by Patrick Hruby, Esq.

Brock &Scott, PLLC*

USFN Member (AL, CT, FL, GA, KY, MA, MD, ME, MI, NC, NH, NJ, OH, PA, RI, SC, TN, VA, VT)

            In February, the United States Supreme Court held, in the case of Bartenwerfer v. Buckley, 598 U.S., 143 S. Ct. 665 (2023), a faultless business partner could be found liable for fraud committed by another business partner. As a result of the unanimous decision, the faultless debtor would be precluded from discharging a fraudulently obtained debt in bankruptcy.

Kate Bartenwerfer (“Kate” or “Bartenwerfer”) purchased a house with her future husband, David Bartenwerfer (“David”), with the intention to renovate and resell the home. Following the purchase, David took charge of the renovation, handling nearly all aspects, while Kate was largely uninvolved in the project. When the couple sold the home, the disclosure statements contained material misrepresentations that only David knew. The buyer, Kieran Buckley, obtained a judgment in excess of $200,000 in a California state court against the couple for breach of contract, negligence, and nondisclosure of material facts. The judgment provided that Kate and David were jointly liable for the damages.

Following the judgment, the Bartenwerfers filed for Chapter 7 bankruptcy. Buckley filed a complaint against the couple, alleging that the judgment debt was non-dischargeable under 11 U.S.C. §523(a)(2)(A). The Bankruptcy Court conducted a trial and concluded that neither Kate nor David could discharge the debt. The Bankruptcy Court noted that David knowingly concealed the defects, but imputed David’s fraudulent intent to Kate because of their partnership in the ownership and renovation of the home.

The Bartenwerfers appealed the decision to the Ninth Circuit Bankruptcy Appellate Panel, which affirmed the Bankruptcy Court’s decision as to David’s intent but found that Kate could only be found liable if she knew or had reason to know of the fraud. Ultimately, the case ended up in the Ninth Circuit Court of Appeals, where the Court relied on existing Supreme Court precedent in the case of Strang v. Bradner, 114 U.S. 555, 5 S. Ct. 1038 (1885) and held that a debtor who is liable for her partner’s fraud cannot discharge such debt in bankruptcy, even if she was not culpable. The Supreme Court “granted certiorari to resolve confusion in the lower courts on the meaning of § 523(a)(2)(A).”

At the Supreme Court, Bartenwerfer made three primary arguments. First, she argued that § 523(a)(2)(A) was written in the passive voice and that ordinary reading of that section would infer that the individual had to be culpable in committing the fraud. The Court dismissed this argument by explaining that Strang was decided when the fraud exception to discharge applied to acts “of the bankrupt” but the Court there still found debts of a faultless partner nondischargeable. The Court noted that the Bankruptcy Act of July 1, 1898, was changed to remove the “of the bankrupt” language. The Court further explained that Congress’ choice to use the passive voice eliminated the actor. Similarly, the Court gave no weight to Kate’s argument that the other subsections of § 523(a)(2) apply to acts committed by the debtor.

Bartenwerfer also argued that holding a nonculpable partner liable for another’s fraud is inconsistent with the “fresh start” policy of bankruptcy law. The Court noted that Section 523 balances competing interests, specifically the rights of a debtor to receive a discharge against those of a creditor who should receive full payment on his debt that was obtained by fraud. The Court took that reasoning one step further and noted that Kate’s liability was based on California law that “Section 523(a)(2)(A) takes the debt as it finds it, so if California did not extend liability to honest partners, § 523(a)(2)(A) would have no role to play.”

The Supreme Court affirmed the Ninth Circuit’s judgment and held that Bartenwerfer could not discharge the debt in bankruptcy, which is a harsh result for a debtor who did not participate in the fraud. However, it may be good news for creditors who may be able to recover from other parties beyond a fraudulent actor.