The US Supreme Court issued a decision today on a significant case that has been followed by bankruptcy practitioners. The case relates to whether a judgment for fraudulent conveyance may be discharged. The Court wrote:
“The Bankruptcy Code prohibits debtors from discharging debts ‘obtained by . . . false pretenses, a false representation, or actual fraud.’ 11 U.S.C. § 523(a)(2)(A). The Fifth Circuit held that a debt is ‘obtained by . . . actual fraud’ only if the debtor’s fraud involves a false representation to a creditor. That ruling deepened an existing split among the Circuits over whether ‘actual fraud’ requires a false representation or whether it encompasses other traditional forms of fraud that can be accomplished without a false representation, such as a fraudulent conveyance of property made to evade payment to creditors. We granted certiorari to resolve that split and now reverse.”
The underlying case involved facts familiar to many lenders. Daniel Lee Ritz, a director and shareholder of Chrysalis Manufacturing Corp., made transfers to entities in which he had ownership interests draining Chrysalis of assets while it was indebted to Huskey International Electronics, Inc., the plaintiff. After Husky commenced a lawsuit against him, Ritz filed a Chapter 7. Husky brought an adversarial proceeding against Ritz claiming the transfers to be “actual fraud” and to bar his discharge. The District Court held that Ritz was personally liable but that the debt was not “obtained by . . . actual fraud” under § 523(a)(2)A). The Fifth Circuit Court of Appeals recognized that in transferring Chrysalis’ assets, Ritz may have hindered Husky’s ability to recover its debt, but found that he did not make any false representations to Husky and therefore did not commit “actual fraud.”
The Court noted that the historical meaning of “actual fraud” provides strong 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.
“‘Actual fraud’ has two parts: actual and fraud. The word ‘actual’ has a simple meaning in the context of common-law fraud: It denotes any fraud that ‘involv[es] moral turpitude or intentional wrong.’ . . . ‘Actual’ fraud stands in contrast to ‘implied’ fraud or fraud ‘in law,’ which describe acts of deception that ‘may exist without the imputation of bad faith or immorality.’ . . . Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.'”
Seven of the sitting judges joined in this decision written by Justice Sotomayor with (as you might expect) Justice Thomas as the sole dissenter, writing “The majority today departs from the plain language of § 523(a)(2)(A), as interpreted by our precedents.”
Notwithstanding, the Court held that it must give the phrase “actual fraud” in § 523(a)(2)(A) the meaning it has long held, and interpreted the term “actual fraud” to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.
May 16, 2016