Debtors hoping to discharge their obligations in bankruptcy may find a new hurdle based on the US Supreme Court’s Feb. 22 ruling. Relying on the plain language of the Bankruptcy Code, and Congress’s use of passive voice, the Supreme Court held that funds obtained through fraud, regardless of who committed such fraud, are not dischargeable through bankruptcy.
The court’s unanimous decision reminds practitioners that the first stop for interpreting statutes is the plain meaning of the text, and there’s no need to use other tools if the meaning is unambiguous. The high court’s opinion also reminds attorneys that precedent doesn’t lose its power—even after a century passes.
Fraud Finding in Remodeling Case
In Bartenwerfer v. Buckley, the high court considered the dischargeability of fraudulently obtained debt of joint debtor Kate Bartenwerfer. Years ago, Bartenwerfer purchased with her then-boyfriend, David Bartenwerfer, a house to remodel and sell at a profit. While Kate Bartenwerfer participated financially in the project, she turned the reins over to David to hire, manage, and pay the remodeling professionals.
Kieran Buckley purchased the completed house. In conjunction with the house sale, Kate and David Bartenwerfer made certain disclosures that were untrue. After discovering many undisclosed defects with the house, Buckley obtained a joint and several judgments against both Bartenwerfers.
Unable to pay Buckley, David and Kate Bartenwerfer filed for Chapter 7 bankruptcy relief. Buckley filed an adversary proceeding against both Bartenwerfers alleging that the judgment he had obtained against them was nondischargeable under Section 523(a)(2)(A) of the Bankruptcy Code as a debt for money that was obtained by fraud. After a two-day trial, the bankruptcy court ruled in Buckley’s favor, finding that the judgment debt was nondischargeable as to both Bartenwerfers.
The Ninth Circuit B.A.P. reversed, holding that, for the judgment debt to be nondischargeable as to Kate, she needed to have actually known or had reason to know that David had made the fraudulent disclosures about the house.
However, the Ninth Circuit reversed again, relying on the Supreme Court’s Strang v. Bradner, which held that a debtor cannot discharge a debt arising from her partner’s fraud, regardless of the debtor’s own culpability for such fraud.
Plain Text Guides
The Supreme Court’s decision relied on basic tenants of statutory interpretation. First, the court looked to the plain text of section 523(a)(2)(A), which expressly holds that a debt “for money … obtained by … false pretenses, a false representation, or actual fraud” is excepted from discharge.
The court’s decision reminds practitioners that, where a statute’s plain meaning is not ambiguous, courts should refrain from applying other mechanisms to interpret the statute.
Here, the statute uses passive voice to describe how the debt was incurred, specifically failing to identify the actor that engaged in the fraud. The Supreme Court rejected Kate Bartenwerfer’s argument that, despite use of passive voice, a typical reader would nonetheless understand that statute to mean that the debtor must have engaged in the fraud for the debt to be nondischargeable.
Next, the court relied on the standard rule that, if Congress includes specific language in one section of a statute but omits such language from another section, the decision to not include the language is deliberate.
Specifically, the court rejected Kate Bartenwerfer’s argument that neighboring sections of Section 523, which except from discharge certain debts based on the debtor’s conduct, implies that Section 523(a)(2)(A) should be interpreted to also mean that the fraud must have been committed by the debtor for the debt to be nondischargeable.
Practitioners are also reminded by the court’s ruling that precedent, no matter how seemingly outdated, generally binds decisions. Here, the court held that its decision was directly supported by Strang and Congress’s response to it.
After the court’s holding in Strang that a debt incurred by a debtor’s business partner’s fraud is nondischargeable by the debtor, Congress embraced Strang by removing “of the bankrupt” from section 523(a)(2)(A)’s predecessor statute. Practitioners should be aware that courts are usually reluctant to overrule precedent where there’s no compelling reason to do so.
Finally, the court identified that other areas of the law also sometimes impose liability for another’s conduct on an otherwise innocent partner. Emphasizing Kate’s business partner relationship with David, the court held that Buckley’s interest in repayment of the debt incurred by David’s fraud outweighs Kate’s “fresh start.”
Accordingly, the high court affirmed the Ninth Circuit ruling that Kate’s debt was nondischargeable. Of note, Justice Sonia Sotomayor’s concurrence also emphasizes this business partner relationship.
This decision is a good refresher for practitioners regarding the standard tenants of statutory interpretation.
Additionally, going forward, judgment creditors whose claims arise from fraudulent conduct should be sure to analyze whether they have a nondischargeability claim rather than simply writing off their debt upon notice of a bankruptcy filing.
On the flip side, judgment debtors should consider that a bankruptcy filing may not relieve them from liability for certain debts arising from fraud.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Elizabeth R. Brusa is a financial services and bankruptcy and creditors’ rights attorney at Bradley Arant Boult Cummings.