In a unanimous decision, the Supreme Court held that § 523(a)(2)(A) of the Bankruptcy Code precludes a debtor from discharging a debt obtained by fraud, regardless of the debtor’s own culpability. In Bartenwerfer v. Buckley, issued February 22, the Court concluded that “§ 523(a)(2)(A) turns on how the money was obtained, not who committed fraud to obtain it.”
As background, in 2005, the debtor and her then-boyfriend jointly purchased a house in San Francisco. Acting as business partners, the pair decided to remodel and flip the property. The boyfriend took charge of the project while the debtor was “largely uninvolved.” Before selling the house, the couple filled out a required disclosure statement, attesting that they were unaware of defects and that alterations or repairs had been made with necessary permits. Yet after the house was sold, the buyer discovered several defects that the couple had not divulged and permit problems. Alleging that he had overpaid in reliance on the couple’s fraudulent misrepresentations, the buyer sued the couple in California state court. The jury found in the buyer’s favor, leaving the couple jointly responsible for more than $200,000 in damages.
The couple filed for chapter 7 bankruptcy protection, in part to discharge the judgment debt. The buyer filed an adversary proceeding contesting the dischargeabilty of the judgment. After a 2-day bench trial, the bankruptcy court decided that the couple could not discharge the debt because, based on the evidence presented, the boyfriend had knowingly concealed the house’s defects from the buyer and the court imputed the boyfriend’s fraudulent intent to the debtor because the two had formed a legal partnership to execute the renovation and resale project. The Ninth Circuit’s Bankruptcy Appellate Panel agreed as to the boyfriend’s fraudulent intent but disagreed as to the debtor’s because it found that § 523(a)(2)(A) barred her from discharging the debt only if she knew or had reason to know of the fraud. On further appeal, the Ninth Circuit reversed, holding that a debtor who is liable for her partner’s fraud cannot discharge that debt in bankruptcy, regardless of her own culpability. The Supreme Court granted certiorari to resolve confusion in the lower courts on the meaning of § 523(a)(2)(A).
The Supreme Court began its analysis with the statute at issue. Section 523(a)(2)(A) states: “A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.” The Court found that by its very terms the section precluded the debtor’s discharge of the debt. “First, she is an ‘individual debtor.’ Second, the judgment is a ‘debt.’ And third, because the debt [arose] from the sale proceeds obtained by [her boyfriend’s] fraudulent misrepresentations, it is a debt ‘for money . . . obtained by . . . false pretenses, a false representation, or actual fraud.”
Additionally, the Court held that its precedent and Congress’s response to it supported its holding. In Strang v. Bradner, the Court held that the fraud of one partner should be imputed to the other partners, who “received and appropriated the fruits of the fraudulent conduct.” The Court held this way despite the fact that the relevant 19th-century discharge exception for fraud disallowed the discharge of debts “created by the fraud or embezzlement of the bankrupt.” When Congress next revised the bankruptcy law, it deleted the phrase “of the bankrupt” from the discharge exception for fraud. According to the Court, the unmistakable implication is that Congress embraced Strang’s holding.
Lastly, the debtor argued to hold her liable for the debt would run contrary to the “fresh start” policy of modern bankruptcy law. However, the Court noted that the Bankruptcy Code is not focused solely on the debtor’s interest, but instead seeks to balance multiple, often competing interests, including those of creditors. Moreover, while the debtor attempted to portray the situation as a liability being imposed on a hapless bystander, the Court found that fraud liability generally requires a special relationship to the wrongdoer (such as a partnership) and even then, defenses to liability do exist.
For these reasons, the Court affirmed the Ninth Circuit’s judgment against the debtor.
Key takeaways: The Supreme Court’s decision does not stand for the proposition that a truly innocent bystander, with no knowledge of fraud and no special relationship to the fraudster, may be deprived of a discharge. It does, however, highlight the heightened risks to debtors posed by partnerships and other business relationships that may create imputed liability.