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Supreme Court Holds ‘Actual Fraud’ Does Not Require Misrepresentation

On May 16, 2016, the U.S. Supreme Court resolved a split among the circuit courts of appeal regarding the definition of “actual fraud” in the Bankruptcy Code. Section 523(a)(2)(A) states:

A discharge … does not discharge an individual debtor from any debt 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.

Some circuits, including the Fifth Circuit, adopted a narrow definition of “actual fraud” that required a false representation. Other circuits understood the term more broadly, capturing more nefarious debtor activity such as fraudulent conveyances. (The Court addresses the confusing fact that the term “actual fraud” might be redundant to other terms in the Bankruptcy Code.)

At issue in Husky Int’l Electronics, Inc. v. Daniel Lee Ritz, Jr. is whether debtor Ritz’s transfers of money lent by Husky International to Chrysalis Manufacturing Corp., managed and partly owned by Ritz, constituted “actual fraud.” Husky International lent Chrysalis Manufacturing about $164,000, but Ritz drained away Chrysalis’ assets by shifting them around to various entities he controlled to avoid repaying Chrysalis’ debts. In the process Ritz made no representations about what he was doing whatsoever. Husky International sued Ritz personally for Chrysalis’ debts in Texas, and Ritz filed chapter 7 bankruptcy. Husky International filed adversary proceedings against Ritz to again hold him personally liable for Chrysalis’ debts and to prevent him from discharging those debts by arguing they fell into the “actual fraud” exemption to discharge.

It’s unclear from the opinion how the case made it to federal district court, but it and the Fifth Circuit Court of Appeals both held that the debt was dischargeable because no “actual fraud” occurred, such as when a debtor falsifies income or employment on a credit card application, because Ritz made no false representations.

The Supreme Court reversed the Fifth Circuit for the following reasons:

(1)  Congress added the term “actual fraud” to section 523(a)(2)(A), even though “false representation” was already there, and the Court does not interpret acts of Congress to be redundant. Thus, “actual fraud” must mean something more than a false representation.

(2)  In a past case, the Court held that section 523(a)(2)(A) refers to the common law definition of “actual fraud,” which means intentional rather than implied fraudulent acts. “Actual fraud” also encompasses fraudulent conveyances, which do not require misrepresentations.

(3)  The Court rejected Ritz’s contentions that fraudulent conveyances are wholly addressed in other parts of the Bankruptcy Code. For instance, section 523(a)(4) only applies to fraudulent conveyances by fiduciaries, and section 523(a)(6) encompasses debtors’ acts beyond fraud. Section 727(a)(2) forbids discharge of all of a debtor’s debts if he or she engages in similar acts to “actual fraud” within a year of filing bankruptcy, but the Court distinguishes the scope and goal of section 727(a)(2) from those of the “actual fraud” statute at issue.

(4)  Finally, the Court spent the rest of its opinion arguing with the lone dissent by Justice Clarence Thomas, which for brevity isn’t worth discussing.

Until now, fraudulent conveyances in bankruptcy really only applied to transferring assets to third parties for less than their market value to stymie creditors, a problem that came up a year ago with parents paying their kids’ college tuition bills. In those circumstances, the trustee can avoid the transfer to recover the property for the bankruptcy estate. With the ruling in Int’l Husky, debtors might be unable to discharge debts to creditors if they’ve fraudulently transferred their property even among entities they control. It also means creditors now have greater ability to recover assets from debtors who engage in the kinds of activities that Ritz did.

The text of Int’l Husky can be found here (pdf).

If you are a debtor whose case might run into problems due to asset transfers, or if you are a creditor who wants to ensure payments from a debtor who is playing shell games, then you need to hire an experienced New York bankruptcy lawyer to handle your case.

For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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