Section 523(a)(2)(A) of the Bankruptcy Code exempts from discharge debts obtained by "false pretenses, a false representation or actual fraud." Circuit courts were split as to whether a debt could be non-dischargeable, if it related to a fraudulent transfer scheme. The Supreme Court, in Husky International Electronics, Inc. v. Ritz, Case No. 15-145 (May 16, 2016), resolved the circuit split and determined that a debt related to a fraudulent transfer scheme may be non-dischargeable for "actual fraud". This decision may allow creditors pursuing subsequent transferees of fraudulently transferred property to except their debt from discharge, in any bankruptcy filing by the subsequent transferee.
In Husky, Chrysalis Manufacturing Corp. incurred a debt of approximately $164,000 for the purchase of goods from Husky International Electronics, Inc. Daniel Ritz, a director and part-owner of Chrysalis then engaged in a scheme to drain Chrysalis of assets, by transferring money and assets to other entities owned and controlled by Ritz. Husky sued Ritz individually, seeking to hold Ritz personally liable for Chrysalis' debt to Husky. Ritz then filed a chapter 7 bankruptcy petition.
In Ritz's bankruptcy proceeding, Husky commenced an adversary proceeding seeking a determination that Husky's claim against Ritz was non-dischargeable as a "debt for money, property, services . . . to the extent obtained by false pretenses, a false representation, or actual fraud." 11 U.S.C. § 523(a)(2)(A). Because Ritz did not make a specific misrepresentation to Husky when it ordered the goods, Husky argued that the debt was obtained by "actual fraud," because of Ritz's scheme to transfer Chrysalis' assets to other entities. However, both the District Court and the Fifth Circuit disagreed, finding that Ritz did not commit "actual fraud," within the meaning of section 523(a)(2)(A) of the Bankruptcy Code. The Supreme Court reversed, finding that the term "actual fraud" encompasses fraudulent transfer schemes, even if the scheme does not involve an affirmative misrepresentation.
Although the Supreme Court found that a debt related to a fraudulent transfer scheme may be non-dischargeable in certain circumstances, it did not specifically hold that Ritz's debt to Husky was non-dischargeable. Notably, section 523(a)(2)(A) also requires that the debt be "obtained by" actual fraud. The Court did not decide whether Ritz's debt to Husky was "obtained by" Ritz's asset transfer scheme, leaving that for the lower court to determine on remand. However, as noted by Justice Thomas in the dissent, a debt for the purchase of goods cannot be said to be "obtained by" a fraudulent transfer scheme. Thus, in most cases, a debt incurred by the purchase of goods will not be rendered non-dischargeable simply because the debtor then engages in a scheme to fraudulently transfer its assets to other entities.
There is, however, one type of debt that may be considered as "obtained by" a fraudulent transfer scheme – a debt owed by the subsequent transferee of a fraudulent transfer, particularly when the recipient obtained the property with fraudulent intent. Pursuant to section 550(a) of the Bankruptcy Code, the trustee is allowed to recover the value of property transferred through, among other things, a fraudulent conveyance scheme from the transferee of that property, unless the subsequent transferee received the property in good faith, without knowledge of the voidability of the transfer. Most states have similar remedies in their creditors' rights laws. If the trustee or a creditor were to obtain a judgment against the subsequent transferee of property, and the subsequent transferee were to file a bankruptcy petition, the Husky decision provides the basis to argue that such debt is non-dischargeable under section 523(a)(2)(A) as the debt was "obtained by . . . actual fraud." Creditors should be aware of this new potential remedy when considering fraudulent conveyance claims.
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