Husky Int'l Elecs., Inc. v. Ritz and the problem of intent in receiving fraudulent transfers.

• Author: Streicher, Brian M.
• Position: Cover story

In the case of Husky Int'l Electronics, Inc. v. Ritz, 136 S. Ct. 1581 (2016), the Supreme Court was asked to determine whether the term "actual fraud" in [section] 523(a) (2)(A) of the Bankruptcy Code (1) included fraudulent transfers. Section 523(a)(2)(A) bars the discharge of "any debt ... for money, property, [or] services ... to the extent obtained by ... false pretenses, a false representation, or actual fraud." (2) Before 1978, the Bankruptcy Code barred debtors from discharging debts obtained by "false pretenses or false representations." (3) In the Bankruptcy Reform Act of 1978, Congress added "actual fraud" to that list, creating the modern [section] 523(a)(2)(A). (4) Did this addition of "actual fraud" mean that the transferee of a fraudulent transfer was barred from discharging the transferee's obligation to the transferor's creditor? If so, how do courts ensure that [section] 523(a)(2)(A)'s discharge bar does not inhibit bankruptcy's fresh start promise granted to the honest debtor? (5) This article examines the state of the law prior to Husky, the reasoning of the majority and dissenting opinions, and its impact on bankruptcy debtors, creditors, and attorneys.

What is a Fraudulent Transfer?

Fraudulent transfers have a long history in English and American law, dating back to the Statute of 13 Elizabeth, enacted in 1571. (6) The Statute of 13 Elizabeth was one of the first bankruptcy acts, and it defined fraud as any transfer made with the intent to delay, hinder, or defraud creditors. (7) The modern iteration of fraudulent transfer law is embodied in the Uniform Fraudulent Transfers Act (UFTA), adopted in most states, including Florida. (8) The UFTA defines fraudulent transfers against present and future creditors as "a transfer made or obligation incurred by a debtor if made with actual intent to hinder, delay or defraud any creditor of the debtor" (9) or a transfer made "without receiving a reasonably equivalent value in exchange for the transfer or obligation." (10) As such, the UFTA mirrors the Statute of 13 Elizabeth, meaning it has its roots in English bankruptcy law. Transfers made with intent to defraud are deemed "actual" or intentional frauds, while transfers given without adequate consideration are considered constructive frauds. (11)

Section 727(a)(2) of the Bankruptcy Code, similar to the UFTA, denies discharge when the debtor has transferred property with the intent to hinder, delay, or defraud creditors within one year of filing for bankruptcy. This section, however, is both broader in scope than [section] 523(a)(2)(A) in that it bars the debtor's entire discharge (as opposed to discharge of specific claims), and narrower than [section] 523(a) (2)(A) in that it only concerns transfers made within one year of filing. Nevertheless, the universal language used to define fraudulent transfers in the Statute of 13 Elizabeth, the UFTA, and the Bankruptcy Code illustrates the established principles used in debtor-creditor law to prevent asset concealment and facilitate collection.

The UFTA defines "debtor" broadly as any "person who is liable on a claim." (12) While the UFTA covers transferors of property, the broad definition of "debtor" means that the statute can reach the recipients of fraudulent transfers as well. The Bankruptcy Code likewise defines "debt" very broadly, as "liability on a claim." (13) Florida bankruptcy courts, such as in In re Tankersley, 305 B.R. 376 (Bankr. M.D. Fla. 2004), have held that the transferor's judgment creditors have a legitimate claim against the bankrupt transferee for the transferee's obligation to return the transferred money or property back to the creditor. Since a judgment creditor has a claim against the transferee in the transferee's bankruptcy, (14) the question posed in Husky was not only whether "actual fraud" included fraudulent transfers, but whether the transferee "obtained" such assets "by" the actual fraud, such that the claim could be barred from discharge. (15)

Is a Fraudulent Transfer "Actual Fraud"? Federal Jurisprudence Before Husky

The 11th Circuit, along with a majority of circuit courts of appeals, (16) historically interpreted [section] 523(a)(2)(A) to bar the discharge of debts obtained by traditional fraud--a material misrepresentation intended to deceive, and the creditor's reliance on the misrepresentation. (17) In Field v. Mans, 516 U.S. 59 (1995), the Supreme Court stated that [section] 523(a)(2)(A) must be interpreted according to its common law definition when the modern Code was passed in 1978, and held that justifiable reliance was a necessary component of a [section] 523(a)(2)(A) challenge. (18) Thus, after Field, the question for the federal courts was whether the common law understanding of "actual fraud" in 1978 was limited to a material misrepresentation intended to deceive, or included something more, such as a fraudulent transfer.

