Passive Voice and 1885 Case Sink Debt Discharge

Posted by NCBRC - February 23, 2023

SCOTUS determined that section 523(a)(2)(A), which excludes from discharge debts incurred by fraud, applies to innocent partners of the fraudulent actor where the statute does not draw any connection between the individual debtor and the fraudulent conduct but instead is written in passive tense saying merely that a debt owed by an individual and procured by fraud is nondischargeable. Bartenwerfer v. Buckley, No. 21-908,  __ U.S. __ (Feb. 22, 2023). The decision was unanimous with a concurring opinion by Justice Sotomayor adding that the decision turned on the fact that the debtor had an agency relationship with the fraudulent actor.  

The debtor, Kate Bartenwerfer and her husband David Bartenwerfer, bought property in San Francisco which they planned to remodel and sell at a profit. David handled the project and the debtor was not actively involved. After they sold the property, the buyer discovered a number of undisclosed problems. He sued both Kate and David in state court for breach of contract, negligence, and nondisclosure of material facts, and won a judgment against them jointly in the amount of $200,000. The Bartenwerfers then filed for chapter 7 bankruptcy. The purchaser filed an adversary complaint seeking a finding that his claim was nondischargeable as having been incurred by false pretenses or fraud. The bankruptcy court found that the debt was nondischargable as to both David and Kate.

The Bankruptcy Appellate Panel for the Ninth Circuit reversed the finding as to Kate, finding that the debt was nondischargeable as to her only if she knew, or had reason to know of David’s fraud. On remand, the bankruptcy court found that Kate’s liability on the debt was discharged. The BAP affirmed. The Ninth Circuit reversed, finding that, under Strang v. Bradner, 114 U. S. 555 (1885), a debtor is liable for her partner’s fraud and cannot discharge that debt in bankruptcy, regardless of her own culpability. The Supreme Court granted certiorari.

Writing for the Court, Justice Barrett began with section 523(a)(2)(A), which provides that a discharge does not discharge an individual debtor for a debt “obtained by false pretenses, a false representation, or actual fraud . . .” The Court found all requirements for exclusion from discharge were met. Kate Bartenwerfer was an individual, the state court judgment created a debt, and the debt was based on fraud. The fact that the individual debtor was not the one who committed the fraud was irrelevant in light of Congress’s use of the passive tense referring only to fraud with respect to the debt rather than the actor.

The Court observed that its conclusion was supported by the common law understanding that fraud is not limited to the wrongdoer but extends to principals liable for the fraud of their agents, or to partners liable for the acts of other partners.

The Court was unpersuaded by the debtor’s argument that the context of section 523(a)(2) lends credence to her position. Specifically, the debtor maintained that sections 523(a)(2)(B) and (C) both refer to acts of misconduct actually carried out by the individual debtor. The debtor extrapolated that Congress intended nondischargeability in section 523(a)(2)(A) also to be based on actual culpability by the debtor.

The Court reached the opposite conclusion, finding that the express reference to the individual actor in paragraphs 523(a)(2)(B) and (C) suggested that the absence of a similar reference in section 523(a)(2)(A) indicated Congress’s intent to broaden nondischargeability under that section to non-culpable actors. The Court was satisfied that the difference between section 523(a)(2)(A) and the similarly fraud-based, but individually targeted, nondischargeability of section 523(a)(2)(B) supported the view that Congress intended different levels of culpability.

The Court referred to its 1885 decision in Strang, where it held that two innocent business partners of the third partner who committed fraud were equally liable because they benefitted from the fraud to the same extent the culpable partner did. They could not discharge the debt in bankruptcy even though the Code at that time specifically referred to nondischargeability of debts incurred by the fraud “of the bankrupt.” The nineteenth century Court established that the fraud of one partner was the fraud of all. Congress’s removal of the phrase “of the bankrupt” in later iterations of the provision reinforced the Court’s finding that Congress intended to extend nondischargeability to non-culpable parties.

The Court observed that the underlying state law judgment applied to both Kate and David and that the debtor’s arguments related to general unfairness of making an innocent party liable for the fraud of another would have been better directed to that court.

The Court affirmed the Ninth Circuit decision finding the debt nondischargeable as to Kate Bartenwerfer.

Justice Sotomayor filed a concurring opinion joined by Justice Jackson. Crucial to her concurrence was Kate Bartenwerfer’s concession that she and David were partners in the remodeling and sale endeavor. Justice Sotomayor noted that had there been no agency or partnership relationship between the two, she would have reached the opposite conclusion.

Bartenwerfer SCt Feb 2023


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