What Constitutes Fraud In Bankruptcy? SCOTUS To Resolve First And Fifth Circuit Split In 2016

Earlier this month the Supreme Court granted certiorari to hear the Fifth Circuit case Husky International Electronics, Inc. v. Ritz, which originated in the United States Bankruptcy Court for the Southern District of Texas. The Fifth Circuit's decision interprets "actual fraud" in the context of an exception to a debtor's discharge that would require a creditor to prove that the debtor made a false representation. As the decision stands, this interpretation would make it more difficult for creditors to prove actual fraud when debtors transfer assets with the intent of hindering payments to creditors, making it easier for debtors to place assets out of creditors' reach.

The question presented to the Supreme Court focuses on the "actual fraud" exception to discharge under § 532(a)(2)(A) of the bankruptcy code, and whether this exception applies only when the debtor has made a false representation, or whether the "actual fraud" exception also applies if the debtor deliberately obtained money through a fraudulent transfer scheme that was actually intended to cheat a creditor.

In Husky, Husky International Electronics, Inc. ("Husky") sold and delivered goods to Chrysalis Manufacturing Corp. ("Chrysalis"), which the debtor, Daniel Lee Ritz, Jr. controlled.1 Chrysalis failed to pay for the goods purchased from Husky, leaving $163,999.38 as the total amount of Chrysalis' unpaid debt to Husky.2 Between November 2006 and May 2007, Ritz transferred millions of dollars from Chrysalis to seven other entities he controlled and owned.3 Husky sought to hold Ritz personally liable and sued him for the debt of Chrysalis in May 2009.4 Seven months later, Ritz filed a chapter 7 petition in the United States Bankruptcy Court for the Southern District of Texas.5 Husky then initiated an adversary proceeding and objected to the discharge of Ritz's alleged debt.6 The bankruptcy court held a trial on the matter and found that the transfers Ritz made "were not made for reasonably equivalent value" and that Husky suffered damages in the amount of the debt owed by Ritz.7 However, the court found that the "actual fraud" exception to discharge did not apply because Husky failed to show that Ritz made a false representation to Husky and therefore Ritz could not have perpetuated an "actual fraud."8 On appeal, the district court affirmed the bankruptcy court's decision, holding that "actual fraud under 11 U.S.C. § 523(a)(2)(A) . . . requires a misrepresentation."9

The...