Bankruptcy Update Blog

Supreme Court Agrees to Hear a Case About the Scope of the Fraud Exception to Discharge

A discharge in bankruptcy usually discharges a debtor from the debtor’s liabilities.  Section 523 of the Bankruptcy Code, however, sets forth certain exceptions to this policy, including for “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. . . .”  11 U.S.C. § 523(a)(2)(A).  (We have previously written about this provision in the context of statements respecting a debtor’s financial condition.)  There is a split among the courts of appeal as to whether this provision applies only to a debtor who has some level of knowledge of the fraud, or whether the bar on discharge applies also when the debtor is liable only by imputation for a fraud committed by an agent or partner of the debtor.  On May 2, the Supreme Court granted a petition for certiorari in Bartenwerfer v. Buckley, No. 21-908, a case presenting this question.

Kate and David Bartenwerfer jointly purchased a house in February 2005 for about $900,000 and then sold it in March 2008 to Kieran Buckley for $2.1 million.  Buckley later sued the Bartenwerfers for breach of contract, negligence, nondisclosure of material facts, negligent misrepresentation, and intentional misrepresentation.  The jury found for Buckley on the breach of contract, negligence, and nondisclosure of material facts claims but found against him on the remaining claims, and awarded damages to Buckley.  The Bartenwerfers then filed for bankruptcy.  Buckley brought an adversary proceeding in the bankruptcy court against the Bartenwerfers, arguing that the state court judgment he had been awarded against them was nondischargeable under section 523(a)(2)(A) because it was a debt that had been obtained through fraud.  The bankruptcy court ruled in Buckley’s favor, finding that David Bartenwerfer had actual knowledge of the false representations and his fraudulent conduct could be imputed to Kate Bartenwerfer as his partner.  The Ninth Circuit Bankruptcy Appellate Panel reversed, holding that nondischargeability under section 523(a)(2)(A) only resulted if a debtor “knew or should have known” of the fraud, based on the Eighth Circuit’s decision in Walker v. Citizens State Bank (In re Walker), 726 F.2d 452 (8th Cir. 1984).  On remand, the bankruptcy court held that Kate Bartenwerfer had no knowledge of the fraud and her debt was therefore dischargeable, and the Bankruptcy Appellate Panel affirmed.  Buckley appealed to the Ninth Circuit, which reversed, holding that the application of section 523(a)(2)(A) does not depend on the debtor’s knowledge of the fraud.  Kate Bartenwerfer then petitioned for certiorari.

Bartenwerfer’s petition focused on the presence of a circuit split, noting that the Ninth Circuit’s ruling follows the Fifth Circuit’s ruling in Deodati v. M.M. Winkler & Assocs. (In re M.M. Winkler & Assocs.), 239 F.3d 746 (5th Cir. 2001), in conflicting with the Eighth Circuit’s ruling in Walker.  Bartenwerfer also made several arguments that the Ninth Circuit’s decision was wrong.  First, Bartenwerfer pointed to the text of the provision and the statutory context of the Bankruptcy Code, arguing that the provision’s text does not expressly include a debtor liable for fraud by imputation and that barring such a liability from discharge would be inconsistent with the Bankruptcy Code’s policy of granting a fresh start to honest but unfortunate debtors.  Second, Bartenwerfer argued that a knowledge requirement is consistent with the statute’s legislative history, noting legislative statements that the provision was meant to cover actual fraud rather than fraud implied by law.  Third, Bartenwerfer argued that Supreme Court decisions finding that scienter is an element of fraud for purposes of section 523 support imposing a scienter requirement here.

Buckley’s opposition acknowledged the existence of a circuit split, but argued it was old and lopsided in favor of the Fifth Circuit’s position, and was not of much significance because it will rarely be the case that a debtor whose agent or partner committed fraud will not have any knowledge of the fraudulent conduct.  Buckley also argued that the Ninth Circuit’s decision was correct.  First, Buckley pointed to the provision’s text, which states that “any debt” for money “obtained by . . . actual fraud” is nondischargeable, without any statement that the fraud need have been by the debtor or that the debtor need have known of the fraud.  Second, Buckley relied on the Supreme Court’s decision in Strang v. Bradner, 114 U.S. 555 (1885), which, interpreting a similar provision in the Bankruptcy Act of 1867, held that the fraud of one partner could be imputed to the others for purposes of nondischargeability.  Third, Buckley argued that the Ninth Circuit’s reading of the statute makes sense, as a reflection of Congress’s desire to prioritize the interests of the victims of fraud over the partners of fraudsters.

The Supreme Court granted the petition on May 2.  The case will likely be argued and decided next term.