This Report summarizes opinions issued on April 28 and May 2, 2022 (Part I); and cases granted review on April 25 and May 2, 2022 (Part II).

Case Granted Review: Bartenwerfer v. Buckley, 21-908

Bartenwerfer v. Buckley, 21-908. The Court will consider whether a debtor may discharge in bankruptcy a debt for money obtained by her business partner’s fraud, when the debtor herself had no knowledge of the fraud. David and Kate Bartenwerfer renovated a house in San Francisco and sold it to Kieran Buckley. After the sale, Buckley sued the Bartenwerfers in state court for multiple claims, including nondisclosure of defects. Kate and David were unmarried during the renovation and sale, but they married before the lawsuit. A jury found in Buckley’s favor and awarded him damages. The Bartenwerfers then filed for bankruptcy. In the bankruptcy court, Buckley argued that the state judgment could not be discharged in bankruptcy because 11 U.S.C. §523(a)(2)(A) prohibits discharge of a debt for money that was obtained through fraud. The bankruptcy court agreed and held that the portion of the judgment traceable to the nondisclosure was nondischargeable. The court found that David had actual knowledge of the false representations made to Buckley, and that his fraudulent conduct could be imputed to Kate because of their partnership. The Ninth Circuit Bankruptcy Appellate Panel (BAP) adopted a “knew or should have known” standard and remanded the case with instructions that the bankruptcy court determine whether Kate knew or should have known of David’s fraud. After an evidentiary hearing, the bankruptcy court held that David’s fraud could not be imputed to Kate because she did not know of it, and her debt was therefore dischargeable. The BAP affirmed. A Ninth Circuit panel reversed. 860 Fed. Appx. 544.

The Ninth Circuit held that that a person cannot escape liability of her business partner’s fraud due to lack of knowledge. The court quoted Strang v. Bradner, 114 U.S. 555, 561 (1885), for the proposition that “if, in the conduct of partnership business, . . . one partner makes false or fraudulent misrepresentations of fact to the injury of innocent person, . . . his partners cannot escape pecuniary responsibility therefor upon the ground that such misrepresentations were made without their knowledge. This is especially so when . . . the partners, who were not themselves guilty of wrong, received and appropriated the fruits of the fraudulent conduct of their associate in business.” The court accordingly ruled that “the bankruptcy court applied the incorrect legal standard for imputed liability in a partnership relationship,” and found petitioner’s debt “nondischargeable regardless of her knowledge of the fraud.”

Kate argues in her petition that Strang has been “misinterpreted to cover issues that were not part of the Court’s actual analysis.” In Kate’s view, Strang focused on the imputation of liability between partners, and simply “assumed away” the issue of discharge. Moreover, Kate argues, Strang was superseded by statutory amendment and subsequent decisions such as Bullock v. BankChampaign, N.A., 569 U.S. 267 (2013), and Field v. Mans, 516 U.S. 59 (1995), which require some level of scienter. Kate urges the Court to adopt the Eighth Circuit’s rule that a debt may be discharged unless the debtor knew or should have known of her partner’s fraud or was “recklessly indifferent” to the partner’s conduct. Walker v. Citizens State Bank, 726 F.2d 452 (8th Cir. 1984). She argues that Walker is consistent with the statutory exception from discharge for debt obtained by “false pretenses, a false representation, or actual fraud,” as well as the historical requirement of “positive fraud or fraud in fact,” which was understood by the drafters of §523(a)(2)(A). Kate maintains that Walker avoids creating new non-statutory exceptions from discharge, and it furthers the goal of providing relief to the “honest but unfortunate debtor.”

Buckley responds that, as explained in Deodati v. M.M. Winkler & Assocs., 239 F.3d 746 (5th Cir. 2001), the statute’s text “focuses on the character of the debt, not the culpability of the debtor.” Section 523(a)(2)(A) excepts from discharge “any debt . . . for money . . . obtained by . . . actual fraud,” and Kate undisputedly owes a debt for money obtained by her partner’s actual fraud. Buckley argues that the Court should not rewrite the statute by adding language that the debtor “knew or should have known” of the fraud, or that the fraud must have been committed “by the debtor.” Buckley asserts that the statute’s context, history, and purpose confirm his interpretation. For example, §523 expressly makes the debtor’s state of mind relevant to the discharge of some kinds of debt, but the fraud provision contains no such requirement. Buckley argues that Strang considered the discharge obligations of innocent business partners, yet adopted a rule that protects fraud victims over a fraudster’s partners. Buckley insists that this principle has been followed for many years, and Congress has not departed from it. He argues that the cases upon which Kate relies simply show that the fraudster himself must have some level of scienter; those cases did not consider the partner-debtor’s scienter. And although one purpose of the Bankruptcy Code is to give a fresh start to honest debtors, Buckley says that in this instance Congress reasonably concluded that creditors’ interests are more important.