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Supreme Court Embraces Broad Definition of Fraud

By Louis S. Robin

Law Offices of Louis S. Robin

Longmeadow, MA

Yesterday, the Supreme Court ruled that a debtor may not be discharged from a debt arising from a fraudulent transfer.   No. 15-145, Husky International Electronics, Inc. v. Ritz (5/16/16).   The case can be found here.   

 

In short, the principal of a debtor corporation transferred assets, without consideration, to other companies he controlled in order to avoid payment to creditors of the initial debtor corporation. The principal eventually filed under Chapter 7. 

 

The Supreme Court sent the case back to the Fifth Circuit which had found that section 523(a)(2)(A) requires a false representation.    Instead, Justice Sotomayor ruled that "actual fraud" was a broader concept. She provides an interesting review of “fraud” and “fraudulent transfers” dating back to 1571’s Statute of Elizabeth, finding that “fraud” was a very broad term, with “actual” meaning a more specific intent (so that the principal committed general fraud, but knew exactly what he was doing). The dissent of Justice Thomas centered on his concerns that (i) “fraudulent transfers” are not included in the phrase of “actual fraud” as defined under the common law and (ii) where, under 523(a)(2), “money, property [or] services [are] obtained by” actual fraud, no such items are “obtained by” in a fraudulent transfer context.

On remand, the Fifth Circuit will need to reach an issue that  it did not previously decide:  whether the owner of a company who initiates a fraudulent transfer to other companies he controls is personally liable.     Under Tex. Bus. Org. Code section 21.223(b), the court may pierce the corporate veil to hold a shareholder liable based on "actual fraud."   The District Court had found that Ritz was liable under this statute, but the Fifth Circuit did not decide the issue.   This highlights an issue in these types of cases since a debtor is not usually the “obligor” under a fraudulent transfer, only the transferor. Regardless of how the remand comes out, the Supreme Court has issued a decision that puts debtors on notice that any activities that can be interpreted as less than honest may not receive protection in bankruptcy.