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Client Alert
U.S. Supreme Court rules that a debtor cannot discharge debt resulting from a business partner's fraudulent activity - Bankruptcy
By: Solymar Castillo Morales, Esq.
Edgardo Rodríguez-LaFontaine, Esq.
February 27, 2023
On February 22, 2023, the United States Supreme Court issued an opinion in Bartenwerfer v. Buckley, 598 U.S. ___ (2023) ruling that a debtor found liable for their partner's fraud cannot discharge the debt in bankruptcy, even if the debtor did not personally commit, or has any knowledge of the fraud.
In Bartenwerfer, the debtor and her then-boyfriend acted as business partners in buying, renovating, and selling a house for a profit. The debtor's boyfriend took charge of the project, while she remained largely uninvolved. During the sale, the couple attested that they had disclosed all material facts related to the property. After the purchase, the buyer discovered several defects that the business partners failed to disclose. The buyer sued the couple and won, leaving both jointly responsible for more than $200,000 in damages. The “innocent” debtor attempted to discharge her debt through a Chapter 7 bankruptcy, claiming she was unaware of her partner's fraud during the sale.
The buyer filed an adversary complaint and after extensive litigation before the Bankruptcy Court, the Bankruptcy Appellate Panel, and the Ninth Circuit, the Supreme Court ruled that even if the “innocent” debtor was unaware of the fraud that resulted in the judgment against her, Section 523(a)(2)(A) of the Bankruptcy Code barred the discharge of the debt based on the previous finding of liability. The Court considered that, ordinarily, a faultless individual is responsible for another’s debt only when the two have a special relationship, and even then, defenses to liability are available. The explanation on §523(a)(2)(A) turns on how the money was obtained, not who committed fraud to obtain it. The Court resolved an apparent confusion in certain lower courts over the meaning of §523(a)(2)(A). The Court concluded by emphasizing, and citing Grogan v. Garner, 498 U. S. 279, 287 (1991), that Congress has “evidently concluded that the creditors’ interest in recovering full payment of debts” obtained by fraud “outweigh[s] the debtors’ interest in a complete fresh start.”
This ruling highlights the importance of adequate business organization and isolation from liability exposure. In addition, it emphasizes the duty to be involved or knowledgeable of the partnership's operations and businesses.
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