Supreme Court to Decide What Congress Meant by “Actual Fraud” in the Bankruptcy Code

A discharge is one of the most important functions of bankruptcy.  It is what releases a debtor from personal responsibility for his debts and helps provide a debtor with a “fresh start.”  The Bankruptcy Code allows a debtor’s discharge to be denied in certain circumstances, and the Supreme Court will soon decide an issue concerning one of these circumstances. On March 1, 2016, the Supreme Court heard oral arguments in the case of Husky International Electronics, Inc. v. Ritz, No. 15-145.  The issue in this case is whether false statements are required to trigger the Bankruptcy Code’s bar to discharge debts that are obtained by fraud.  Section 523(a)(2)(A) of the Bankruptcy Code prohibits a debtor from discharging “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.”

Husky International Electronics, Inc. v. Ritz

The case concerns a business relationship between two businesses.  Chrysalis Manufacturing Corp. was a company that made circuit boards.  Over a period of several years, Chrysalis bought electronic components from Husky International, Inc.  Chrysalis didn’t pay Husky all that it was owed, and ended up owing Husky around $164,000.  Husky filed a lawsuit in federal court against one of Chrysalis’s owners, Daniel Ritz, to try to recover some of the money it was owed.  Before the judge ruled on the lawsuit, Ritz filed for a Chapter 7 bankruptcy.

Transfer of Property Before Bankruptcy

Ritz transferred money from Chrysalis to other companies he owned, and Husky argued in bankruptcy court that Ritz’s debt was non dischargeable because the transfers to these other companies were fraudulent.  Ritz argued that the debt should be discharged because he did not make any false representations to Husky regarding the debt or transfers.  The lower courts agreed and ruled that actual fraud must be based on a showing that the debtor made a false representation to the creditor.   Husky appealed the case to the Supreme Court, contending that the Bankruptcy Code bars a discharge not only when the debtor makes false representations, but also what the debtor obtained money through a fraudulent transfer.  The Supreme Court will examine what Congress meant by the term “actual fraud,” and decide whether Ritz’s conduct falls under that definition.

Supporters for both sides of the argument advise that the Supreme Court’s interpretation of the term will result in serious consequences for the bankruptcy system.  They argue that a ruling for Ritz would create a loophole that will cause dishonest debtors to “game the system.”  On the other hand, the National Association of Consumer Bankruptcy Attorneys assert that a ruling for Husky would harm the small business owners who often file for Chapter 7 bankruptcies, since those debtors often transfer money between personal and business accounts and a ruling for Husky would give the creditors of those small business owner debtors an unjustified advantage.