The Supreme Court of the United States in Bartenwerfer v. Buckley, NO. 21-908, Slip Opinion, 506 U.S. _(2023), resolved split opinions in the circuit courts regarding the fraud exception to the discharge of debts in the Bankruptcy Code. SCOTUS established a precedent favoring fraud victims by preventing those who not only perpetrated the fraud, but also those who benefited from it, from having the capability to discharge that debt in bankruptcy. In this case, a wife who was unaware of her husband's fraudulent activity in selling their home with known defects that he failed to disclose, was not permitted to discharge her portion of a judgment for damages against the couple in bankruptcy. The court found that to rule otherwise, would shield those who potentially benefitted from the fraud and allow them to escape liability.
Kate and David Bartenwerfer jointly owned a home in San Francisco. At the time of the purchase they were boyfriend and girlfriend, but by the time this lawsuit was filed their status had changed to a married couple. They decided to remodel the home and David led the project. Kate was not closely involved with the day-to-day process of the upgrades. Ultimately, they sold the house to Kieran Buckley. After the sale was complete, Buckley found several construction defects that the Bartenwerfers did not disclose before the purchase. Buckley sued them and the court found the Bartenwerfers liable for over $200,000 in damages.
The Bartenwerfers were unable to pay the judgment debt or other creditors and filed for Chapter 7 bankruptcy. Buckley filed an adversary complaint in the proceeding claiming that the debt the Bartenwerfers owed him was non-dischargeable under the Bankruptcy Code, which states that debts that arise from false pretenses, false representation, or fraud for money may not be discharged. U.S.C. §523 (a)(2)(A). In its decision, the Bankruptcy Court ruled that David had committed fraud and Kate was imputed into his fraudulent intent because the two formed a valid legal partnership to renovate and sell the property. On appeal, the court held that Kate could not be liable for David's fraud unless she had knowledge or should have had knowledge of the fraud. On remand the court found that she did not have knowledge and as such could discharge the debt she owed to Buckley. The Bankruptcy Appellate Panel affirmed. The Ninth Circuit reversed in part finding that "a debtor who is liable for her partner's fraud cannot discharge that debt in bankruptcy, regardless of he own culpability." The Supreme Court granted certiorari and agreed with the Ninth Circuit. It held that Section 523(a)(2)(A) precludes Kate from discharging the debt in bankruptcy.
Issue Before the Court
Bartenwefer v. Buckley answers the question of whether 11 U.S.C. §523(a)(2)(A) requires that the agent or partner of a debtor who obtained funds by fraud is also liable for the debt under the exception discharging all debts and making a fresh start under the Bankruptcy Code.
Purpose of the Bankruptcy Code
The Bankruptcy Code seeks to balance the interests of debtors and creditors fairly. Debtors who file for bankruptcy are normally insolvent and bankruptcy allows them to disrupt their debts in order to make a "fresh start." The code also includes several exceptions to this rule, however, which prevent the full discharge of debt under certain circumstances. Section 523(a)(2)(A) provides an exception to discharge of 'any debt….for money… to the extent obtained by…. false pretenses, false representation, or actual fraud.11 U.S.C. This not only includes fraud that the debtor personally committed, but also that by a partner or agent. The purpose of U.S.C. § 523(a)(2)(A) is to "focus on an event that occurs without respect to a specific actor, and therefore without respect to any actor's intent or culpability." Dean v. United States, 556 zu.S. 568, 572. The common law has "long maintained that fraud liability is not limited to the wrongdoer." Id. §523(a)(2)(A) addresses how the money was obtained, not who committed the fraud to obtain it.
When Kate and David Bartenwerfer purchased the home in question, their relationship status was boyfriend-girlfriend, but acting legally as business partners. Together they made the decision to remodel the house and sell it at a profit. David took the lead on the redesign project and as part of that process hired an architect, structural engineer, designer and general contractor. David supervised the work, kept track of invoices and made payments. Kate was not really involved in the process at all other than agreeing to it and benefitting from the profits equally with David when the house was sold.
As the project progressed, several problems cropped up, but the couple still proceeded to put it up for sale and Adrian Buckley bought it. Although the Bartenwefers attested that they had disclosed all facts relevant to the property, Buckley discovered several defective conditions after the purchase that the Bartenwerfers did not reveal as required by law. Buckley then brought a claim against the Bartenwerfers alleging that the value of the property he purchased was less due to the undisclosed issues with the home such as leaks in the roof, defective windows, a missing fire escape and issues with the permits. He argued and the court agreed that the Bartenwerfers had intentionally misrepresented the state of the property. The jury found that the Bartenwerfers were jointly liable for breach of contract, negligence, and nondisclosure of material facts. They were found jointly liable for over $200,000 in damages. When the couple was unable to pay Buckley, they filed for Chapter 7 bankruptcy.
