinder and impair the rights of creditors, the Supreme Court has clarified that these creditors have a wider range of remedies than may have otherwise been presumed.
For Further Information
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