On Tuesday, we blogged about the Supreme Court’s decision in Husky International Electronics Inc. v. Daniel Lee Ritz. The decision focused on the phrase “actual fraud” in 11 U.S.C. § 523(a)(2)(A), which excepts from discharge any debts arising from money, property, services, or credit “to the extent obtained by . . . false pretenses, a false representation, or actual fraud.” Regardless of what we think of the merits of the case, the Supreme Court held in a precise, narrow Part A of the opinion that “actual fraud” doesn’t require, as urged by the Fifth Circuit and Justice Thomas (in his dissent) a false representation. As promised, we’ll now cover Part B of the opinion, arguably the more interesting but almost more confusing part of the opinion.
Decoding Part B of Husky v. Ritz
In Part B, Justice Sotomayor addresses the arguments raised by Ritz and by Justice Thomas in his dissent. Initially, Part B is a straightforward response to Ritz’ arguments on appeal. In fact, the majority dispenses easily with Ritz’ arguments that Husky’s and, ultimately, the majority’s reading of § 523(a)(2)(A) somehow renders “duplicative” or overlaps undesirably with § 523(a)(4), (a)(6), and § 727(a)(2).
However, discovering a more formidable argument in Justice Thomas’ emphasis on the phrase “obtained by” in § 523(a)(2)(A), the majority starts to color outside the lines of an otherwise precise and logical decision. In our opinion, Part B is simply dicta and, thus, arguably is worthy of being left alone. And we would leave it alone if it wasn’t already causing needless confusion–academic confusion at least. Additionally, it very well might confuse litigation under § 523(a)(2)(A). As a result, even the best of the practitioners studying the decision might find themselves drawn confused as to the definition of “obtained by.”
Justice Thomas “Speaks”
Justice Thomas, who some are suggesting is the Court’s last remaining vestige of “plain meaning,” argues that the majority misconstrues the phrase “obtained by” to bring fraudulent transfers under the purview of § 523(a)(2)(A). Specifically, he reads the majority opinion as imposing a weaker definition of “obtained by” in which debts from money, property, or services “traceable to the fraudulent conveyance” are excepted from discharge. He makes two arguments against this weaker definition. First, Field v. Man’s discussion of “actual fraud” includes “reliance” on some false statement, misrepresentation, or omission. Second, the phrase “obtained by” modifies “false pretenses,” “false representation,” and “actual fraud” equally. Because neither the debt nor the money, property, or services was obtained by the fraudulent transfer, Justice Thomas concludes that the debt should be dischargeable.
Justice Sotomayor Responds Too Much
In seeking to push back against Justice Thomas, the majority opinion only succeeds in muddying the waters of an otherwise very narrow, clear opinion. Indeed, in Part A, the majority isolates the narrow issue that produced the split between the Fifth and Seventh Circuits, sides with the Seventh Circuit, and “drops the mic” so to speak. But then Justice Sotomayor picks back up the mic in Part B.
Initially, Justice Sotomayor acknowledges that the transferor does not “obtain” debts in a fraudulent conveyance. Nor, we would note, does the debtor obtain money, property, or services in a fraudulent transfer; the debtor’s purpose in making a fraudulent transfer is to lodge those items in a trustworthy third party for protection from creditors. But Justice Sotomayor then points out that “the recipient of the transfer—who, with the requisite intent, also commits fraud, can ‘obtai[n]’ assets ‘by’ his or her participation in the fraud.” (Justice Sotomayor may have made this point because Ritz was arguably both the transferor and transferee. If Ritz was the transferee (because of his interest in the companies receiving the assets), then Justice Sotomayor is pointing to Ritz’ receipt of money and property as the crux of the dischargeability action. Indeed, she makes this dual transferor/transferee point in footnote 3 of the opinion.)
