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SCOTUS Clarifies “Actual Fraud” Bankruptcy Exception; Companies Should Take Utmost Care in Managing Assets

When does omission become a lie?  Is it still lying if you don’t actually make any false statements?  Consider the same in the context of fraud.

Fraud by omission is still fraud, as recently held by the Supreme Court of the United States.  Previously, the courts required some affirmative “lie” or misrepresentation to a creditor to be deemed fraud.  However, the Supreme Court recently reexamined the law and issued an opinion clarifying the “actual fraud” exception to the Bankruptcy Code’s discharge statute.  It held that “actual fraud” includes fraudulent asset transfers, even if they did not involve a false representation or “lie” to a creditor.  If a person or company is found to have committed actual fraud, they may not discharge the debt in bankruptcy.  This ruling means that companies should take the utmost care in managing their assets.

Pursuant to the Bankruptcy Code, a debtor cannot discharge a debt in bankruptcy if the debt was “obtained by false pretenses, a false representation, or actual fraud.”  11 U.S.C. § 523(a)(2)(A).  In the case of Husky International Electronics, Inc. v. Daniel Ritz, Jr., No. 14-145, 578 U.S. (May 16, 2016), Daniel Ritz, Jr., who was the director of Chrysalis, incurred a debt to Husky International.  Instead of paying the debt, Ritz transferred assets from Chrysalis to other entities he controlled.  Husky International filed a lawsuit against Ritz, seeking to hold him personally liable for the debt.  Shortly thereafter, Ritz filed for Chapter 7 bankruptcy and attempted to discharge the debt.  Husky International intervened and again sought to hold Ritz personally liable, arguing that the debt could not be discharged pursuant to the actual fraud exception to the Bankruptcy Code.

Under common law, “actual fraud” is any fraud that involves moral turpitude or an intentional wrong, therefore encompassing fraudulent conveyances.  A false representation to a creditor is not required to qualify as actual fraud.

Further, one of the disputes about the bankruptcy statute was whether there must be fraud in the acquisition of the debt.  The statute states the debt must be “obtained by” fraud.  In the Husky International case, the Supreme Court held that fraud at the inception of the debt is not an essential element of “actual fraud;” all that is required is fraud during some point in the life of the debt.  The Court held that fraud still exists in the act of concealment and hindrance of the debt collection process, and therefore fraudulent transfers (and likely Ritz’s acts) qualify the related debts as non-dischargeable.

Companies or individuals who owe any debt should exercise extreme caution in the transfer of assets, especially if they are considering filing bankruptcy, lest the transfers be considered fraudulent.  If the transfers are determined to fall under the “actual fraud” exception, the principal in control of the company may be held personally liable for the entirety of the debt.

For additional information on this or any related topic, please contact any member of the KDDK Creditors’ Rights and Bankruptcy Law Practice Team.

About the Author

Michael DiRienzo

Michael E. DiRienzo, a Partner at Kahn, Dees, Donovan & Kahn, LLP, in Evansville, Ind., has nearly 15 years of experience assisting clients in the areas of education law, government, schools and municipal law, environmental law, business law, real estate law, and bankruptcy, collection & creditors’ rights law. Mike helps educational institutions, municipalities and government entities, healthcare institutions, construction companies, and clients in other industries effectively resolve disputes and continue to build their businesses. In addition, Mike uses his litigation experience to give his clients special perspective and advice on legal strategies regarding complex commercial transactions involving acquisitions, distributorships, commercial leases and protection of confidential information.

 

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