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United Stated Supreme Court Rules Individuals Cannot Discharge Debt Incurred Through Fraud

Mar 7, 2023

On February 22, 2023, the United States Supreme Court affirmed a decision of the Ninth Circuit Court of Appeals (the “Ninth Circuit”) in the case of Bartenwerfer v. Buckley, 860 Fed. Appx. 544 (Feb. 22, 2023) and held that debts obtained through fraud cannot be discharged in bankruptcy, even if the individual seeking the bankruptcy discharge was unaware of the actual fraud.  

Background:

Homeowners Kate Bartenwerfer (“Kate”) and her husband, David Bartenwerfer (“David”), purchased a home in San Francisco, CA in 2005, with the intention of remodeling and flipping it.  David was in charge of the project, while Kate was largely uninvolved and unaware of the specifics of the remodel.  The couple later sold the home to buyer Kieran Buckley (“Buckley”).  Shortly after purchasing the home, Buckley noticed there were major defects with the property, such as a leaky roof and defective windows, which defects were purposefully withheld by David.  

Buckley sued both Kate and David for concealing the defects, and obtained a California state court judgment for $200,000.  Kate and David then filed for Chapter 7 bankruptcy protection and sought to discharge Buckley’s money judgment.  David was barred from discharging Buckley’s judgment because he committed the actual fraud by purposefully withholding and concealing the defects.  In 2021, the Ninth Circuit held that Kate could not discharge the judgment either, even though she was unaware of the defects and did not commit the fraud herself.  Kate then appealed to the United States Supreme Court.  

Bankruptcy Law:

Section 523(a)(2)(A) of the United States Bankruptcy Code bars the discharge of certain debts to the extent obtained by… “false pretenses, a false representation, or actual fraud.”  11 U.S.C. § 523(a)(2)(A).  The Bankruptcy Code, however, is less clear if Section 523(a)(2)(A) applies in situations where the person seeking the discharge did not commit the actual fraud, but merely benefited from it.  

Supreme Court Decision:

In writing for the Supreme Court’s 9-0 decision, Justice Amy Coney Barret wrote that the Bankruptcy Code allows someone like Kate, who was unaware of the fraud, to still be held liable as the law “turns on how the money was obtained, not who committed fraud to obtain it.”  In rejecting the arguments of Kate’s counsel, the Supreme Court wrote that the “common law of fraud – has long maintained that fraud liability is not limited to the wrongdoer.”  In addition, the fact that the language of Section 523(a)(2)(A) is written in the passive voice means the focus is on the event that occurs, not the specific actor.    

Conclusion:

When seeking to discharge debts incurred by fraud, the focus is not on the party who actually committed the fraud, but rather, on all parties who benefitted from it, even if such beneficial party had nothing to do with the actual fraud.  Simply put, the Supreme Court has now made clear that the Bankruptcy Code cannot be used as a shield to avoid the debt of someone who profits from another’s fraud.

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