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The Bankruptcy StrategistFeaturesBankruptcyLitigationUnited States Supreme Court

Innocent Business Partner's Fraud Liability Survives Bankruptcy

By Michael L. Cook
April 01, 2023

"[S]ometimes a debtor is liable for fraud that she did not personally commit," held the U.S. Supreme Court on Feb. 22, 2023, when the debtor's business partner had deceptively obtained money by fraud, thereby making the innocent partner liable for a nondischargeable debt under Bankruptcy Code (Code) §523(a)(2)(A) ("any debt from money "obtained by … fraud" not dischargeable and survives debtor's bankruptcy). Bartenwerfer v. Buckley, 2023 WL 2144417 (Feb. 22, 2023). Unanimously affirming the Ninth Circuit and resolving "confusion in the lower courts," the Court explained that the common law and precedent precluded an innocent debtor from discharging a debt obtained by the fraud of the debtor's agent or partner. Id. at *8. The innocent debtor here thus could not use bankruptcy to avoid liability. More important, the decision has practical significance for corporate officers and others in an agency or partnership relationship. The decision also may have serious consequences for corporate Chapter 11 debtors whenever a "domestic governmental unit" is a creditor.

Relevance

The Circuits have been split as to whether an innocent business partner's liability could be discharged in bankruptcy. See, e.g., In re M.M. Winkler & Assoc., 241 F.3d 746, 749 (5th Cir. 2001) (debts that arise from fraud cannot be discharged); In re Villa, 261 F.3d 1148, 1151 (11th Cir. 2001) (debt cannot be discharged when fraud is imputed to the debtor under agency principles). But see, Sullivan v. Glenn, 782 F.3d 378, 381 (7th Cir. 2015) (debt non-dischargeable only if debtor knew or should have known of fraud); In re Walker, 726 F.2d 452, 454 (8th Cir. 1984) (same).

Facts

The debtor (D) and her contractor "then-boyfriend" bought a house "as business partners," intending to renovate and to resell the property. D "was largely uninvolved" in the renovation directed by her partner. When selling the house to the plaintiff (P), the debtor and her boyfriend-later-husband completed a mandatory disclosure statement, falsely claiming they knew of no leaks or other defects and that the necessary repairs on the property had been made under applicable law.

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