When the Actor Leaves the Stage: Passive Voice in the Bankruptcy Code

By Hon. Brian C. Walsh1 and Taylor L. Rowland

In Bartenwerfer v. Buckley,2 the U.S. Supreme Court analyzed the effect of the passive voice in § 523(a)(2)(A) of the Bankruptcy Code.3 In that case, the debtor was liable for a judgment of more than $200,000 because of her business partner’s fraudulent activity.4 The fraud victim objected to the debtor’s attempt to discharge the judgment under § 523.5 Section 523(a)(2)(A) prohibits a debtor from discharging a debt that was “obtained by ... fraud.”6

Analyzing the statute’s language, the Court determined that the passive voice focuses on “how the money was obtained, not who committed fraud to obtain it.”7 Disagreeing with the debtor’s argument that the statute most naturally refers to fraud committed by the individual debtor, the Court noted that use of the passive voice intentionally broadens the statute by “pull[ing] the actor off the stage.”8

The Court further supported its interpretation of the statute by pointing to “the common law of fraud,” which “has long maintained that fraud liability is not limited to the wrongdoer.”9 Because the statute used the passive voice and did not limit the fraud to that which was personally committed by the debtor, and because the underlying state law extended liability for fraud to all members of a partnership, the debtor could not discharge the debt that was obtained by her business partner’s fraudulent activity.10

The Court’s analysis of the passive voice in § 523(a)(2)(A) raises questions of how far the Bartenwerfer holding may be extended and how it applies to other sections of the Bankruptcy Code that use the passive voice.11 Although this article will focus on the different uses of the passive voice within the Code, it is important to note that statutes outside of the Code use the passive voice, and they also might be viewed in a new light post-Bartenwerfer.12

Straightforward Applications

Looking to other Bankruptcy Code sections, there are some clear applications of Bartenwerfer. For example, § 523(a)(4) prevents a discharge of a debt that arose from fraud, embezzlement or larceny.13 Like § 523(a)(2)(A), this section does not say whether the debtor must have committed the fraud or other bad acts.14 The focus is on the actions leading to the debt, not on the actors.15 In light of Bartenwerfer, courts have interpreted § 523(a)(4) to apply to debtors who are liable for a debt procured by fraud when liability arose because of a special relationship existing between the debtor and the fraudulent actor.16

Similarly, § 1144 allows a court to revoke an order confirming a chapter 11 plan if that order was “procured by fraud.”17 Sections 1230 and 1330 contain language that mirrors § 1144.18 It is easy to imagine a straightforward application of Bartenwerfer in which a court revokes a confirmation order because of fraud committed by an agent of the debtor. However, looking at the text of the revocation statutes, it is not obvious that the fraud must have been committed by the debtor or a party with a special relationship to the debtor. According to Collier on Bankruptcy, “While in nearly all instances, it is likely to be the debtor or the plan proponent engaging in fraud, it may not always be the case. The perpetrator of the fraud could be counsel for the debtor, an entity acquiring rights under the plan, or perhaps a creditor.”19

Consider a group of creditors that inflate the value of their claims so that their votes accepting the plan outweigh dissenting votes and eliminate an absolute-priority objection that the dissenters would like to advance.20 Absent other confounding factors, there is a plausible argument that the confirmation order was procured by these creditors’ fraud.

Because §§ 1144, 1230 and 1330 give a court discretion on whether to revoke a confirmation order, courts probably will be reluctant to do so when the debtor is innocent.21 Even after Bartenwerfer, courts seem to assume that the debtor must have engaged in the fraudulent conduct.22 Whether other courts will expand the Supreme Court’s broad view of the passive voice by extending the application of these sections remains to be seen.

