Michigan Bankruptcy Blog

Supreme Court Adopts a Broad Reading of “Actual Fraud” Under the Bankruptcy Code

On May 16, the U.S. Supreme Court decided Husky International Electronics, Inc. v. Ritz[1], ruling that the term “actual fraud” in section 523(a)(2)(A) of the Bankruptcy Code includes forms of fraud that do not involve a fraudulent misrepresentation.

In this case, Husky International Electronics, Inc. sold products to and was owed money by Chrysalis Manufacturing Corporation. Daniel Ritz, one of the owners of Chrysalis, transferred money from Chrysalis to other entities that he owned, draining Chrysalis of its assets and making it impossible for Chrysalis to pay its debts owed to Husky and other creditors.

Husky brought suit against Ritz, seeking to hold him personally responsible for the debts. Ritz then filed for Chapter 7 bankruptcy. Husky initiated an adversary proceeding in the bankruptcy seeking to have the debt declared nondischargeable under section 523(a)(2)(A) of the Bankruptcy Code, which prevents debtors from discharging debts “obtained by false pretenses, a false representation, or actual fraud.” Husky argued that Ritz engaged in “actual fraud” by directing the fraudulent conveyances of Chrysalis’s property.

The district court found that Ritz did not obtain the debt by actual fraud and, thus, it was dischargeable. The U.S. Court of Appeals for the Fifth Circuit affirmed on appeal, holding that “actual fraud” requires proof of a fraudulent misrepresentation from a debtor to a creditor.

The Supreme Court agreed to review the case and reversed the lower court’s decision. The Court, in a 7-1 opinion written by Justice Sonia Sotomayor, explained that “actual fraud” in section 523(a)(2)(A) “encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.” The Court explained that this conclusion is supported by the history of U.S. bankruptcy laws. Prior to 1978, the Bankruptcy Code did not allow discharge of debts obtained by “false pretenses or false representations.” When Congress amended section 523(a)(2)(A) in 1978 to add the term “actual fraud,” the Court explained, Congress could not have intended that “actual fraud” include false representations because the term “false representations” was already included in the statute.

The Court looked back even further to explain that the historical meaning of the term “actual fraud” in bankruptcy laws is broader than just false representation. That history “provides even stronger evidence that the phrase has long encompassed the kind of conduct alleged to have occurred here: a transfer scheme designed to hinder the collection of debt.” The Court concluded that, “a false representation has never been a required element of ‘actual fraud,’ and we decline to adopt it as one today.”

---

[1] Docket No. 15-145 (U.S. May 16, 2016).

Categories: Chapter 7, U.S. Supreme Court