[CLBS] Bartenwerfer v. Buckley, 21-908 (Sup. Ct.),

[Tecla Druffel]

Colleagues,

Something interesting is brewing at the Supreme Court that may relate to many of our cases. Take a look at the email below for more information.

Many thanks to Carol Mills and Judge Pappas for taking the time to alert us to this interesting issue.

Tecla


Tecla E. Druffel
Attorney at Law
TED BK, PLLC
312 Main Street
P.O. Box 323
Lewiston, Idaho 83501
P: (208) 743-9569
F: (888) 877-4307

From: Carol Mills
Sent: Thursday, May 05, 2022 10:55 AM
To: Tecla Druffel <tecla at lewistonbankruptcylawyer.com>
Subject: FW: Bartenwerfer v. Buckley, 21-908 (Sup. Ct.),

Hi Tecla,
Judge Pappas asked that I forward this article from Bill Rochelle (ABI) to the listserve because he believes it will be interesting to our bankruptcy bar, as this is a common scenario in bankruptcy cases.
Thank you!
Carol

[cid:image001.png at 01D86076.DC7719F0]

Carol Keating Mills

Career Law Clerk to
Chief Bankr. Judge Joseph M. Meier, U.S. Courts, District of Idaho
carol_mills at id.uscourts.gov<mailto:carol_mills at id.uscourts.gov>
(208) 334-9947



The Supreme Court granted certiorari this week to resolve a split of circuits and decide whether a debtor is saddled with a nondischargeable debt for a false representation or actual fraud under Section 523(a)(2)(A) based entirely on the fraud of a partner or agent. In other words, does the imputation of liability for fraud also result automatically in nondischargeability, or must the debtor have some degree of scienter?

The decision in Bartenwerfer v. Buckley, 21-908 (Sup. Ct.), likely to be argued this fall, will say whether the debtor must have known or should have known about the agent's fraud before the debt is considered nondischargeable.

The circuits are split as follows: (1) The Second, Fourth, Seventh and Eighth Circuits hold that the debtor must have some degree of scienter before an imputed liability for fraud becomes nondischargeable, while (2) the Fifth, Sixth, Ninth and Eleventh Circuits hold that a debt is nondischargeable as to an entirely innocent debtor based on the fraud of a partner or agent.

The 'Innocent' Wife

A couple owned a home. They moved out to renovate and then sell the home. The husband oversaw the renovations. The wife had little to do with the renovations. After renovation, they sold the home.

The buyers sued in state court, alleging fraud in the disclosure statement for failure to disclose known defects in the home. A jury found the couple liable, resulting in a judgment against them for about $540,000, plus interest.

The couple filed a chapter 7 petition, and the bankruptcy court ruled that the debt was nondischargeable as to the husband.

Bankruptcy Judge Hannah L. Blumenstiel discharged the debt as to the wife, finding that she neither knew nor should have known that the disclosures were fraudulent. See Buckley v. Bartenwerfer (In re Bartenwerfer), 596 B.R. 675 (Bankr. N.D. Cal. 2019). The Ninth Circuit Bankruptcy Appellate Panel affirmed in a nonprecedential opinion. See Bartenwerfer v. Buckley (In re Bartenwerfer), 16-1277, 2017 BL 461730, 2017 Bankr. Lexis 4396, 2017 WL 6553392 (B.A.P. 9th Cir. Dec. 22, 2017).

The Ninth Circuit reversed in a nonprecedential opinion and directed the bankruptcy judge to enter judgment in favor of the creditor, declaring the debt to be nondischargeable. Raising the circuit split, the debtor-wife filed a petition for certiorari in December. The Supreme Court granted the petition on May 2.

The Supreme Court's order granting review did not describe the issue on appeal. The debtor's petition stated the question presented as follows:

May an individual be subject to liability for the fraud of another that is barred from discharge in bankruptcy under 11 U.S.C. § 523(a)(2)(A), by imputation, without any act, omission, intent or knowledge of her own?

The (Outdated?) Supreme Court Precedent

The root of the circuit split is found in what the debtor calls a misinterpretation of an 1885 decision by the Supreme Court under the Bankruptcy Act of 1867, Strang v. Bradner, 114 U.S. 555 (1885). There, the Court was primarily concerned with whether a partner in a law firm was entitled to a discharge. The Court said the debt was not discharged, because the partner had himself committed fraud.

According to the debtor, the Court in 1885 "simply assumed - without authority or analysis - that the liability [of other partners] was nondischargeable."

The debtor went on to say,

[T]he Court did not actually consider the particular issue, perhaps because it was not raised on appeal, the parties having elected to focus their arguments on the underlying liability for fraud, which occupies most of the opinion.

In other words, the debtor is arguing that the Court's pronouncement in 1885 about per se nondischargeability of one partner for another's fraud is dicta.

The Circuits' Opposing Camps

The circuits these days that find no per se liability are led by the Eighth Circuit in Walker v. Citizens State Bank (In re Walker), 726 F.2d 452 (8th Cir. 1984). The St. Louis-based appeals court held that actual participation in the fraud is not required for the debt to be nondischargeable. However, the circuit said that the debt is nondischargeable if "the principal either knew or should have known of the agent's fraud." Id. at 454.

On the other side of the fence, Deodati v. M.M. Winkler & Assocs. (In re M.M. Winkler & Assocs.), 239 F.3d. 746 (5th Cir. 2001), is the leading authority for a principal's strict liability. Writing for the Fifth Circuit, Circuit Judge Edith H. Jones held "that § 523(a)(2)(A) prevents an innocent debtor from discharging liability for the fraud of his partners, regardless of whether he receives a monetary benefit." Id. at 751.

Conclusion

Absent lengthy extensions, the briefs should be filed by summer, allowing for argument in the fall. As the debtor said in her certiorari petition, did the Ninth Circuit commit error when it "impose[d] nondischargeability upon an innocent debtor for the fraud of another without any act, omission, intent or knowledge of the debtor's own"?

It's a classic question that asks whether scienter is an implicit requirement before a debt is excepted from discharge under Section 523(a)(2)(A).

The face of the statute itself may or may not answer the question. The subsection renders a debt nondischargeable if it was obtained by "false pretenses, a false representation, or actual fraud."

The subsection does not say whether the debtor must have made the false representation or committed the fraud. Still, the statute could be read to mean that any liability for fraud or misrepresentation is nondischargeable, regardless of who committed the fraud.

The drafters of the Code did not explicitly overrule Strang, of which they surely were aware. Being vague on the issue now in the Supreme Court, did they mean for the courts to decide whether the debtor must be guilty of fraud?

We will have the answer about one year from now.

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