Peter Cal

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.  Bartenwerfer v. Buckley, No. 21-908 (U.S. Feb 22, 2023).

Acting as business partners, Kate and David Bartenwerfer flipped a home they jointly owned, i.e., they purchased the home, remodeled the home, and then resold the home. 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 both Kate and David 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 both Kate and David 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 both David and Kate based on Section 523(a)(2)(A) of the Bankruptcy Code.

After a two-day trial, the bankruptcy court found that David had knowingly concealed the defects from the purchaser and did not discharge the judgment against him. Further, the bankruptcy court imputed David’s fraudulent intent to Kate and also did not discharge the judgment against her. After several appeals and a retrial, the United States Court of Appeals for the Ninth Circuit held that, notwithstanding Kate’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 Barrett relied on the language of the statute and the common law of fraud and held that Kate’s debt to the purchaser was not discharged. Justice 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.[1] 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.”  Bartenwerfer, slip op. at 5 (quoting Dean v. United States, 556 U.S. 568, 572 (2009).  Justice 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.  Id., slip op. at 5- 6.

The Court also dismissed Kate’s public policy argument that bankruptcy is intended to provide debtors with a fresh start. According to Justice 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.

If you have questions about how bankruptcy filings like this can affect you or your business, please contact your Sherman & Howard attorney.

[1] “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 a debtor’s or insider’s financial condition.”  11 U.S.C. § 523(a)(2)(A).