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Supreme Court Takes Broad Perspective of “Fraud” in Bankruptcy

Posted in Bankruptcy

In a win for creditors, the Supreme Court of the United States has taken an expansive view of the type of fraud that will prevent a debtor from discharging his debts in bankruptcy. The Court’s decision in Husky International Electronics, Inc. v. Ritz settles a circuit split over whether the Bankruptcy Code prohibits debtors from discharging debts obtained by purposeful concealment where the debtor does not make a misrepresentation to the creditor.

The facts of Husky center on an individual who served as the director and part owner of the debtor corporation. The corporation owed the plaintiff creditor nearly $164,000. Instead of paying the debts, the director transferred large sums of cash from the corporation to other entities he controlled. The plaintiff attempted to hold the director personally liable for the corporation’s debts which resulted in the director filing for Chapter 7 bankruptcy protection.

In bankruptcy, debtors are prohibited from discharging debts “obtained by . . . false pretenses, a false representation, or actual fraud.” 11 U.S.C. § 523(a)(2)(A). The director argued that because he did not make any misrepresentations the conveyances did not rise to the level of “actual fraud.”

In reversing the Fifth Circuit, the Supreme Court noted that the phrase “actual fraud” had been added by amendment to the existing terms constituting prohibited conduct, and its meaning is not limited to the same misconduct proscribed by the other two. The Court held that actual fraud can be effectuated without an affirmative misrepresentation. The Court held that actual fraud may occur not just “when a person applying for credit adds an extra zero to her income or falsifies her employment history” but can result from the transfer of property made to evade payment.

This decision should be well received by creditors as the prohibition on discharging debt due to actual fraud applies to Chapters 7, 11, 12, and 13.