By Peter Cal
Sherman & Howard
In a unanimous decision, the U.S. Supreme Court held that a Chapter 7 debtor cannot discharge a debt based on money obtained by fraud even when the Chapter 7 debtor did not perpetrate the fraud.
Acting as business partners, Kate Bartenwerfer and David Bartenwerfer flipped a home they jointly owned. David was primarily responsible for the project; Kate was uninvolved and was unaware that certain defects were not disclosed when they resold the home.
After discovering the defects, the purchaser sued the Bartenwerfers in state court and obtained a $200,000 judgment against them jointly for breach of contract, fraud and nondisclosure of material facts. This judgment, and other debts, drove the Bartenwerfers to file Chapter 7 bankruptcy petitions. The purchaser then commenced an action in the bankruptcy case seeking a ruling that the state court judgment could not be discharged as to the Bartenwerfers based on Section 523(a)(2)(A) of the Bankruptcy Code.
After a two-day trial, the bankruptcy court found that David Bartenwerfer had knowingly concealed the defects from the purchaser and did not discharge the judgment against him. Further, the bankruptcy court imputed David Bartenwerfer’s fraudulent intent to Kate Bartenwerfer and also did not discharge the judgment against her. After several appeals and a retrial, the Ninth Circuit Court of Appeals held that, notwithstanding Kate Bartenwerfer’s lack of fraudulent intent, her debt was not discharged based on her partner’s fraud. The Supreme Court took the case to resolve confusion in the lower courts on this issue.
Writing for the court, Justice Amy Coney Barrett relied on the language of the statute and the common law of fraud and held that Kate Bartenwerfer’s debt to the purchaser was not discharged. Barrett relied heavily on principles of statutory construction and that the statute was written in the passive. Section 523(a)(2) provides in substance that an individual Chapter 7 debtor does not receive a discharge from any debt for money obtained by fraud. Because the statute is written in the passive, the focus is “on an event that occurs without respect to a specific actor, and therefore without respect to any actor’s intent or culpability.” Barrett supported this conclusion by noting that under the common law, fraud liability is not limited to the wrongdoer. For example, principals can be liable for the frauds of their agent.
The court also dismissed Kate Bartenwerfer’s public policy argument that bankruptcy is intended to provide debtors with a fresh start. According to Barrett, the Bankruptcy Code, like all statutes, balances multiple interests. Section 523(a)(2) necessarily reflects a goal other than giving the debtor a fresh start in all cases.
For creditors whose claims arise out of fraud, Bartenwerfer is a welcome decision and provides an option for creditors in the event an individual liable for fraud, whether they were the fraudster or liable based only on the fraud of their partner or agent, seeks bankruptcy protection. The applicable rules impose strict deadlines for filing a complaint objecting to discharge based on fraud and other grounds. Therefore, creditors should consult with counsel promptly upon learning of a bankruptcy filing by a debtor.
– Sherman & Howard member Peter Cal focuses on bankruptcy and insolvency matters including workouts, restructurings and bankruptcy court litigation, as well as financial and real estate litigation in state and federal courts. He regularly represents secured and unsecured creditors and chapter 7 trustees.