Talk about timing. Yesterday, barely a week after Dave blogged about Justice Thomas’ admission that he might enjoy and appreciate bankruptcy cases more than his colleagues, Justice Thomas was the sole dissenting justice in the Supreme Court’s 7-1 decision in Husky International Electronics, Inc. v. Daniel Lee Ritz. The stated issue before the Court: Does the term “actual fraud” in 11 U.S.C. § 523(a)(2)(A) require a misrepresentation? The Court answered “No.” Justice Thomas disagreed.
We’ll cover Husky in 2 posts. Today, I’ll provide the overview that all Supreme Court decisions merit. Next, I’ll attempt to untangle Justice Sotomayor’s dicta (holding?) regarding the term “obtained by” in § 523(a)(2). Thus, over the next couple of days, we’ll aim to sort out whether the Supreme Court’s surgical attempt to resolve a limited split between the Fifth and Seventh Circuits spilled over into and, thus, clouded (rather than illuminated) our understanding of § 523(a)(2)(A).
Overview of the Case
The Husky facts do not represent a typical voidable transfer. As a result, they’re necessary to, but also might obstruct, a clear understanding of the majority’s opinion.
Husky, an electronic components supplier, sold its products to Chrysalis. Over the course of Chrysalis’ purchases, Chrysalis ran-up a $163,999 bill. During that time, Daniel Ritz was a director of Chrysalis and owned at least 30% of Chrysalis’ common stock. In 2006 and 2007, Ritz drained Chrysalis of sufficient assets to pay Husky by transferring large sums of Chrysalis’ money to other entities controlled by Ritz. In 2009, Husky sued Ritz, claiming that Ritz was personally liable for Chrysalis’ debt under Texas Business Organizations Code § 21.223(b). While the Supreme Court did not quote that provision, the text is important.
Specifically, it provides that § 21.223(a)(2), which limits shareholder liability for corporate obligations, “does not prevent or limit the liability of a holder, beneficial owner, subscriber, or affiliate if the obligee demonstrates that the holder, beneficial owner, subscriber, or affiliate caused the corporation to be used for the purpose of perpetrating and did perpetrate an actual fraud on the obligee primarily for the direct personal benefit of the holder, beneficial owner, subscriber, or affiliate.” Essentially, § 21.223(b) is a veil-piercing statute.
Ritz Files Bankruptcy
Before the federal District Court could rule, Ritz filed an individual Chapter 7 bankruptcy. In response, Husky simply repackaged its claim against Ritz in an adversary proceeding in the Bankruptcy Court and then raised § 523(a)(2)(A) as bar to Ritz being discharged of his liability for that claim on account of his “actual fraud.” Section 523(a)(2)(A) provides that a bankruptcy discharge “does not discharge an individual debtor from any debt…for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by…false pretenses, a false representation, or actual fraud…”
Bankruptcy Court v. District Court
The Bankruptcy Court rejected both of Husky’s claims, concluding that (1) Ritz was not liable for Chrysalis’ debt under the Texas statute and (2) even if Ritz were liable, § 523(a)(2)(A) did not except that liability from discharge. The District Court disagreed with the former, concluding that, by draining Chrysalis of its assets (i.e., orchestrating “fraudulent transfers”) Ritz committed “actual fraud” against Husky within the meaning of the Texas statute. Therefore, Ritz was personally liable for the Chrysalis debt. Nevertheless, the District Court agreed with the latter. Specifically, it concluded that, because the term “actual fraud” in § 523(a)(2)(A) requires a misrepresentation and Ritz made no misrepresentation to Husky, Ritz’ liability for Chrysalis’ debt should still be discharged in Ritz’ bankruptcy.
Appeal in the Fifth Circuit
On appeal, the Fifth Circuit affirmed. However, it didn’t address whether Ritz was liable for Chrysalis’ debt under Texas law. Instead it focused on the the § 523(a)(2)(A) issue. That is, does the term “actual fraud” in § 523(a)(2)(A) require a misrepresentation? Agreeing with the District Court, the Fifth Circuit held, as paraphrased by the Supreme Court, that a “necessary element of ‘actual fraud’ is a misrepresentation from the debtor to the creditor.” And because the fraudulent transfers orchestrated by Ritz didn’t involve misrepresentations to Husky, § 523(a)(2)(A) didn’t provide an exception. In holding so, the Fifth Circuit split with the Seventh Circuit’s decision in McClellan v. Cantrell (holding, essentially, that the term “actual fraud” doesn’t require a misrepresentation).
Part A of the Decision: Majority Reads “Actual Fraud” Broadly
A 7-1 Supreme Court reversed, with Justice Thomas dissenting. The majority opinion breaks down into two major sections. Part A addresses the circuit split: Does the term “actual fraud” in § 523(a)(2)(A) require a false representation? No, answers the majority. Part B addresses Ritz’, as well as Justice Thomas’, positions. In the process, the majority discusses § 523(a)(2)(A)’s “obtained by” term and, arguably, confuses an otherwise straightforward opinion. Put another way, my knee-jerk reaction was to get caught-up in that discussion instead of the stated “actual fraud” issue that created the Circuit split. More on this later.
Does “actual fraud” require a misrepresentation? No.