More Aggressive Applications

The Supreme Court’s holding in Bartenwerfer also could have some more-attenuated applications. For example, § 363(f)(5) allows estate property to be sold “free and clear of any interest in such property of an entity ... only if ...such entity could be compelled ... to accept a money satisfaction of such interest.”23 Because this section uses the passive voice, it hides the identity of the hypothetical person who could compel the creditor to accept a monetary satisfaction. Some courts before Bartenwerfer interpreted this section to require that the trustee or the debtor be the actor.24

In light of Bartenwerfer, the requirement of § 365(f)(5) might be satisfied if there is any party, or any court, that could compel a lienholder to accept a money satisfaction. Thus, a trustee might be able to sell property under § 363(f)(5) if it could be sold in a hypothetical eminent-domain proceeding that otherwise bears no resemblance to the trustee’s proposed transaction.25 Alternatively, a debtor might sell an asset free and clear of an interest of a junior lienholder if that creditor could be forced to accept a monetary satisfaction when a senior lienholder forecloses.26

Bartenwerfer also could affect proceedings under § 522(c)(4). This somewhat obscure provision limits the effect of a debtor’s exemption of property from the bankruptcy estate if the debtor owes “a debt in connection with fraud in the obtaining or providing of any ... financial assistance for purposes of financing an education at an institution of higher education.”27 This section does not require that the debtor has engaged in fraud, or even that the debtor is vicariously liable for fraud, just that there was fraud in connection with the obtaining or provision of a loan. Thus, there is an argument that if an educational institution defrauds the government in connection with providing loans to its students, those students might not receive the benefit of the homestead and other exemptions in a later bankruptcy case. This result is possible — even if the debtor did not personally engage in any wrongdoing, was not aware of any fraud and is not liable under nonbankruptcy law for the fraud.

Mischievous Applications

Broadly interpreting the passive voice in other Bankruptcy Code sections could lead to strange — and likely unintended — results. For example, the definition of “current monthly income,” an important concept in chapter 13 plans, “excludes ... payments to victims of war crimes or ... victims of international terrorism” and other similar crimes.28 Although the most natural reading of the statute is that a victim of a crime is not required to devote restitution income to the repayment of creditors, that is not the only possible interpretation.

If the debtor is a war criminal who is required by nonbankruptcy law to make regular reparations payments to his victims, he might be able to deduct these payments from his current monthly income and projected disposable income. There would be other obvious obstacles to a war criminal’s attempt to confirm a chapter 13 plan or to obtain a discharge, but the fact that he is required to devote very little disposable income to pay general creditors might not be one of them.

Similarly, a debtor generally must contribute all of her disposable income to the payment of unsecured creditors through a chapter 13 plan.29 Section 1325(b) defines “disposable income” as “current monthly income received by the debtor ... less amounts reasonably necessary to be expended” for certain purposes.30 Necessary expenditures include charitable contributions and payments necessary to operate a business, but the statute does not say who must do the expending.31 For example, if the debtor’s employer matches the debtor’s charitable contributions, may the debtor deduct the employer’s matching payment from her current monthly income? May a debtor who is engaged in business calculate monthly disposable income by deducting business expenditures paid by the debtor’s business partner or someone else?32 If the passive voice in § 1325(b)(2) allows a debtor to deduct expenses paid by others, the effect might be to artificially lower plan payments.

A similar problem might arise under § 1129, which contains the requirements for confirmation of a chapter 11 plan. Under several of its subsections, creditors must receive specified amounts of cash, deferred cash payments or property.33 For example, § 1129(a)(9)(A) requires that a creditor with an administrative-expense priority claim “receive on account of such claim cash equal to the allowed amount of such claim,” but the statute does not say that the creditor must receive that cash from the debtor or the plan’s disbursing agent. Does this mean that a debtor may propose a plan stating that a creditor will receive cash or property from some third party, such as a guarantor, even if that party has not agreed to make these contributions? If so, may the plan relieve the debtor of the obligation to pay the debt?34

Conclusion

The Supreme Court’s interpretation of the passive voice in Bartenwerfer could have implications beyond § 523(a)(2)(A). The sections cited in this article are just a few examples of the use of the passive voice and similar language that does not clearly identify an actor in the Bankruptcy Code. Some of these examples are straightforward, and others are obscure, but all of them may present opportunities for creative advocacy when the right facts are present.

Hon. Brian Walsh is a U.S. Bankruptcy Judge, and Taylor Rowland is a term law clerk, for the U.S. Bankruptcy Court for the Eastern District of Missouri in St. Louis.