Case Summary: Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581 (2016) Expands Scope of Section 523(a)(2)(A)

In a 7-1 decision written by Justince Sotomayor, with Justice Thomas dissenting, the Supreme Court ruled that actual fraud under Section 523(a)(2)(A) of the Bankruptcy Code does not require a false representation and is broad enough to include a fraudulent conveyance.[1]

Chrysalis Manufacturing Corp. purchased products from Husky International Electronics Inc. and became indebted to Husky in the amount of approximately $164,000.[2] Instead of paying back Chrysalis’s debt to Husky, Daniel Ritz, the director of Chrysalis, transferred large sums out of Chrysalis’s accounts into other entities that he controlled.[3] Husky sued Ritz seeking to hold him personally liable for the $164,000 debt, arguing that by transferring Chrysalis’s funds to other entities, Ritz effectuated actual fraud.[4] Ritz in turn filed for Chapter 7 bankruptcy.[5] Husky initiated an adversary proceeding against Ritz again seeking to hold him personally liable for Chrysalis’s debt and also seeking for the debt to be found nondischargeable under Section 523(a)(2)(A) as being obtained by actual fraud.[6]

The Court looked at the language of Section 523(a)(2)(A) and compared it to its predecessor.[7] The Court noted that in 1978 Congress added “actual fraud” to the list of actions which would render a debt nondischargeable.[8] The Court reasoned that by adding actual fraud to Section 523(a)(2)(A), Congress intended it to mean something different than false representation.[9] The Court further explained that actual fraud means any fraud that is “done with wrongful intent.”[10] The Court did not find it necessary to enumerate every situation which would fall under the actual fraud definition, but it pointed out that it is well established that schemes, such as the one effectuated by Ritz, designed to defraud one’s creditors have always been described as actual fraud.[11] The Court explained that a fraudulent conveyance is not an inducement-based fraud.[12] Instead, a fraudulent conveyance is the concealment of property in order to prevent one’s creditors from collecting on a debt.[13] Because false representation is not an element of actual fraud under its common law definition, the Court concluded that a false representation is not required for actual fraud to be found.[14]

Ritz argued that the Court’s definition of actual fraud renders Section 523(a)(2)(A), (a)(4) and (a)(6) and Section 727(a)(2) duplicative.[15] The Court explained that while some redundancies exist, there are also significant differences among the sections and thus it did not feel compelled to come up with a new definition of actual fraud to avoid them rather than use the common law definition.[16]

Ritz as well as the dissenting opinion argued that a debt cannot be “obtained by” a fraudulent conveyance as Section 523(a)(2)(A) provides.[17] The Court disagreed and noted that even if the transferor cannot obtain a debt by actual fraud, the transferee can do so.[18] Thus, the Court concluded that at least in some situations a transfer can be obtained by a fraudulent conveyance.[19] The Court also noted that the dissent’s requirement that the fraud occurs at the “inception” of the transaction between the debtor and the creditor is nonexistent in the language of the code and thus it refused to impose such requirement as an element of actual fraud.[20]

The Court finally refused to interpret actual fraud as modifying false representation and false pretenses as suggested by Ritz.[21] The Court explained that if Congress meant for actual fraud to modify the preceding terms, it would have used the word “by” instead of the word “or.”[22]

In conclusion, the Supreme Court adopted the common law definition of “actual fraud,” which is any fraud that is effectuated by ill will, and concluded that it is broad enough to include a fraudulent conveyance and it does not require a false representation.[23]