The Seventh Circuit in McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000), was the first circuit to hold that [section] 523(a) (2)(A) bars the discharge of debts obtained by fraudulent transfers, reasoning: '"Fraud is a generic term, which embraces all the multifarious means which human ingenuity can devise and which are resorted to by one individual to gain an advantage over another by false suggestions or by the suppression of truth. No definite and invariable rule can be laid down as a general proposition defining fraud, and it includes all surprise, trick, cunning, dissembling, and any unfair way by which another is cheated."' (19) The court stated that the matter was one of first impression post-Field: "Plenty of cases, it is true, assume that fraud equals misrepresentation, but like Field, they are cases in which the only fraud charged was misrepresentation." (20) Thus, the Seventh Circuit expanded [section] 523(a)(2)(A)'s definition of fraud to include any variety of nefarious schemes. The First Circuit later adopted McClellan's expanded reading of [section] 523(a)(2)(A) in Sauer, Inc. v. Lawson, 791 F.3d 214, 219 (1st Cir. 2015).

The McClellan court also addressed the question of whether a transferee "obtains" assets "by" actual fraud: "The words 'obtained by' go with 'money, property, [or] services,' not with 'debt.' A debt is not something you obtain; it is something you incur as a consequence of having obtained [property]...." (21) The court concluded, therefore, that it was possible that the transferee "obtained" the transferor's property "by" actual fraud if the transfer was fraudulent and the transferee bore the requisite intent, thus incurring a nondischargeable debt to the transferor's creditors. (22)

While Lawson followed McClellan in extending [section] 523(a)(2)(A)'s discharge bar to fraudulent transfers, the Fifth Circuit in Husky declined to follow McClellan. The Fifth Circuit first recited McClellan's explanation of how a transferee "obtains" a debt in a fraudulent transfer: "The [McClellan] court further reasoned that the debt at issue 'arose not when the [transferee's] brother borrowed money from [the creditor] but when [the transferee] prevented [the creditor] from collecting from the brother the money the brother owed him.' Accordingly, the debt was for 'property ... obtained by fraud.'" (23)

The court then explained why it would not follow McClellan's expanded definition of actual fraud:

McClellan appears to be in tension with the Supreme Court's opinion in [Field] ... [where] the Court reasoned that the terms false pretenses, a false representation, or actual fraud, carry the acquired meaning of terms of [11] art and imply elements that the common law has defined them to include.... Although not directly addressing the issue, the Court throughout its opinion in Field appeared to assume that a false representation is necessary to establish "actual fraud." ... The majority in McClellan asserted that Field was inapposite because "[t]he fraud there took the form of a misrepresentation" and "[n]othing in the Supreme Court's opinion suggests that misrepresentation is the only type of fraud that can give rise to a debt that is not dischargeable under section 523(a)(2)(A)." Although it is true that the facts underlying Field involved a misrepresentation, we do not believe that the case [13] can be so easily disregarded. Nowhere in Field did the Court suggest that different definitions of "actual fraud" apply depending on the type of fraud ... alleged.... Moreover, ... the Court in Field made clear that the meaning of "actual fraud" depends on the 1978 common law meaning of the term.... [W]e are not aware of any [authority] suggesting that the common law meaning of "actual [14] fraud" at that time encompassed fraudulent transfers of the type at issue here. Indeed ... fraudulent transfers are statutory constructs, and are not creatures of the common law. (24)

The court also noted that McClellan contradicted the Fifth Circuit's test for a discharge bar under [section] 523(a)(2)(A), which required a creditor's reliance on the debtor's misrepresentation. (25) The Fifth Circuit's formulation of [section] 523(a) (2)(A)'s discharge bar was, therefore, identical to the 11th Circuit's test in Schweig. (26)

While the First, Seventh, and Fifth circuits made definitive statements regarding "actual fraud's" application to fraudulent transfers, the law in the 11th Circuit was more muddled when...