March 7, 2023
On February 22, 2023, the U.S. Supreme Court held that an individual who is found liable for fraud cannot discharge that debt in bankruptcy, regardless of the individual’s culpability. According to the Court: “. . . sometimes a debtor is liable for fraud that she did not personally commit—for example, deceit practiced by a partner or an agent. We must decide whether the bar [that prevents a debtor from discharging that debt in bankruptcy] extends to this situation too. It does.”
Kate Bartenwerfer and her then-boyfriend, David Bartenwerfer, jointly purchased a house. Acting as business partners, they agreed to remodel the house, intending to sell it for a profit. David took charge of the project. Kate was largely uninvolved. Upon completing the remodel, they sold the house to Kieran Buckley. In connection with the sale, Kate and David represented to Buckley that they had disclosed all material facts related to the property.
After the purchase closed, however, Buckley discovered several defects that the Bartenwerfers had not disclosed. Buckley sued them in California state court and won. The jury awarded judgment against the Bartenwerfers jointly for more than $200,000.
Unable to pay that judgment, the Bartenwerfers filed for Chapter 7 bankruptcy protection. Buckley then sued them in the bankruptcy case, alleging that the debt on the state court judgment was not dischargeable under an exception in section 523(a)(2)(A) of the Bankruptcy Code. That section bars discharge by “an individual debtor” of “any debt . . . for money . . . to the extent obtained by . . . false pretenses, a false representation, or actual fraud.”
The bankruptcy court found that David had committed fraud and imputed his fraudulent intent to Kate because the two had formed a legal partnership to execute the renovation and sale project.
The Bankruptcy Appellate Panel agreed as to David’s fraudulent intent but disagreed regarding Kate’s. It ruled that section 523(a)(2)(A) prevented Kate from discharging the debt only if she knew or had reason to know of David’s fraud. On further appeal, the Court of Appeals for the Ninth Circuit reversed in part.
In a unanimous decision, the Supreme Court affirmed the Ninth Circuit and ruled against Kate.
The Court began with the text of the statute. Noting that section 523(a)(2)(A) “obviously applies to a debtor who was a fraudster,” and that “sometimes a debtor is liable for fraud that she did not personally commit–for example, deceit practiced by a partner or agent,” the question to be decided was whether the bar against discharge applied in this situation. It does, wrote the Court: “Written in the passive voice, §523(a)(2)(A) turns on how the money is obtained, not who committed the fraud to obtain it.”
The state court judgment against Kate satisfied section 523(a)(2)(A). Kate was “an individual debtor”; the state court judgment was a “debt”; and that debt arose from sale proceeds obtained by David’s fraudulent misrepresentation. The state court judgment thus was a debt “for money . . . obtained by . . . false pretenses, a false representation, or actual fraud.”
Kate argued that the phrase “money obtained by fraud” in the statute means “money obtained by an individual debtor’s fraud” (not someone else’s fraud). The Justices were unmoved: “The passive voice in §523(a)(2)(A) does not hide the relevant actor in plain sight, as [Kate] suggests—it removes the actor altogether.” According to the Court, Congress framed section 523(a)(2)(A) to focus broadly on an event that occurs without respect to a specific actor, and therefore without regard to any actor’s intent or culpability. The debt must result from someone’s fraud, it concluded, but Congress was “agnostic” about who committed it.
The Court acknowledged that context sometimes can limit a passive-voice sentence to a likely set of actors, but it observed that the legal context relevant to section 523(a)(2)(A) – i.e., the common law of fraud – “has long maintained that fraud liability is not limited to the wrongdoer.” Other persons also may be liable for the fraudster’s act. The Court cited examples: courts traditionally have held principals liable for the frauds of their agents and individuals can be held liable for frauds committed by their partners within the scope of the partnership. Understanding section 523(a)(2)(A) to reflect the passive voice’s usual “agnosticism” “is thus consistent with the age-old rule that individual debtors can be liable for fraudulent schemes they did not devise.”
The Court found additional support for its conclusion in one of its earlier decisions — Strang v. Bradner, 114 U.S. 555 (1885) – and how Congress reacted to it. When Strang was decided, the exception to discharge under the relevant 19th century statute applied to debts “created by the fraud or embezzlement of the bankrupt.” That language suggested that only debts arising from the bankrupt debtor’s own fraud were barred from discharge. In Strang, however, the Supreme Court held otherwise. It ruled that the fraud of one partner should be imputed to the other partners who shared in the fruits of that fraud, such that none of them could discharge the debt in bankruptcy. When Congress next amended the bankruptcy statutes, in 1898, it deleted the phrase “of the bankrupt” from this exception. Given the Court’s assumption that Congress is aware of the Court’s relevant precedents when it enacts statutes, the implication of that change is that Congress embraced the holding in Strang. The Court therefore embraced Strang in its decision too.
Finally, Kate argued that precluding faultless debtors from discharging debts for others’ fraudulent acts would undermine modern bankruptcy law’s policy that debtors should receive a “fresh start.” The Justices disagreed. Bankruptcy law balances debtors’ and creditors’ interests, the Court explained, and “in Congress’s judgment, [sometimes] the creditor’s interest in recovering a particular debt outweighs the debtor’s interest in a fresh start.” Section 523(a)(2)(A) is one such example. If a fresh start were all that mattered, the Court concluded, section 523 would not exist, but it does. The Court declined Kate’s invitation to rewrite the statute.
The Court also made several observations. It reminded Kate that section 523(a)(2)(A) did not create Kate’s liability for fraud; California law did. Section 523(a)(2)(A) merely “took the debt as it found it.” Therefore, Kate’s argument was better directed to the California state law that made her, an “honest partner,” liable in the first place. Also, the Court pointed out that the law of fraud does not (as Kate suggested) make “hapless bystanders” invariably liable. “Ordinarily, a faultless individual is responsible for another’s debt only when the two have a special relationship, and even then, defenses to liability are available.”
The Concurring Opinion
In a concurring opinion, Justice Sotomayor (with whom Justice Jackson joined) emphasized the importance of that “special relationship” between the wrongdoer and the “innocent” debtor to the outcome. In this case, Kate did not dispute that she and David were business partners. Justice Sotomayor explained her “understanding” that, therefore, the Court’s decision concerns fraud only by “agents” and “partners within the scope of the partnership.” The decision does not, in her view, address “a situation involving fraud by a person bearing no agency or partnership relationship to the debtor.”
Perhaps Justices Sotomayor and Jackson seek to place a limiting “gloss” on the Court’s holding. Whether a majority of the Justices share that “understanding” of their ruling, and whether lower courts will adopt that interpretation in future cases, remains to be seen.
The decision is Bartenwerfer v. Buckley, No. 21-908, 598 U.S. ___ (2023).
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