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Supreme Court Expands Grounds to Object to Bankruptcy Discharge Based on Fraudulent Transfers by Debtor

Financial Restructuring and Bankruptcy Alert | May 18, 2016
By: Earl Forte

If a debtor owes you money but transfers away assets so it can’t pay you, you may be able to block that debtor from obtaining a discharge of that debt in bankruptcy.

On May 16, 2016, the Supreme Court of the United States issued its opinion in Husky International Electronics, Inc. v. Daniel Lee Ritz, Jr., No. 15-145, 578 U.S. ___ (2016) in which the Court ruled that Husky, an unsecured creditor, could object to Ritz’s bankruptcy discharge on the ground that Ritz had fraudulently transferred away assets, thereby hindering and delaying Husky’s collection efforts. The Court’s decision appears to expand the grounds on which unsecured creditors can object to a debtor’s bankruptcy discharge.

Chrysalis Manufacturing Corporation, a company controlled by Ritz, purchased electronics components from Husky, incurring a debt to Husky of $163,999.38. Over a two-year period, Ritz drained Chrysalis of assets by transferring away large amounts of its funds to other companies he controlled. Husky sued Ritz for “actual fraud” and sought to impose personal liability on him under a provision of Texas state law. Ritz filed for Chapter 7 bankruptcy protection and Husky filed a complaint against him objecting to the discharge of the debt to Husky under § 523(a)(2)(A) of the Bankruptcy Code on the ground that Ritz was personally liable for the debt under Texas law and because he had engaged in “actual fraud” against Husky by transferring away Chrysalis’ funds. See 11 U.S.C. § 523(a)(2)(A).  Id. at 1-2

The District Court held that while it agreed with Husky that Ritz could be held personally liable for the debt to Husky under Texas law, because the debt had not been “obtained by…actual fraud” as required by § 523(a)(2)(A), Husky could not block the bankruptcy discharge. The United States Court of Appeals for the Fifth Circuit affirmed the District Court. The Supreme Court granted certiorari to resolve a split among the Circuit courts on this issue.  Husky v. Ritz at 1, 2. 

In deciding to reverse the Fifth Circuit, the Supreme Court analyzed fraudulent transfer law going back to Statute 13 Elizabeth (1571) and concluded that “actual fraud” as used in § 523(a)(2)(A) “is broad enough to incorporate a fraudulent conveyance” and does “not require a misrepresentation from a debtor to a creditor." Id. at 5. “In such cases, the fraudulent conduct is not in dishonesty inducing a creditor to extend a debt. It is in the acts of concealment and hindrance.” Id. at 6. On this basis, the Supreme Court reversed the Fifth Circuit, holding that Husky could object to Ritz’s discharge, and remanded the case back to the Fifth Circuit for further proceedings. Id. at 11.

Husky raises some questions such as: (1) In Husky, there was no evidence that Husky had been defrauded when it extended credit to Chrysalis. Does the Supreme Court’s decision in Husky effectively eliminate the requirement in § 523(a)(2) of the Bankruptcy Code that the subject debt be “obtained, by…actual fraud?"; and (2) As an unsecured creditor, Husky could have recovered its money by bringing its own fraudulent transfer claim against Ritz, or a bankruptcy trustee could have done so once Ritz had filed for Chapter 7 protection. It is not clear from the opinion in Husky that this ever occurred. Does the Court’s decision in Husky disturb the discharge provisions of the Bankruptcy Code by effectively eliminating the “obtained, by …actual fraud” requirement for no good reason since there is already a remedy available to injured creditors, such as Husky, under state fraudulent transfer law and under §§ 544 and 548 of the Bankruptcy Code?

Despite these questions, if you are a creditor of a debtor in bankruptcy and believe the debtor has transferred away assets, thus hindering or delaying your collection efforts, you may want to consider objecting to the debtor’s discharge based on Husky.

If you have questions on this matter or would like further information, please contact Earl Forte (fortee@whiteandwilliams.com; 215.864.6822) or another member of our Financial Restructuring and Bankruptcy Group.

For more about bankruptcy and fraudulent transfer law see Forte, Earl M., The Fraudulent Transfer Handbook (2013 Ed.); Forte, Earl M., The Fraudulent Transfer Handbook – 2014 Supplement; and Forte, Earl M., The Fraudulent Transfer (a/k/a Voidable Transactions) Handbook – 2015 Supplement at www.amazon.com.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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