U.S. Supreme Court Rules Another Person’s Fraud Can Bar a Debt Discharge
Bankruptcy law has long barred the discharge of debts when the debtor has committed fraud. The rationale is that people should not be rewarded for the negative consequences of their unlawful actions. Now, the U.S. Supreme Court has settled the question of whether the fraud exception can apply when someone other than the debtor is involved in the fraud.
In Bartenwerfer v. Buckley, the high court ruled that fraud committed by a woman’s spouse in a real estate deal could bar her from receiving a discharge in bankruptcy, even though it was undisputed that she was innocent of fraud. The case began when David and Kate Bartenwerfer decided to renovate and sell their home in California. After the sale, the buyer Kieran Buckley found defects in the home that were not disclosed as required by California law. Buckley sued the couple in state court and won a judgment of more than $200,000. The court found that although only David was aware of the defects and did not disclose them, Kate was jointly liable because she was a partner in the sale.
Subsequently, the Bartenwerfers filed a Chapter 7 bankruptcy in which they sought to discharge Buckley’s judgment, among other debts. Buckley objected to the discharge in an adversary proceeding, based on the fraud found in the state court case. The bankruptcy denied both spouses a discharge of the debt. An appellate bankruptcy panel reversed as to Kate, finding the fraud exception applies only if a debtor was in some way complicit in the fraud. The Ninth Circuit Court of Appeals disagreed.
The Supreme Court found the fact that Kate knew nothing about the defects in the home was irrelevant to applying the fraud exception against her. The applicable bankruptcy code section exempts debts “obtained by” fraud without specifying the perpetrator. The justices noted that liability for fraud may attach to partners and agents, regardless of their actual knowledge or participation. Although Kate was not a party to the fraud, she benefited from it through the sale of the home.
This expansive reading of the bankruptcy code’s fraud exception may serve to restrict the ability of Chapter 7 debtors to discharge certain judgments. However, the burden is on the judgment creditor to seek a court determination that the fraud exception applies. Having an experienced bankruptcy attorney on your side can help you present an effective defense to such an allegation.
The Law Offices of Michael Jay Berger is one of the Southern California’s busiest bankruptcy law firms, with 12 locations in the region. If you are overwhelmed by consumer debt, contact us online or call 310-271-6223 to schedule a free initial consultation.