Husky v. Ritz – the Supreme Court Really Needs Some Bankruptcy Basics

I get calls all the time from people who say that so and so owes them money and just filed bankruptcy.  I ask, “Did the debtor lie and cheat and steal when you loaned him the money or sold him the goods?”  No – well then I would take your files and pitch them in the ocean.  You are out of luck.  The debtor gets his fresh start.

Now I can say, “any chance the debtor hid some assets or transferred something he owned to some relative?”  If so, the Supreme Court says that MIGHT form the basis for declaring the debt to you to be non dischargeable.  If the debtor really did that I usually tell the client, we can ask the court to deny his discharge altogether under section 727 but then you are in line with all other creditors whose debts are likewise not discharged.  But now we can go after the debtor alone under 523(a)(2) and have the debt discharged only as to us, not everyone else.    The Supreme Court really had no idea of this.  

Luckily the Supreme Court decision in Husky v. Ritz will likely be limited to situations that almost never happen.  All the Supreme Court said in Husky is that the words “actual fraud” in 523(a)(2)(A) include fraudulent conveyances, hiding your assets conduct.  But 523(a)(2) says that to be non-dischargeable, the debt must be obtained by the actual fraud.  Whether it did in Husky v. Ritz, the Supremes left to the Fifth Circuit Court of Appeals.

Here is a short ABI article about the case.

My brief follows:

Husky International Electronics, Inc. v. Ritz, , — U.S. —-, 13- S.Ct. ——  (May 16, 2016)

Issue:  Does the term “actual fraud” in section 523(a)(2)(A) include the making of a fraudulent conveyance by the debtor?

Holding:  Yes.  The Supreme Court left open the issue of whether the “actual fraud” in transferring and hiding assets here makes the debt owed to this creditor non-dischargeable.

SOTOMAYOR, J., delivered the opinion of the Court, in which ROBERTS, C. J., and KENNEDY, GINSBURG, BREYER, ALITO, and KAGAN, JJ., joined.  THOMAS, J., filed a dissenting opinion.

“Husky International Electronics, Inc., is a Colorado based supplier of components used in electronic devices.  Between 2003 and 2007, Husky sold its products to Chrysalis Manufacturing Corp., and Chrysalis incurred a debt to Husky of $163,999.38.”  Daniel Ritz was a director and “owned at least 30% of Chrysalis’ common stock.”   “All parties agree that between 2006 and 2007, Ritz drained Chrysalis of assets it could have used to pay its debts to creditors like Husky by transferring large sums of Chrysalis’ funds to other entities Ritz controlled.”  Husky sued Ritz in state court seeking to hold him personally liable for “actual fraud’ for purposes of a Texas law that allows creditors to hold shareholders responsible for corporate debt.”  Ritz filed chapter 7 and Husky filed a non-dischargeability complaint saying that “the same intercompany-transfer scheme constituted ‘actual fraud’ under 11 U. S. C. §523(a)(2)(A)’s exemption to discharge.”  The district court ruled that there was no “actual fraud” and the Circuit Court of Appeals affirmed.  “In transferring Chrysalis’ assets, Ritz may have hindered Husky’s ability to recover its debt, but the Fifth Circuit found that he did not make any false representations to Husky regarding those assets or the transfers and therefore did not commit “actual fraud.”

The Supreme Court reversed, 7-1.  It started with “the presumption that Congress did not intend ‘actual fraud’ to mean the same thing as ‘a false representation.’”  So what does “actual fraud” mean?  “Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.’”  “There is no need to adopt a definition for all times and all circumstances here because, from the beginning of English bankruptcy practice, courts and legislatures have used the term ‘fraud’ to describe a debtor’s transfer of assets that, like Ritz’ scheme, impairs a creditor’s ability to collect the debt.”  The majority opinion discussed the history of bankruptcy and the discharge at some length and concluded “we interpret ‘actual fraud’ to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.”

The debtor argued that section 727 provides a remedy for debtors who fraudulently transfer assets before filing.  The court said,

“Although the two provisions could cover some of the same conduct, they are meaningfully different.  Section 727(a)(2) is broader than §523(a)(2)(A) in scope—preventing an offending debtor from discharging all debt in bankruptcy.  But it is narrower than §523(a)(2)(A) in timing—applying only if the debtor fraudulently conveys assets in the year preceding the bankruptcy filing.  In short, while §727(a)(2) is a blunt remedy for actions that hinder the entire bankruptcy process, §523(a)(2)(A) is a tailored remedy for behavior connected to specific debts.”

Editor’s note:  That seems pretty non-responsive.

As to the code requiring that the debt be “obtained by” the fraud, the court seems to acknowledge that the times that a person obtains a asset or a debt via a fraudulent conveyance may be “rare.”  In a footnote, the court leaves the issue open as to whether the “actual fraud” here necessarily leads to a non-dischargeable debt.  “We take no position on that contention here and leave it to the Fifth Circuit to decide on remand whether the debt to Husky was ‘obtained by’ Ritz’ asset-transfer scheme.”

In his dissent, Justice Thomas states “Section 523(a)(2) covers only situations in which ‘money, property, [or] services’ are ‘obtained by . . . actual fraud,’ and results in a debt.”  “I do not quibble with the majority’s conclusion that the common-law definition of ‘actual fraud’ included fraudulent transfers.” [emphasis in original]  “In my view, context dictates that ‘actual fraud’ ordinarily does not include fraudulent transfers because ‘that meaning does not fit’ with the rest of §523(a)(2).”

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