Bartenwerfer v. Buckley, No. 21-908, slip opinion, 506 U.S. ___ (2023)

Dear constituency list members of the Insolvency Law Committee, the following is a case update analyzing a recent case of interest:

SUMMARY

On February 22, 2023, the United States Supreme Court held that 11 U.S.C. §523(a)(2)(A) bars a debtor from discharging a debt “obtained by … fraud,” regardless of her mental culpability with respect to incurring the debt.  Bartenwerfer v. Buckley, No. 21-908, slip opinion, 506 U.S. ___ (2023). 

To read the full published decision, click here.

FACTS

In 2005, Kate and her then-boyfriend David Bartenwerfer purchased a house in San Francisco, California. They later formed a business partnership to remodel the house with the goal of selling it for a profit.  David did all the work – hiring an architect, structural engineer, designer, general contractor, monitoring their work, reviewing invoices, and signing checks.  Kate was not an active participant. 

The Bartenwerfers eventually sold their house to Kieran Buckley.  As a part of the required disclosures under California law, the Bartenwerfers certified that they disclosed all material facts related to the property.  In reality, the Bartenwerfers failed to disclose a leaky roof, defective windows, a missing fire escape, and permit problems.  Kate was apparently unaware of the defects.  Buckley sued the Barternwerfers, alleging he overpaid in reliance of their misrepresentations.  The jury ruled in Buckley’s favor and awarded $200,000 in damages based on breach of contract, negligence, and nondisclosure of material facts. The judgment, therefore, included a fraud claim.

Unable to pay the judgment the Bartenwerfers, now married, filed for Chapter 7 bankruptcy.  Buckley filed an adversary complaint seeking that his debt be excepted from discharge pursuant to 11 U.S.C. §523(a)(2)(A) based on the Barternwerfers’ fraud. The Bankruptcy Court ruled against the Bartenwerfers finding that (1) David knowingly concealed the house’s defects and (2) imputing David’s fraudulent intent to Kate based on their business partnership.   

On appeal, the Ninth Circuit Bankruptcy Appellate Panel (“BAP”) affirmed as to David but held that §523(a)(2)(A) only applied to Kate if she knew or had reason to know of David’s bad acts.  On remand, the Bankruptcy Court held that Kate lacked this knowledge and ruled her liability could be discharged.  The judgment was then affirmed by the BAP.  The Ninth Circuit Court of Appeals reversed in relevant part, relying on Strang v. Bradner, 114 U.S. 555 (1885) which held that a partner’s fraud can be imputed to an innocent partner in determining whether a debt can be discharged in bankruptcy.   

The Supreme Court granted Kate’s petition for certiorari to resolve a split among the Courts of Appeals as to whether an individual’s fraudulent intent is required to establish non-dischargeability under §523(a)(2)(A).

REASONING

The Supreme Court rejected Kate’s argument that §523(a)(2)(A)’s logical reading is “to bar the discharge of debts for money obtained by the debtor’s fraud.”  Bartenwerfer v. Buckley, slip op. at 4.  Section 523(a)(2)(A)’s use of the passive voice (“A discharge under section 727 … does not discharge an individual debtor from any debt … “(2) … to the extent obtained by – “(A) false pretenses, a false representation, or actual fraud …”) indicates that Congress was “agnostic” about who committed the fraud.  Watson v. United States, 552 U.S. 74, 81 (2007).  The bar for dischargeability merely requires that the debt result from someone’s fraud, not necessarily the debtor’s fraud. 

The Supreme Court was not persuaded that the exception to discharge implicitly related to the debtor’s culpability in obtaining the debt.  The relevant legal context in interpreting §523(a)(2)(A) is the common law of fraud which “long maintained that fraud liability is not limited to the wrongdoer.”  Bartenwerfer, slip op., at 5 citing Field V. Mans, 516 U.S. 59, 70-75 (1995) (interpreting §523(a)(2)(A) with reference to the common law of fraud).  Under the common law of fraud, a principal’s fraudulent intent can be imputed to an agent within the scope of the agency in the same way that one partner’s intent can be imputed to other partners in a partnership. 

The Supreme Court also rejected Kate’s argument that subparagraphs (B) and (C)’s inclusion of language explicitly tying non-dischargeability to the debtor’s actions implies that Congress intended the same result for subparagraph (A).  “The more likely inference is that (A) excludes debtor culpability from consideration given that (B) and (C) expressly hinge on it.”  Bartenwerfer, slip op. at 7.

