Imputed Fraud Liability Not Dischargeable in Bankruptcy
On February 22, 2023, the U.S. Supreme Court handed down its opinion in Bartenwerfer v. Buckley, 143 S. Ct. 665 (2023), in which the Court held that a debtor cannot discharge in bankruptcy imputed liability for fraud committed by the debtor’s partner. This case should serve as a warning to businesspersons to be careful when choosing partners. It is best to seek legal advice before starting a business venture.
Kate Bartenwerfer and her then-boyfriend and business partner, David Bartenwerfer, jointly purchased a house in San Francisco. After remodeling the house, they sold it to Kieran Buckley. As is typical in real estate transactions, the sellers, Kate and David, provided a disclosure of material facts relating to the house. The problem in this case, however, was that Kate and David did not disclose the house’s leaky roof, defective windows, missing fire escape, and permit problems. Upon discovery of the problems, the buyer, Buckley, sued Kate and David and alleged that he would not have paid so much for the house if Kate and David had disclosed the problems. A jury found in Buckley’s favor and awarded him over $200,000 in damages against Kate and David jointly.
Unable to pay the judgment, Kate and David filed for Chapter 7 bankruptcy. Buckley, however, filed an adversary complaint and alleged that the $200,000 judgment could not be discharged because it was a “debt . . . for money . . . obtained by false pretenses, a false representation, or actual fraud.” 11 U.S.C. § 523(a)(2)(A). After a bench trial, the bankruptcy court found that David had fraudulently concealed the house’s defects. Further, because Kate was David’s business partner, the court imputed David’s fraudulent intent to her and held that she could not discharge any part of the judgment, despite her lack of actual fraudulent intent. The Ninth Circuit eventually affirmed the bankruptcy court’s judgment and, relying on the Supreme Court’s decision in Strang v. Bradner, 114 U.S. 555 (1885), held that an innocent partner cannot discharge a debt due to a guilty partner’s fraud.
The Supreme Court affirmed. The Court determined that the plain language of the statue was sufficient to decide the case:
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 . . . .
11 U.S.C. § 523(a)(2)(A). The only element disputed was whether the debt was for money obtained by fraud. More specifically, whether the money had to be obtained by the debtor’s fraud to be non-dischargeable. The Court deployed three arguments to support its position:
- The statute is written in the passive voice (“obtained by . . . fraud”), rendering the identity of the actor irrelevant. The Court found support for this interpretation of the passive voice in the common law rule that liability for fraud is not limited to the actor (for example, respondeat superior, liability of all partners for debts incurred in furtherance of a partnership).
- The omission of reference to actions of the individual debtor in § 523(a)(2)(A) where the neighboring sections (§§ 523(a)(2)(B)-(C)) include said references implies that the omission in § 523(a)(2)(A) was intentional; ergo, the debtor need not be the person who actually committed the fraud.
- A previous version of the statute, which specifically exempted “debt created by the fraud or embezzlement of the bankrupt” from discharge was interpreted by the Court in Strang to prevent innocent business partners from discharging a debt incurred through the fraud of another business partner. When Congress later amended the statute and removed the “of the bankrupt” language, the Court assumed that Congress was codifying the holding from Strang.
Finally, the Court noted that any accusations of unfairness should be directed at state law, not the Bankruptcy Code, because it is state law that defines fraud and who is liable for fraud. The Bankruptcy Code provides no remedy if a state’s law of fraud unjustly places responsibility on an innocent party.
The Court’s holding serves as a reminder that businesspeople should take care to shield themselves from the consequences of a business partners’ actions. As the Court’s holding in Bartenwerfer shows, innocent individuals can incur personal liability as a result of their business partners’ misdeeds, even where the partnership simply involves flipping houses together. Therefore, if you are considering engaging in a business venture with others, you should seek competent legal counsel to take steps to mitigate your risks. Beckman Lawson’s experienced business team can guide you through the legal complexities of various types of business ventures to help you avoid potential pitfalls, and liability, along the way.