The case argued on March 1 in the Supreme Court pitted Fifth Circuit Judge Carolyn D. King against the Seventh Circuit’s Richard A. Posner.
Judge King, whose opinion was up for review on a grant of certiorari, read Section 523(a)(2)(A) of the Bankruptcy Code more narrowly, while Judge Posner had reached the opposite result 15 years earlier by employing the court’s equitable powers to ensure that someone profiting from fraud does not escape the bankruptcy court unscathed.
Based on the Justices’ questions from the bench, it’s not clear who will come out on top. It is clear, however, that the late Justice Antonin Scalia is sorely missed. The courtroom lacked his good humor and laser-like analysis of statutory language.
The two circuit judges, who authored some of the most outstanding bankruptcy opinions at the appeals court level in recent decades, disagreed about the ability of a creditor to bar discharge of a debt for “actual fraud.” Judges King and Posner both dealt with Section 523(a)(2)(A) of the Bankruptcy Code, which precludes discharging a debt based on property “obtained” by “actual fraud.”
The case argued yesterday in the Supreme Court involved a man who caused his company to transfers funds to himself. The man later went bankrupt. A creditor, owed $164,000 by the company, sued in bankruptcy court to bar the man’s discharge of the debt under Section 523(a)(2)(A), presuming that the man was equally liable for the debt on an alter ego theory. The bankruptcy judge rejected the dischargeability complaint, was upheld in district court and was affirmed again by Judge King in May 2015. She held that misrepresentation and reliance is required before a debt can be declared nondischargeable for “actual fraud.”
The Supreme Court granted certiorari because Judge King’s holding differed with Judge Posner’s 2000 opinion in McClellan v. Cantrell. In that case, Judge Posner said that a fraudulent misrepresentation is not the only form of fraud that can render a debt nondischargeable under subsection (a)(2)(A).
Underlying Judge King’s conclusion was the fact that the bankrupt individual made no misrepresentation to the creditor. Were the law as broad as Judge Posner says, Judge King believed that “other exceptions to discharge in the Bankruptcy Code may be rendered redundant by the McClellan majority’s broad” definition of actual fraud.
The lack of reliance on a misrepresentation was a focus of the Justices’ questions from the bench. Redundancy was also a frequent topic of discussion at oral argument yesterday. Counsel for the creditor argued that redundancy is no statutory sin when the objective of the law is to reserve bankruptcy relief for honest debtors.
Based on questions from the bench, the result may come down to a question of whether or not aiding and abetting someone else’s fraud is grounds for nondischargeability under subsection (a)(2)(a). Counsel for the debtor, who won in the Fifth Circuit, contended that a plethora of other provisions in the Code provide relief against someone who benefits from fraud, so there is no need to declare a debt nondischargeable as to a particular creditor who, as a result, might end up recovering more than other creditors who suffered the same injustice.
Based simply on oral argument, it seemed as though more Justices are inclined to come down on the side of Judge Posner and declare the debt nondischargeable even in the absence of misrepresentation and reliance, the two lynchpins of actual fraud in the common law sense of the term. If the majority take that view, the Supreme Court will have reaffirmed the equitable powers of the bankruptcy court, which were undercut by the 2014 decision in Law v. Siegel.
At the time she wrote the Fifth Circuit opinion last year, Judge King pointed out that no appellate court had ever followed the Seventh Circuit on that issue.
That statement proved short-lived, however, because the First Circuit in July handed down Sauer Inc. v. Lawson (In re Lawson), which sided with Judge Posner and held that “actual fraud” includes fraudulent transfers intended to hinder creditors. Analyzing the Restatement of Torts, the First Circuit said that the “common law concept of fraud” requires looking “beyond fraudulent misrepresentation to at least include fraudulent conveyances.”
Scholars and bankruptcy trade organizations do not agree on whether “actual fraud” requires misrepresentation. The National Association of Bankruptcy Trustees submitted an amicus brief on the side of the creditor, while the National Association of Consumer Bankruptcy Attorneys is in the debtor’s camp with its brief arguing that the debt was properly discharged.
Professors including Susan Block-Lieb from Fordham Law School, Edward Janger from Brooklyn Law School, G. Eric Brunstad Jr. from Georgetown Univ. Law Center and Bruce Grohsgal from Widener University Delaware Law School submitted amicus briefs for the debtor.
Professors Ronald Mann from Columbia Law School, Alan Schwartz from Yale Law School and David Skeel from Univ. of Pennsylvania Law School were among scholars filing a brief for the creditor.
Shay Dvoretzky from Jones Day in Washington, D.C., argued for the creditor. Dvoretzky had been a clerk for Justice Scalia. In addition, the U.S. Solicitor General submitted a brief on the side of the creditor and argued that Judge Posner had the correct ruling.
Opposing counsel was Erin E. Murphy from Bancroft PLLC in Washington, D.C. She had been a clerk for Chief Justice John G. Roberts Jr.