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Supreme Court Holds Misrepresentation Not Required For Actual Fraud Under The Bankruptcy Code

In a 2016 case, the U.S. Supreme Court held that a debtor who transferred assets between business related entities to shield these assets from creditors could not discharge the underlying debt in his bankruptcy case. In Husky International Electronics, Inc. v. Ritz, 2016 U.S. LEXIS 3048, 578 U.S. ___ (2016), the Supremes settled a split among lower federal courts concerning the question of whether "actual fraud" requires a false representation.  

The Bankruptcy Code creates exceptions to discharge for certain debts. Included is a category for debts obtained by fraud and misrepresentation. Specifically, 11 U.S.C. § 523 (a)(2)(A) provides:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) 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;

In the Husky case, Ritz filed for bankruptcy and made certain fraudulent conveyances between business entities in which he held an interest. Ritz was also a director for a company, Chrysalis, which made circuit boards and conducted business with Husky. When Chrysalis failed to pay a debt of $164,000 to Husky, the latter tried to recover the debt from Ritz personally.    

Husky argued in the lower courts that the debt was nondischargeable under § 523 (a)(2)(A) because Ritz had engaged in actual fraud by making fraudulent conveyances. The facts indicated that Ritz made no false representations. Husky's argument was rejected with the reasoning that a debt may only be “obtained by actual fraud” if “the debtor’s fraud involves a false representation to a creditor.” The Fifth Circuit affirmed and in 2015 the Supreme Court agreed to hear the case.

While § 523(a)(2)(A) declares that debts are nondischargeable if based on false pretenses, a false representation, or actual fraud, a split of authority developed over time regarding the forms of fraud referred to by the term “actual fraud.” Some courts have held that regardless of the form of fraud, any finding of actual fraud must include an express or implied misrepresentation.

Justice Sotomayor explained that the term “actual fraud” includes forms of fraud, such as fraudulent conveyances, that do not involve a false representation. This is supported by the history of the U.S. bankruptcy laws in that although the Bankruptcy Code had once barred the discharge of debts obtained by “false pretenses” or “false representations,” Congress specifically amended the Bankruptcy Code to add the phrase “actual fraud,” thus suggesting that Congress would not have intended “actual fraud” to have the same meaning as “false representation.”

Thus, the Supreme Court held that the debtor committed “actual fraud” by simply transferring the assets and, therefore, the debt was nondischargeable under Bankruptcy Code § 523 (a)(2)(A). Further, and more importantly, the Court held that although the debtor did not make any false representations regarding the transfer, a misrepresentation by the debtor is not a necessary prerequisite for a showing of “actual fraud” under § 523 (a)(2)(A).

The experienced South Florida defense attorneys at Loan Lawyers are here to review your potential claims against a debt collector, and will help you recover the damages you deserve. To schedule a free consultation at any of our three conveniently located offices, contact Loan Lawyers today by calling (888) FIGHT-13 (344-4813).