High Court Will Hear Bankruptcy Fraud Case

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By Stephanie Cumings

Nov. 6 — The U.S. Supreme Court agreed to hear its first bankruptcy case of the October 2015 term and will decide whether or not “actual fraud” under the Bankruptcy Code requires a false representation.

The appeal comes out of the Fifth Circuit, where the circuit court held that barring the discharge of a debt for “actual fraud” requires a false representation by the debtor.

This ruling was at odds with a Seventh Circuit case from 2000 which held that fraudulent conduct can be enough to constitute “actual fraud” even if no false representation is made. Shortly after the Fifth Circuit's decision, the First Circuit also weighed in on this issue and adopted the Seventh Circuit's approach.

Fraudulent Transfers?

The debtor in this case transferred a substantial amount of funds from a manufacturing company to several other entities that he controlled for less than “reasonably equivalent value.” Creditor Husky International Electronics, Inc. sued to have the debt it was owed declared non-dischargeable.

Husky argued that its debt was non-dischargeable under Section 523(a)(2)(A) of the Bankruptcy Code, which excepts debts from discharge for “false pretenses, a false representation, or actual fraud.” Husky argued that a misrepresentation wasn't necessary to trigger “actual fraud,” relying on McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000).

Conflict With Supreme Court Case

But the Fifth Circuit held that Husky's approach would conflict with Field v. Mans, 516 U.S. 59 (1995), which addressed the level of reliance a creditor must demonstrate to satisfy Section 523(a)(2)(A).

“Although not directly addressing the issue, the [Supreme Court] throughout its opinion in Field appeared to assume that a false representation is necessary to establish ‘actual fraud,'” the Fifth Circuit said. “.... Moreover, at bottom, the [c]ourt in Field made clear that the meaning of ‘actual fraud' depends on the 1978 common law meaning of the term. Husky has pointed to no authority, and we are not aware of any, suggesting that the common law meaning of ‘actual fraud' at that time encompassed fraudulent transfers of the type at issue here.”

The Fifth Circuit added that a different section of the Bankruptcy Code, Section 727(a)(2), covers fraudulent transfers and the court said that it would be “odd, at the very least, for Congress to have intended that the ‘actual fraud' provision cover fraudulent transfers, when there is another provision directly addressing such transfers.” Husky didn't raise the fraudulent transfer provision in the lower courts.

First Circuit Enters the Fray

Less than two months after the Fifth Circuit handed down its decision, the First Circuit addressed the same issue but ended up siding with the Seventh Circuit's approach.

The First Circuit found that the “common law concept of fraud” requires looking “beyond fraudulent misrepresentation to at least include fraudulent conveyances.” The court concluded that “actual fraud” includes fraudulent transfers intended to hinder creditors.

Husky is being represented by Shay Dvoretzky of Jones Day, Washington.

The debtor is being represented by Erin E. Murphy of Bancroft PLLC, Washington.

To contact the reporter on this story: Stephanie Cumings in Washington at sacree@bna.com

To contact the editor responsible for this story: Jay Horowitz at mailto:%20jhorowitz@bna.com