One of the generally accepted aphorisms of bankruptcy law is that the scope of a discharge in bankruptcy is broad, in order to get the debtor a fresh start. Challenges to the extent of a discharge are generally resolved in favor of the debtor. However, Congress excepted from the otherwise sweeping scope of the debts eliminated some which, for various reasons, should not be easily wiped out. Examples include obligations such as child support, for death or injury caused by driving under the influence, certain tax liabilities, certain student loans, domestic support obligations and others. Among the debts excepted from discharge are any debts:
… for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by … false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition …
Whether this exception to discharge applied to a certain transaction was addressed by the Supreme Court in the case of Husky International, Inc. v. Ritz, decided on May 16, 2016. Ritz was a part-owner of Chrysalis, Manufacturing Corp. (“Chrysalis”). During the course of its operations, Chrysalis incurred debts to Husky International, Inc (“Husky”). Ritz used his position with Chrysalis to siphon off its assets and to transfer those assets to other entities in which he had an ownership interest. When Husky sought payment from its customer, there were no funds available for payment. Husky sued Ritz on a fraudulent transfer theory asserting he was personally liable for the debt.
Ritz filed a personal bankruptcy and Husky objected to the discharge of its debt, relying upon the provision quoted above. Both the district court and the Fifth Circuit Court of Appeals dismissed the claim, finding that Ritz’s debt to Husky did not arise from “actual fraud” under the statute because Ritz had made no misrepresentation to Husky. Thus, the Courts found that Ritz’s debt to Husky was dischargeable.
On appeal, the United State Supreme Court reversed the lower Courts. The Supreme Court concluded that “actual fraud” had a much broader meaning than was ascribed to it by the lowers courts. Writing for the majority, Justice Sotomayor pointed out that the historical meaning of “actual fraud” demonstrated that the phrase has long encompassed the kind of conduct alleged against Ritz: a transfer scheme designed to hinder the collection of a debt. The Court went on to hold that the phrase “actual fraud” in 11 U.S.C. §523(a)(2)(A) encompasses fraudulent conveyance schemes, even when those schemes do not involve a false representation.
The holding serves to expand the scope of the section’s exceptions to discharge and broadens the range of debts that can be excepted from discharge. As a consequence, the hope that the broad scope of a bankruptcy discharge can allow individuals to escape liability for certain debts has been limited. People engaged in schemes falling within the historical purview of “actual fraud” will not find refuge in the bankruptcy courts and the remedies available to creditors to pursue collection of debts incurred through or arising from “actual fraud,” have been expanded.
