May 16, 2016

Supreme Court Decides Husky International Electronics, Inc. v. Ritz

On May 16, 2016, the U.S. Supreme Court decided Husky International Electronics, Inc. v. Ritz (No. 15-145), holding that the term “actual fraud” in § 523(a)(2)(A) of the Bankruptcy Code (one of the discharge exceptions) applies to fraudulent conveyance schemes even when those schemes do not involve a false representation.

Chrysalis Manufacturing Corp. owed money to Husky International Electronics, Inc. for products that Husky sold to Chrysalis. Daniel Ritz was a director and 30-percent shareholder of Chrysalis, and he transferred money from Chrysalis to other entities that he owned, thus draining Chrysalis of assets that the company could have used to pay its debts to Husky and other creditors.

Husky sued Ritz under a Texas statute that allows creditors to hold shareholders responsible for corporate debt. Ritz then filed for Chapter 7 bankruptcy. Husky filed an adversary proceeding in Ritz’s bankruptcy case, asserting that Ritz was personally liable for Chrysalis’s debt under Texas law and that Ritz’s debt was not dischargeable in bankruptcy under § 523(a)(2)(A) because he engaged in “actual fraud” by causing fraudulent conveyances of Chrysalis’s property.

The District Court held that Ritz was personally liable for the debt under Texas law, but that the debt was not “obtained by … actual fraud” and therefore could be discharged in Ritz’s bankruptcy. The Fifth Circuit affirmed on appeal, holding that the term “actual fraud” in § 523(a)(2)(A) required proof of a misrepresentation from the debtor to the creditor. While Ritz may have hindered Husky’s ability to recover its debt, the Fifth Circuit concluded, he did not make any false representations to Husky.

The Supreme Court reversed and held that the term “actual fraud” in § 523(a)(2)(A) “encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.” The Court began by pointing out that before 1978, the Bankruptcy Code prohibited discharge of debts obtained by “false pretenses or false representations.” The Court concluded that when Congress added the term “actual fraud” in 1978, it could not have intended that phrase to require false representations because the term “false representations” was already in the statute. The Court also explained that the historical meaning of the term “actual fraud” is broader than just false representation, and has included transfers of assets that impair a creditor’s ability to collect a debt. The Court concluded that “a false representation has never been a required element of ‘actual fraud,’ and we decline to adopt it as one today.”

Justice Sotomayor delivered the opinion of the Court, in which Chief Justice Roberts and Justices Kennedy, Ginsburg, Breyer, Alito, and Kagan joined. Justice Thomas filed a dissenting opinion.

Download Opinion of the Court.

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