In 2005 Kate and her boyfriend David
jointly purchased a house in San Francisco. Acting as business partners, they
decided to remodel and sell it. David took charge by hiring an architect,
structural engineer, designer, and general contractor. David monitored their
work, reviewed invoices, and signed checks.
Kate was uninvolved.
David married Kate. Kieran Buckley
bought the house. In conjunction with the sale, David and Kate stated that they
had disclosed all material facts related to the property. But after closing
Buckley discovered a leaky roof, defective windows, missing fire escape, and
Buckley sued Kate and David in State
court. The jury awarded damages to Buckley of $200,000+.
Kate and David could not pay
Buckley, not to mention their other creditors. So they filed for Chapter 7
bankruptcy relief, which allows debtors to get a “fresh start” by discharging
Unfortunately, however, not all
debts are dischargeable. The Bankruptcy Code bars the discharge of debts to the
extent obtained by false pretenses, false representation, or actual fraud.
Buckley filed an adversary complaint
alleging that the monies owed on the State-court Judgment fall within this
exception, and should not be discharged. After trial, the Bankruptcy Court
agreed that neither Kate nor David could discharge their debt to Buckley.
Based on the testimony from the
parties, real estate agent, and contractors, the Bankruptcy Court found that
David had knowingly concealed the defects from Buckley. And – the compelling
part for lawyers – the Bankruptcy Court imputed David’s fraudulent intent
Meaning, neither could discharge the
Buckley debt in the context of their Chapter 7 bankruptcy.
Recall that Kate had virtually
nothing to do with this, other than formation of a partnership. So Kate
The Bankruptcy Appellate Panel
agreed as to David’s fraudulent intent but disagreed as to Kate’s. So the case
was remanded back to Bankruptcy Court, where this time the Court concluded that
Kate lacked the requisite knowledge of David’s fraud and therefore Kate could
discharge her liability to Buckley.
Liking this outcome better, the
Bankruptcy Appellate Panel affirmed the judgment. So Buckley appealed.
The Supreme Court of the United
States of America agreed to review it. Doing so, SCOTUS used 10 pages of legal
prose to determine that it hardly matters who perpetrates the fraud. The
statutory analysis goes like this:
(1) Question: Is there an individual debtor? Answer: Yes, Kate.
(2) Question: Is there a debt? Answer: Yes, owing to Buckley.
(3) Question: Did the debt arise due to false pretenses, false representation, or actual fraud? Answer: Yes, as determined previously by other courts.
Not relevant to the analysis is
who, exactly, committed the fraud.
What is relevant here is that a debt
+ fraud = non-discharge in bankruptcy. Full stop. “The debt must result from
someone’s fraud, but Congress was ‘agnostic’ about who committed it.”
Kate Bartenwerfer’s debt is not dischargeable in her bankruptcy proceeding. See
Kate Bartenwerfer v. Kieran Buckley; Supreme Court of the United States; February 22, 2023: https://www.supremecourt.gov/opinions/22pdf/21-908_n6io.pdf.
Note that this case had its inception in 2005, close to 20 years ago!
Questions / Issues:
- Did that result surprise you? I had guessed that a
debtor required some level of active participation to be stuck with a non-dischargeable
debt. But then I am not a bankruptcy lawyer. Perhaps the bankruptcy specialists
anticipated exactly this result. However, if this was the obvious result
then an appeal to SCOTUS would not have been required.
- What does this mean to your investments in
partnerships, corporations, joint ventures, limited liability companies,
and similar passive entities? If those in a control position make poor
choices, could the liability extend to you?
- If you are nervous about Q2, then do you have /
can you get indemnities from those in a control position? But indemnities
are just more words on more paper. Can you get collateral or security to
backstop the indemnity?
Stuart A. Lautin, Esq.*
* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law, Texas Board of Legal Specialization
Licensed in the States of Texas and New York
Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.