Fraud Exception to Debt Discharge Can Apply to Fraud by Others

Bankruptcy law generally allows debtors to discharge obligations that accrued prior to the filing of the bankruptcy petition. There are, however, exceptions, such as when a debt is obtained by fraud. Though this is generally understood to mean fraud by the debtor, the United States Supreme Court recently ruled that actions by other people can also trigger this exception to discharge of a debt.

The bankruptcy code embodies the common law principle that people should not benefit from their wrongdoings. The code’s fraud exception provision, however, is somewhat ambiguous, since it speaks of a debt being “obtained by” fraud without specifying the fraud’s perpetrator.

The case, Bartenwerfer v. Buckley, originated from a California real estate deal. Kate and David Bartenwerfer, in selling a house they co-owned, did not fully disclose material facts about its condition as required by California law. The homebuyer, Kieran Buckley, later sued for breach of contract and other causes of action and won a judgment against the couple. Although only David knew about the problems with the house, the state court found that because Kate was a partner in the sale, she was jointly liable for the judgment.

When the couple filed for bankruptcy, Buckley brought an adversary proceeding, claiming the judgment was not dischargeable because it had been obtained by fraud. The bankruptcy court initially ruled in his favor, denying both spouses a discharge of the debt. But an appellate bankruptcy panel disagreed as to Kate, holding that the fraud exception applies only to a debtor who knew or should have known of the fraud. The Ninth Circuit Court of Appeals then reversed.

The Supreme Court found that Kate’s innocence throughout the sale was not determinative of the issue. The justices pointed out that under common law, people in partner or agency relationships can be held liable for each other’s fraudulent conduct even if they did not participate. The court said there was no reason to depart from this principle, which the California court had applied in holding Kate liable.

This ruling serves as a reminder that bankruptcy courts can broadly define fraud that will prevent a debtor from receiving a discharge of debt. Certain transactions can be found fraudulent and thus exempt from discharge even if the debtor can show he or she was acting honestly and in good faith. An experienced bankruptcy attorney can thoroughly analyze your debt portfolio and protect your rights.

Jeff Field & Associates represents debtors in bankruptcy matters throughout the Atlanta, Marietta and Athens regions of Georgia. If you are struggling with consumer debt, feel free to contact us online or call 404-381-1278 for an initial consultation.