While we can understand the majority’s desire to address Justice Thomas’ arguments, we’re at a loss to understand exactly what to take away from Part B and where it leaves us in defining the phrase “obtained by.” The Supreme Court states that the transferee of a fraudulent transfer (if the necessary actual fraud is found) can be the subject of a § 523(a)(2)(A) action to except that debt from his or her bankruptcy discharge. The majority opinion acknowledges that this factual scenario “may be rare” because the transferee is unlikely to be headed for bankruptcy, but claims that this supports the argument that fraudulent conveyances are not wholly incompatible with the “obtained by” requirement. Even more puzzlingly, after going through all the brain damage, the Supreme Court ducks the “obtained by” issue entirely, as footnote 3 of the opinion remands to the Fifth Circuit “whether the debt to Husky was ‘obtained by’ Ritz’ asset-transfer scheme.”
In our view, Part B of the majority opinion was unnecessary and causes more questions than answers. (Stern v. Marshall anyone?) The Supreme Court had already addressed the definition of “actual fraud,” and the district court had found that Ritz had committed actual fraud. Thus, the third element of § 523(a)(2)(A) was satisfied. The opinion should have stopped there. Instead, we are left with a muddled understanding of “obtained by” under § 523(a)(2)(A).
First, we’re not clear how the Supreme Court found that Ritz owed a debt for money, property, or services to Husky. For that matter, we aren’t even sure if the Court did make that finding. As best we can tell, the Supreme Court relied upon the district court’s holding that Ritz was liable to Husky under the Texas statute quoted in the last post. Does that mean that the Ritz incurred the debt when he committed the fraudulent transfer or when the district court entered the judgment against him? The opinion doesn’t say. If the former, how did Ritz incur a debt to Husky? If the latter, how can it be said that the debt (i.e., the judgment) was obtained by actual fraud? Or is the district court’s finding of actual fraud equivalent to a veil piercing action which, in essence, holds that Ritz became liable when Chrysalis did, as if Ritz had ordered the products from Husky? It’s critical to understand the nature of a piercing remedy.
Second, the majority’s loose use of language in discussing the “obtained by” language will cause confusion. For example, it states at one point in the opinion that “any debts ‘traceable to’ the fraudulent conveyance will be nondischargable under § 523(a)(2)(A).” “Traceable to” and “obtained by” are, in our humble opinion, two different concepts. Nevertheless, we anticipate that some creditor at some point will make exploit or conflate the two, and cite to Husky.
Third, the majority also rejects Justice Thomas’ contention that the fraud must arise at the inception of a credit transaction, but fails to address Justice Thomas’ contention that the phrase “obtained by” modifies “false pretenses” “false representation,” and “actual fraud,” equally. Does the dicta in Husky apply to these phrases as well?
Fourth, it is clear that the Supreme Court distinguishes between fraudulent transfers judgment based on actual fraud and constructive fraud for purposes of a transferee filing bankruptcy to discharge the judgment. For example, under Georgia law, a creditor may obtain a judgment against a debtor and a transferee if the debtor made a voidable transfer either with actual intent or as a constructive matter. O.C.G.A. § 18-2-74. Under Husky, a judgement against the transferee would be excepted from discharge as long as the transferee was found to have acted with actual intent to hinder, delay, or defraud. Conversely, the transferee would be free to discharge a judgment under a constructively fraudulent theory. While courts have long looked at the debtor-transferor’s intent, it now appears that courts will have to rule on the transferee’s intent, as well, if creditors want to except their judgment against the transferee in bankruptcy.
In summary, we don’t think that Justice Sotomayor eliminated the “obtained by” requirement for excepting a debt from discharge. In fact, footnote 3 leaves it for the Fifth Circuit to figure out. The statutory language is still there and the unusual facts of the case (especially the fact that the debtor was, arguably, both the transferor and transferee) coupled with the fact that the Supreme Court expressly stated that the Fifth Circuit should consider the “obtained by” issue on remand should limit the confusion caused Justice Sotomayor’s dicta on the phrase.