In a decision rendered on May 16, 2016, in the case of Husky International Electronics, Inc. v. Ritz, the U.S. Supreme Court ruled that the exception to bankruptcy discharge for debts incurred through actual fraud applies to debts imposed for fraudulent transfer liability, even when the individual did not make a false representation.

Background

Chrysalis Manufacturing Corp. (Chrysalis) incurred a debt to Husky International Electronics, Inc. (Husky) of approximately $164,000.  Daniel Lee Ritz, Jr. (Ritz) was a director and part-owner of Chrysalis.  Ritz drained money from Chrysalis and transferred it to other entities Ritz controlled.  Husky sued Ritz to recover the debt pursuant to a Texas law that allows creditors to hold shareholders liable for corporate debt where the shareholder “caused the corporation to be used for the purpose of perpetrating and did perpetrate an actual fraud on the obligee primarily for the direct personal benefit of the [share]holder.”  Ritz filed a Chapter 7 bankruptcy petition, and Husky filed a complaint in Ritz’s bankruptcy case to have Ritz’s debt to Husky be deemed non-dischargeable under Section 523(a)(2)(A) of the Bankruptcy Code as a debt incurred through Ritz’s “actual fraud.”

Debating the Meaning of “Actual Fraud”

The U.S. Bankruptcy Court for the Southern District of Texas held that Husky had not proved actual fraud required by Texas law and Section 523(a)(2)(A).  On appeal, the District Court held that Ritz was personally liable under Texas law because there was sufficient circumstantial evidence suggesting that Ritz acted with the intent to hinder, delay, or defraud Husky, but also held that the debt was not “obtained by … actual fraud” and thus could not be excepted from discharge under Section 523(a)(2)(A).  The U.S. Court of Appeals for the Fifth Circuit affirmed, holding that an actual misrepresentation from the debtor to the creditor was required and was lacking in this case.  Although Ritz may have hindered Husky’s ability to recover its claim, Ritz made no false representations to Husky.

The Supreme Court reversed in a 7 to 1 decision, holding that the term “actual fraud” in Section 523(a)(2)(A) “encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.”  The Supreme Court’s ruling provides a favorable tool for a creditor with valid non-bankruptcy claims against an insider of its debtor for fraudulent transfers, preventing the easy discharge of such claims in an individual Chapter 7 bankruptcy case where the creditor timely objects to discharge.

© 2016 Perkins Coie LLP