On February 22, 2023, the United States Supreme Court (“the Supreme Court”) issued its Opinion in the matter of Bartenwerfer v. Buckley, No. 21-908, LEXIS 943 (Feb. 22, 2023), holding that per 11 U.S.C. § 523(a)(2)(A), a partnership member is not entitled to discharge a debt incurred by the fraud of another partnership member, regardless of the fact the innocent member had no knowledge of the fraud.

Background

In 2005, Kate Bartenwerfer (“Plaintiff”) and her then-boyfriend and later husband, David Bertenwerfer (“David”), jointly purchased a San Francisco home with the intention of remodeling the property and “flipping” it for a profit. The two formed a legal partnership and undertook the renovations as ostensible equal partners; however, in reality, David handled all facets of the remodeling project and Plaintiff remained uninvolved. The home was eventually listed for sale and purchased by Kieran Buckley (“Defendant”), based, in part, on attestations by both Plaintiff and David that there were no defects in the property. Contrary to these attestations, post-purchase Defendant discovered numerous significant property defects, including permitting issues, roof leaks, and defective windows. Defendant sued Plaintiff and David for these defects in California state court, ultimately prevailing and obtaining a joint judgment against them for more than $200,000 in damages (“the Judgment”).

Plaintiff and David subsequently filed for Chapter 7 bankruptcy seeking to discharge the Judgment. Defendant opposed, submitting an adversary complaint alleging the Judgment was nondischargeable under section 11 U.S.C. § 523(a)(2)(A) of the Federal Bankruptcy Code, which prohibits the discharge of “any debt . . . for money . . . to the extent obtained by . . . false pretenses, a false representation, or actual fraud.” The dischargeability issue proceeded to trial, where Plaintiff claimed she had no knowledge that the attestations were fraudulent. While this assertion was true, the bankruptcy court nevertheless held that neither party could discharge the Judgment, holding that David had knowingly concealed the defects from Defendant and “imput[ing] David’s fraudulent intent to [Plaintiff] because the two had formed a legal partnership” for the renovation project.

The Road to the Supreme Court

This outcome was appealed to the Ninth Circuit Bankruptcy Appellate Panel, which disagreed with the lower court, holding that David’s fraudulent intent could only be imputed to Plaintiff if she “knew or had reason to know” of his fraud. The matter was remanded and another trial conducted using this revised standard. Ultimately, it was held that while the Judgment remained enforceable against David, it was dischargeable by Plaintiff as she lacked knowledge of David’s fraud. A subsequent appeal to the Bankruptcy Appellate Panel resulted in an affirmance.

Another appeal followed, this time to the Ninth Circuit Court of Appeals, where, in the published opinion of Bartenwerfer v. Bartenwerfer, 860 F. App’x 544 (9th Cir. 2021), the Court of Appeals reversed in part, creating the bright-line rule that any debtor who is liable for their partner’s fraud cannot discharge that debt in bankruptcy regardless of their own personal culpability for the fraud. To resolve the apparent confusion over the operation of 11 U.S.C. § 523(a)(2)(A), the Supreme Court granted certiorari to issue a clear ruling on the intended scope and meaning of the provision.

The Supreme Court Affirms the Non-Dischargeability of the Judgment

To settle this statutory interpretation issue, the Supreme Court turned to historical precedent, observing the 1885 decision issued in Strang v. Bradner, 114 U.S. 555 (1885), which involved similar factual circumstances. Therein, one member of a three member business partnership lied to secure promissory notes for the benefit of the partnership itself, with the two innocent parties subsequently seeking to discharge the debt owed in bankruptcy on the basis that the third partner’s lies were “not made [at] their direction [or] with their knowledge.” The Strang Court denied this request, holding that the fraud of one partner was to be considered the fraud “of all,” as each partner “was [an] agent and representative” of the partnership itself.

The Supreme Court next considered what it deemed to be “the linchpin” to resolution of the issue, that being Congress’s “post-Strang” legislation. Specifically, the Supreme Court noted that thirteen years after Strang – in July 1898 – Congress overhauled our nation’s then-bankruptcy law, altering the statutory predecessor to the current section § 523(a)(2)(A) which, at the time,  read as follows:

No debt created by the fraud or embezzlement of the bankrupt . . . shall be discharged.

Post-1898 amendment, this language was changed to provide as follows:

A discharge in bankruptcy shall release a bankrupt from all of his provable debts, except such as . . . are judgments in actions for frauds, or obtaining property by false pretenses or false representations.

The Supreme Court held that the deletion of the term “of the bankrupt” from the revised statutory provision evidenced an “unmistakable” Congressional intent to adopt the holding issued in Strang, holding that by doing so “Congress cut from the statute the strongest textual hook counseling against the outcome in Strang.” Accordingly, the Supreme Court formally adopted the Strang line of reasoning and affirmed the Court of Appeals, holding that Plaintiff could not discharge the Judgment in bankruptcy.

As a side issue, the Supreme Court also commented upon Plaintiff’s assertion that the underlying bankruptcy policy of providing debtors with a “fresh start” counseled against refusing the discharge of the Judgment. The Supreme Court held this assertion “earn[ed] credit for color but not much else,” noting that the Bankruptcy Code was intended to serve creditors as much as debtors, and that it was not the Supreme Court’s place to second-guess Congress’s conclusion that a creditor’s interest in recovering the full payment of debts obtained by fraud outweighed a debtor’s interest in a “fresh start.”

Takeaways

While the potential application of this holding is far-reaching, the principle to be taken away is simple: a partnership member must choose their partners carefully and be cognizant of their partners’ actions, as those actions can bind that member to debts.

For a copy of the decision, please contact Michael O’Donnell at modonnell@riker.com, James Mazewski at jmazewski@riker.com, Kevin Hakansson at khakansson@riker.com or Kori Pruett at kpruett@riker.com.