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Supreme Court Broadly Interprets “Actual Fraud” Bankruptcy Discharge Exception

On May 16, 2016, the United States Supreme Court held in Husky International Electronics, Inc. v. Ritz, 578 U.S. ___ (2016), that the term “actual fraud” in a bankruptcy non-discharge section encompasses fraudulent conveyance schemes, even when those schemes do not involve a false representation. The Bankruptcy Code prohibits debtors from discharging debts “obtained by . . . false pretenses, a false representation, or actual fraud.” Debts of this type pass through the bankruptcy and creditors continue to be able to seek and enforce judgments arising from those claims. In Ritz, Husky International Electronics sold goods to Chrysalis Manufacturing, and Chrysalis incurred a debt to Husky of approximately $164,000. During the same period, defendant Daniel Lee Ritz, Jr. served as a director of Chrysalis and owned at least 30% of Chrysalis’s stock. He drained Chrysalis of assets it could have used to pay its debts to creditors like Husky by transferring large sums of Chrysalis’s funds to other entities Ritz controlled. Husky filed a lawsuit seeking to hold Ritz personally liable for Chrysalis’s debt. Ritz then filed for Chapter 7 bankruptcy. Husky brought an adversary proceeding against Ritz seeking to hold Ritz personally liable to Husky and to hold the debt non-dischargeable because Ritz’s intercompany-transfer scheme constituted “actual fraud” under the Bankruptcy Code’s exemption to discharge in 11 U.S.C. 523(A)(2)(A). In a split with other Circuit Courts, the Fifth Circuit held that a debt is “obtained by . . . actual fraud” only if the debtor’s fraud involves a false representation from the debtor to the creditor. The Supreme Court reversed, holding that the term “actual fraud” encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.

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