Bankruptcy Judge Henry A. Callaway of Mobile, Ala., declined an invitation to turn the Supreme Court’s decision in Husky International Electronics Inc. v. Ritz into a rationale for barring the discharge of a debt anytime a creditor shows that the debtor committed a later fraudulent transfer with actual intent to hinder, delay or defraud.
In Husky, the Supreme Court held in May that a debt can be nondischargeable under Section 523(a)(2)(A) even if the debtor made no misrepresentation to the creditor. Sitting in Pensacola, Fla., Judge Callaway said that the Supreme Court did not read “obtained by” out of the statute, which prescribes the denial of discharge of any debt “to the extent obtained by . . . false pretenses, false representation, or actual fraud.”
The case involved a creditor who obtained a $1.8 million judgment based on a defaulted note. After the judgment but before filing a chapter 11 petition, the judgment debtor allegedly attempted to thwart collection of the judgment by effecting several fraudulent transfers. Invoking Husky, the judgment creditor filed a complaint to declare the judgment nondischargeable under Section 523(a)(2)(A).
Reading Husky narrowly in his opinion on Nov. 3, Judge Callaway dismissed the complaint.
Judge Callaway said that the debtor in Husky had liability to the creditor as a result of his fraudulent transfers, even though the debtor had made no fraudulent misrepresentation to the creditor. In the case in his court, Judge Callaway said that the debtor’s liability to the creditor predated the fraudulent transfers and thus did not give rise to the liability that the creditor sought to declare nondischargeable.
Judge Callaway said that the Supreme Court “in dicta may open the door for potential Section 523(a)(2) claims against debtor-transferees who have received fraudulently transferred assets.” He distinguished Husky by observing that the debtor in his case “is alleged to have fraudulently transferred his own assets.” Moreover, he said, the Supreme Court did not rule on the “obtained by” issue and remanded the case to decide that question.
The case in his court was different, Judge Callaway said, because the debtor was already obligated on the debt represented by the judgment. The judge was “not willing to extend Husky dicta to find that debts ‘obtained by’ [the debtor’s liability on the note] can somehow be ‘re-obtained’ and thus rendered nondischargeable by later alleged fraudulent actions.”
Judge Callaway concluded his opinion by saying that the judgment was not “obtained by” fraud because the “debtor’s liability arose not from the original debt but from his later fraudulent transfers.”
The opinion makes no comment on whether the transfers, if proven fraudulent, could be grounds for denial of discharge under Sections 727(a)(2) and 1141(d)(2).
There is a policy argument to support Judge Callaway’s decision. If the debtor indeed committed a fraudulent transfer with “actual intent” within a year of bankruptcy, Section 727(a)(2) is designed to benefit all creditors by denying the debtor’s discharge of all debts. Arguably, a creditor should not be permitted to use Husky in a manner that would only benefit that one creditor when the statute is intended for all creditors to benefit.
And what if all creditors banded together and brought a proceeding to deny discharge of their debts under Section 523(a)(2)(A) based on an intentionally fraudulent transfer more than a year before bankruptcy? If Husky meant they should win, then the creditors in substance would have denied the debtor’s discharge even though the debtor would be entitled to a discharge under section 727(a)(2).