Buckley filed an adversary complaint finding that the Bartenwerfers should not be allowed to discharge the debt owed him because it was obtained by fraud. The Bankruptcy Court found that because the evidence showed that David intentionally concealed the home's defects from Buckley, neither David nor Kate Bartenwerfer could discharge that debt. The court also imputed David's fraudulent actions to Kate because they had a legal partnership in the remodel and sale of the home. On appeal, the court found that David should definitely not be allowed to discharge his debt to Buckley, but that Kate should not have to pay unless she knew or should have known of David's fraud. Ultimately, the lower court found that Kate lacked the intent to hide defects and the fraud could not be imputed to her.
Does the Bankruptcy Code Impute Liability on Unknowing Partners to Fraud?
Section 523(a)(2)(A) states: "A discharge under section 727…. of this title does not discharge an individual debtor for 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." By its plain terms and reading, the statute prohibits Kate from discharging her debt to Buckley. The court found that Kate's situation met all three requirements of the statute:
- She is an individual debtor
- The judgment is a debt
- The debt arises from the sales proceeds obtained from false pretenses, false misrepresentation, or actual fraud.
Kate takes issue with the third premise. She asserts that the statute covers those who actually commit the fraud in order to obtain the funds; not those associated with the fraudulent actor. The court disagreed and found that the context of the statute does not single out the wrongdoer as the only possible relevant actor. Field v. Mans, 516 U.S. 59, 70-75 (1995). Further, "courts have traditionally held principals liable for the frauds of their agents." McCord v. Western Union Telegraph Co., 39 Minn. 181, 185, 39 N.W. 315, 317 (1888). Individuals in a partnership have also regularly been held liable for the bad acts of their partner within the scope of the partnership. Tucker v. Cole, 54 Wis. 539, 540-41, 11 N.W. 703, 703-704 (1882).
Although Kate asks the court here to confine the exceptions to the bankruptcy rules "to those plainly expressed", the court responded by saying it "has never used this principle to artificially narrow ordinary meaning. Instead, we have invoked it to stress that exceptions should not extend beyond their stated terms." In this case, the court reasoned that the language plainly expresses what is meant and Kate's reading of its terms are opposite of what was intended by the legislature.
Kate also argues that the neighboring provisions of §523(a)(2)(A) support her argument that the statute only meant to hold the actual tortfeasor accountable. Specifically, §523(a)(2)(B) "bars the discharge of debts of debts arising from the use of a statement in writing (i) that is materially false; (ii) respecting the debtor's or an insider's financial condition; (iii) on which the creditor to whom the debtor is liable… reasonably relied; and (iv) that the debtor caused to be made or published with intent to deceive." In addition, §523(a)(2)(C) "presumptively bars the discharge of recently acquired consumer debts owed to a single creditor and aggregating more than $500 for luxury goods or services incurred by an individual debtor." Bartenwerfer claims that the language in these provisions makes it clear that section (A) only requires the debtor's own fraud to precluded from discharge in bankruptcy.
Generally, courts have found guidance in the rule that "when Congress includes particular language in one section of a statute, but omits it in another section of the same Act, we generally take the choice to be deliberate." Badgerow v. Walters, 596 U.S. ___ (2022). This court points out this rule is not absolute and context is important when determining if the language of accompanying sections should impact the section in question. The court reasoned here that Kate's reading of the language was faulty and that "the more likely inference is that (A) excludes debtor culpability from consideration given that (B) and (C) expressly hinge on it."
The court looked to the Field case to explain why (B) provides for a "more debtor-friendly discharge rule" than (A). The Field v. Mans case concluded, "Congress may have wanted to moderate the burden on individuals who submitted false financial statements, not because lies about financial condition are less blameworthy than others, but because the relative equities might be affected by practices of consumer finance companies, which sometimes have encouraged such falsity by their borrowers for the very purpose of insulating their own claims from discharge." 516 U.S. 59 (1995). "This concern may also have informed Congress' decision to limit (B)'s prohibition on discharge to fraudulent conduct by the debtor herself." Id.
Finally, Bartenwerfer argues that holding her liable for the fraud of her partner as to her bankruptcy defeats the purpose of the "Fresh Start" doctrine. The Court disagreed yet again and found that the Bankruptcy Code seeks to balance competing interests, rather than protect the debtor in entirety. In fact, as discussed above, the statute does not address the scope of liability for another's fraud and takes the debt as it finds it. Therefore, liability for fraud can be extended to honest or unknowing partners with a special relationship with the fraud actor. In this case the Bartenwerfers were married, purchased a house together and decided to remodel and sell the house together for a joint profit. These facts establish a special relationship and allow the court to impute liability to Kate for David's fraudulent acts. Justice Barrett wrote, "A debtor who is liable for her partner's fraud cannot discharge that debt in bankruptcy, regardless of her own culpability. Mrs. Bartenwerfer could not discharge her partner's debt even though she lacked knowledge of his fraud."