In Husky Int'l Electronics, Inc. v. Ritz, No. 15-145 (U.S. May 16, 2016), a 7-1 majority of the Supreme Court held that a fraudulent conveyance scheme comported with the requirements of "actual fraud" to create a potential new debt dischargeability exception pursuant to section 523(a)(2)(A) of the Bankruptcy Code. This is a significant development in bankruptcy law jurisprudence because, prior to this decision, courts had interpreted section 523(a)(2)(A)'s provisions on nondischargeablity of a debt to require either (a) reliance on a debtor's misrepresentations or (b) that a debt be "obtained by" fraud to qualify as actual fraud. The majority reasoned around this "obtained by" limitation by concluding that a recipient of a transfer in a fraudulent transfer scheme obtained asserts as a result of their "participation" in the scheme.

The facts of Husky were, honestly, pretty egregious. At oral argument, Ritz's attorney did not dispute the existence of a fraudulent transfer scheme. A company called Chrysalis Manufacturing incurred a debt to Husky. Ritz, a Chrysalis director and part owner, proceeded to drain Chrysalis of all assets that could be used to pay the debt owed to Husky, transferring the assets to other entities Ritz controlled. Husky sued Ritz to recover on the debt, and Ritz filed for bankruptcy. An adversary proceeding was filed in the bankruptcy case seeking to hold Ritz personally liable for the debt to Husky.  Applying the previously well-established jurisprudence of the "actual fraud" requirement, the District Court and Court of Appeals for the Fifth Circuit held that the actual fraud requirement of nondischargeability under section 523(a)(2)(A) was missing because (1) the transfers came subsequent in time to the creation of the debt to Husky and (2) Ritz had made no false representations to Husky.

What does this decision mean? Two things. First, if you are counseling a client facing significant liabilities and considering bankruptcy (a situation in which both franchisors and franchisees occasionally find themselves), you now need to ensure that any efforts to secure and protect assets do not run afoul of state or federal (bankruptcy code) fraudulent transfer law.  Second, this opinion is almost certainly going to allow creditors to pursue many more debtors for bankruptcy fraud. As such, it is likely to become a new tool for franchisors seeking recovery from franchisee-debtors who have stolen trade secrets, violated noncompetition or nonsolicitation agreements or simply failed to pay royalties where a scheme to fraudulently transfer assets can be established.

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