The majority concludes that the term “actual fraud” does not, in fact, require a misrepresentation. First, the majority makes much of the distinction between the prior Bankruptcy Act (“false pretenses or false representations”) and the current Bankruptcy Code (“false pretenses, a false representation, or actual fraud). Emphasizing, as it always does, the canons of construction, the Court presumed that Congress intended a change to the statute and, thus, rejected Justice Thomas’ contention that “actual fraud” was added to clarify, rather than expand, the scope of the phrases “false pretenses” and “false representation.”
Second, the majority relies on the Court’s Field v. Mans decision to conclude that the common law informs the terms used in § 523(a)(2)(A), including the term “actual fraud.” Thus, under the common law, the word “actual” refers to any fraud that involves “moral turpitude” or “intentional wrong.” On the one hand, the majority, refusing to be pinned-down on a definition “for all times and all circumstances,” leaves the definition of “fraud” open. On the other hand, the majority is satisfied that, going all of the way back to the Statute of 13 Elizabeth, “fraud” has included transfers of assets that (“like Ritz’ scheme”) impair a “creditor’s ability to collect” (i.e., fraudulent transfers). Further, the majority concludes that, historically, being liable for such “fraud” didn’t depend on a “false representation” or any representation, for that matter. Ultimately, the majority concludes that § 523(a)(2)(A) isn’t limited to “inducement-based” frauds; a “false representation has never been a required element” of “actual fraud”; and, thus, “actual fraud” can include fraudulent conveyances.
Our takeaway on the “actual fraud” question
To be sure, the Supreme Court granted certiorari on the limited issue of whether the term “actual fraud,” as used in § 523(a)(2)(A), requires a misrepresentation. Indeed, the Supreme Court sensed a sufficient split between the Fifth and Seventh Circuits on that precise issue. Additionally, much of the discussion and commentary leading-up to the decision focused on that question. For example, see here and here. Finally, but for Part B of the decision (which I’ll focus on in tomorrow’s post), the majority decision, right or wrong, articulates that limited issue, addresses that limited issue, and, still arguably decides just that issue.
Thus, one might expect that I’d devote this part of the post to evaluating whether the majority decided that limited issue correctly. That is, did the Supreme Court err in holding that a misrepresentation is not a required element of “actual fraud” under § 523(a)(2)(A)? However, if I’ve learned one thing about blogging about Supreme Court opinions, it is that opinions are a dime a dozen. From our standpoint as practitioners, however, does it really matter? It is now the law of the land that “actual fraud” doesn’t require a misrepresentation. Unlike other recent Supreme Court cases where the core holdings might leave room for discussions about scope (e.g., Baker Botts v. ASARCO), Part A of Husky is clear: misrepresentations aren’t required, period.
In short, if answering the “Did they get it right?” question is not essential to communicating the potential impact of a Supreme Court decision, then we’d just as soon leave that question to those who specialize in and are better-equipped for answering academic questions. For example, in his amicus brief, Eric Brunstad argued, rather convincingly, that equating the culpability required for “actual fraud” and for “actual intent” to “hinder, delay, or defraud” is not only inappropriate, but also expands § 523(a)(2)(A) in a dangerous way. However, his argument merely represents a studied conclusion that differs from the majority’s studied conclusion. Both conclusions flow from the same question: What does common law tell us? It just so happens that answering that question is the exclusive purview of the Supreme Court, whether acting as 8 or acting as 9.
For us as practitioners, while we like the debate and intellectual combat, the question is now decided.
In short, I’ll let those with more perspective and more time weigh-in on whether the majority decided the “actual fraud” question correctly in Part A. However, I’m still very interested in whether, notwithstanding Part A, the majority decision might impact our practice area in ways that exceed the Circuit split. That (i.e., Part B) will be the subject of the next post. Reserving the right to change my mind on further reflection, my initial reaction to Part B is that the majority, in seeking to overcome Justice Thomas’ dissent, begins to reach. As I’ll discuss in the next post, Part B is a straightforward and correct response to Ritz’ arguments on appeal. However, finding a more formidable foe in Justice Thomas, the majority starts to color outside the lines of an otherwise precise and defensible decision. As a result, even the best of the practitioners studying the decision might find themselves confused without additional effort. Thus, I’m punting ’til next time!
If you’d like to stay on top of this and other important bankruptcy issues, then you can subscribe to Plan Proponent via email here.
 Commenting on the March 1, 2016 Husky oral argument, the ABI’s Bill Rochelle remarked that “I very much miss Justice Scalia and his laser-like analysis of statutory language. It is remarkable how different oral argument is without him on the bench and without his insistence on a careful reading of the statute.” Not only are Bill’s remarks fitting in light of the above photo, but they also might explain a little about the now 8 justice Court’s Husky v. Ritz decision.
 The Supreme Court’s terminology is behind the times. Not that the Court would care, but in Georgia, for example, these causes of action are now voidable transfers under the new Model Act passed last year. In deference to the Court (and most of the other states that have not adopted the Uniform Voidable Transfer Act, we will use the term “fraudulent transfer” and “fraudulent conveyance.” For more info, here’s a panel discussion that Dave participated in in 2014.