Supreme Court Clarifies the Standard for Actual Fraud
On May 16, 2016, the United States Supreme Court decided Husky International Electronics Inc. v. Ritz, holding by a 7-1 vote that the “actual fraud” standard found at 11 U.S.C. Section 523(a)(2)(A) encompasses fraudulent transfer schemes, even when these schemes do not have a fraudulent representation or any misrepresentation made as part of the scheme.
Petitioner Husky International is a supplier of components used in electronic devices. During the years 2003 through 2007, Husky sold its components to Chrysalis Manufacturing, which in the course of this business, incurred a debt of over $163,000 owed to Husky. Respondent Daniel Lee Ritz served as the director of Chrysalis and owned 30% of its common stock. In the years 2006 and 2007, Ritz transferred assets, namely large amounts of cash, to different companies he owned or had an interest in, assets which could have been used to pay the debt owed to Husky.
This transfer scheme prompted Husky to file a lawsuit in Texas State Court seeking to hold Ritz personably liable for the debt owed to Husky by Chrysalis. Husky argued in the state court that Ritz committed actual fraud by use of the transfers, relying on a state statute making shareholders responsible for corporate debts. Ritz then promptly filed a chapter 7 petition in the United States Bankruptcy Court for the Southern District of Texas. Husky then filed an adversary proceeding seeking to except the debt from discharge pursuant to 11 U.S.C. Section 523(a)(2)(A), among other claims. The District Court ruled that the debt could be discharged because the transfer scheme did not amount to “actual fraud” as the debt was not obtained by use of actual fraud, or the use of a fraudulent representation which is relied upon by the creditor. The Fifth Circuit Court of Appeals affirmed the decision of the District Court, disagreeing with Husky that transfer schemes are a form of actual fraud. The Fifth Circuit held that a necessary element of actual fraud is a misrepresentation made by the debtor to the creditor in which the creditor relies. Ritz had not made any representations to Husky, and therefore, couldn’t have committed actual fraud as meant in the statute.
Copy of Opinion here…