The Supreme Court’s interpretation was buttressed by Strang v. Bradner and Congress’ reaction to it.  In Strang, the Court held that for purposes of non-dischargeability one partner’s fraud can be attributed to other innocent partners if that partner was acting within the scope of the partnership.  This was true despite the language of the Bankruptcy Act of 1867 which limited the discharge exception to the “fraud … of the bankrupt.”  Bartenwerfer, slip op., at 8.  Congress subsequently amended the Bankruptcy Code by deleting “of the bankrupt” from the discharge exception for fraud.   Bartenwerfer, slip op., at 9.  By removing this language, Congress reinforced its intent to preclude from discharge debts attributable to fraud regardless of a debtor’s culpability.   

Lastly, the Supreme Court rejected Kate’s argument that “[p]recluding faultless debtors from discharging liabilities” attributable to their partner’s fraud “is inconsistent” with the policy of promoting a debtor’s “fresh start.”  Bartenwerfer, slip op., at 10.  The Supreme Court noted that the Bankruptcy Code “balances multiple, often competing interests” and that §523(a)(2)(A) “takes the debt as it finds it, so if California did not extend liability to honest partners, 523(a)(2)(A) would have no role to play.”   Bartenwerfer, slip op., at 11.    

In a brief concurrence by Justices Sotomayor and Jackson, they implied that the Supreme Court could have stopped its analysis and reached the same result faster when they stated “Congress incorporated into the statute the common-law principles of fraud,  Husky Int’l Electronics, Inc. v. Ritz, 578 U.S. 356, 360, 136 S.Ct. 1581, 194 L.Ed.2d 655 (2016) (citing  Field v. Mans, 516 U.S. 59, 69, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995)), which include agency and partnership principles, ante, at 5-6. This Court long ago confirmed that reading when it held that fraudulent debts obtained by partners are not dischargeable.  Strang v. Bradner, 114 U.S. 555, 559–561, 5 S.Ct. 1038, 29 L.Ed. 248 (1885), and Congress ‘embraced’ that reading when it amended the statute in 1898, ante, at 10.”

AUTHOR’S COMMENTS

Justice Barrett, joined by a unanimous Court, takes a textualist interpretation of §523(a)(2)(A) and purports to apply a plain-meaning approach to a clause that is capable of different interpretations.  In a post-Bartenwerfer world, bankruptcy counsel would be wise to consider the following –

(1)  Textualism trumps contextualism.  The Supreme Court focused on §523(a)(2)(A)’s failure to specify the actor committing the fraud and refused to read into the statute that Congress was referring to the “debtor’s” fraud.  The Supreme Court rejected the argument that contextual clues such as §523(a)’s reference to debts that an “individual debtor” cannot discharge and subparagraph (B) and (C)’s reference to actions of the individual debtor indicated Congress’ intent that subparagraph (A) requires the debtor’s fraudulent intent.             

(2) Policy of “competing interests” takes precedence over “fresh start.”  The Supreme Court gave short rift to the argument that “[t]he same Congress that ‘championed’ the fresh start could not also have shackled honest debtors with liability for frauds that they did not personally commit.”  Bartenwerfer, slip op., at 10.  In its place, the Supreme Court focused on competing interests, citing §523 as an example where “Barring certain debts from discharge necessarily reflects aims distinct from wiping the bankrupt’s slate clean.” Bartenwerfer, slip op., at 11. 

(3) Caveat Debtor. Bartenwerfer clears the way for creditors to seek non-dischargeability actions against non-culpable debtors based on a theory of imputed intent. This may result in increased litigation – or threats of litigation – and counsel must take this into account when advising debtors of potential risks and in determining appropriate fees. Moreover, while the concurrence focuses on agency and partnership principles, the opinion can arguably be interpreted to provide for vicarious liability for non-culpable individuals who are not agents or partners of the guilty actor. It is worth considering whether the Supreme Court would have decided differently if the Bartenwerfers had not formed a partnership.   

These materials were written by Leonidas G. Spanos, a Partner at Jen Lee Law, Inc. based out of the San Francisco Bay Area. (leo@jenleelaw.com). Editorial contributions were provided by Kathleen A. Cashman-Kramer, of Counsel at Sullivan Hill Rez & Engel, APLC, of San Diego.