The Multifarious Ways of Proving Fraud After Husky

Section 523(a)(2)(A) of the Bankruptcy Code provides that to the extent a debt is obtained by “false pretenses, a false representation, or actual fraud[,]” it is excepted from discharge.[1] In the past, many courts have read the phrase “false pretenses, a false representation, or actual fraud” as meaning only fraud made through misrepresentation or omission. In the recent Supreme Court case of Husky Int’l. Elecs. Inc. v. Ritz,[2] the U.S. Supreme Court held that the term “actual fraud” is separate and apart from “false pretenses” and “false representation” and that “actual fraud” “encompasses forms of fraud like fraudulent conveyance schemes that can be affected without a false representation.”[3]

The Court concluded that actual fraud “connotes deception or trickery” but acknowledged that “the term is difficult to define more precisely.”[4] The Court stated that “[T]here is no need to adopt a definition for all times and all circumstances here because, from the beginning of English bankruptcy practice, the courts and legislatures have used the term ‘fraud’ to describe a debtor’s [fraudulent transfer of assets].”[5] The Court concluded: “Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.’”[6] The Court remanded for a determination of whether the debt in that case was obtained by the debtor through his fraudulent asset-transfer scheme.[7] The Court, therefore, left a number of questions unanswered.

Defining “Actual Fraud”

In confronting the definition of “actual fraud,” Justice Sotomayor was facing a similar situation to the one confronting Justice Potter Stewart in his attempts to define “hardcore pornography.” Recognizing that he might never succeed in defining the term, he stated, “But I know it when I see it.”[8] As a result of Husky: “The precise elements of actual fraud are currently in flux.”[9] This paper will discuss the cases decided after Husky addressing “actual fraud” and its definitions and characteristics, including the other issues addressed by the Court: the types of claims for fraud under § 523(a), the need for a misrepresentation, reliance, the “obtained by” or causation requirement, the timing of causation, whether and to what extent the debtor must benefit from the fraud, and the elements for a cause of action for actual fraud.

Although the Supreme Court stated that it was difficult to define “fraud,” the case primarily relied upon by the Supreme Court in reaching its decision in Husky — McClellan v. Cantrell[10] — defined fraud as the “multifarious means which human ingenuity can devise and which are resorted to by one individual to gain an advantage over another by false suggestions or by the suppression of truth.”[11] Other courts have stated, “[F]raud may be based on any type of conduct calculated to convey a misleading impression.”[12] Fraud “involv[es] moral turpitude or intentional wrong.’”[13] Fraud also involves “an intention and purpose to deceive the creditor.”[14]

Put simply, actual fraud is “anything that counts as fraud and is done with wrongful intent.” No misrepresentations, however, are necessary to determine actual fraud or wrongful intent. Wrongful intent can be manifested “when a debtor intentionally engages in a scheme to deprive or cheat another of property or a legal right.”[15]

Husky ultimately determined that “actual fraud” has two parts: “actual” and “fraud.”[16] The lower courts have generally recognized that the U.S. Supreme Court has also divided “actual fraud” into the same two parts.[17]

Three Causes of Action — or Two or One

The cases also generally recognize that § 523(a)(2)(A) contains three causes of action: (1) false pretenses, (2) false representation or (3) actual fraud.[18] However, one opinion states that the Fifth Circuit has “distinguished between ‘actual fraud’ and ‘false pretenses and representations,’ so there are two distinct paths to a determination of nondischargeability under [§ 523(a)(2)(A)].”[19] Another court has stated that in the Ninth Circuit, “false pretenses,” “false representations” and “actual fraud” all have the same meaning and “do not provide an independent basis for finding a debt non-dischargeable.”[20] This dispute continues, despite Husky’s statement to the contrary.

No Misrepresentation Is Necessary — or Is It?

The courts also generally recognize that a misrepresentation is not necessary to prove actual fraud.[21] In fact, at least one court has limited the holding of Husky to “a determination that ‘actual fraud’ does not require a misrepresentation.”[22] In other words, in that court’s review, the rest of the opinion is dicta. However, courts have held that, if the creditor pursues an objection to dischargeability based solely on a misrepresentation or omission, then the creditor will be required to prove all of the elements of common law fraud, including a misrepresentation and reliance.[23] On the other hand, some cases in the Ninth Circuit appear to continue to require the debtor to make a misrepresentation for a debt to be nondischargeable in all cases.[24] Other cases in the Ninth Circuit acknowledge that a misrepresentation is no longer necessary.[25]

To Rely or Not to Rely?

Cases from other jurisdictions, including the Seventh and Tenth Circuits, state that actual fraud does not require reliance.[26] This makes sense, given that no misrepresentation is required, according to Husky. Other cases require that the creditor exercise justifiable reliance on the debtor’s statement or omission, which, of course, implies some sort of explicit or implicit misrepresentation, contrary to the holding in Husky.[27]

Timing

Some courts hold that the fraud must have occurred at the time the debt is incurred and that the harm must have been caused to the person upon whom the fraud was committed.[28] The requirement that the debt be incurred and the harm be caused at the time the fraud is committed appears to contradict the holding in Husky, where the fraud occurred not at the inception of the loan, but later when the fraudulent transactions occurred in that case. Husky evaded this issue by remanding for a determination of whether the debt was “obtained by” the fraud.

Benefit to the Debtor, Damages and Causation

At least one case in the Eleventh Circuit followed established precedent in that circuit and “‘requires that the debtor gain a benefit from the [property] that was obtained by fraudulent means.’”[29] In Hatfield v. Thompson (In re Thompson),[30] the court discussed the split among the circuit courts as to whether a debtor must personally receive money, property, services or an extension of credit,[31] stating:

The first approach requires the debtor personally to receive money, property, services, or credit “through her fraud or use of false pretenses.”... The second approach prevents an innocent debtor from discharging liability for fraud of his partners, regardless of whether he receives a monetary benefit…. The Ninth Circuit has adopted a third approach holding that “the receipt of a benefit is no longer an element of fraud under §523(a)(2)(A).”...[32]

Some cases have held that the creditor is not required to show that the debtor received a direct benefit “as a prerequisite for a determination that a fraud debt is non-dischargeable.”[33] But although proof of a direct benefit to the creditor is not required, proximate cause of the damage is still required.[34]

The debt must at least be related to the fraud in order to be “obtained by” the fraud.[35] Courts have recognized that the Husky decision fails to dictate what is required to establish the causal link between the fraud and the harm caused to the creditor.[36] This issue was also addressed in the case of Hatfield v. Thompson.[37]

The Hatfield v. Thompson Approach

Thompson is an insightful approach to the holding in Husky, recognizing the problems and the various disputes among the courts arising from or related to the opinion. In Thompson, the court adopted a test and elements for analyzing whether “actual fraud” has been committed. Thompson stated that the inquiry begins with a two-part analysis: “[F]irst, the bankruptcy court must determine the validity of the debt under applicable law (the claim on the debt); and second, the bankruptcy court must determine the dischargeability of the debt under § 523 (the dischargeability claim).”[38]

This approach is not new, yet the three-part test stated in Thompson does appear to be a novel approach. Once the creditor has established the validity of the claim under applicable state or federal law, the creditor, in order to show actual fraud, must establish by a preponderance of the evidence these elements: “(a) the debtor committed actual fraud; (b) the debtor obtained money, property, services or credit by the actual fraud; and (c) the debt arises from the actual fraud.”[39]

The Thompson court, recognizing a split among the circuits,[40] concluded that the obligation owed the creditor does not have to be for something the debtor actually obtains from the creditor.[41] The court concluded that there was also no requirement “that the debtor obtain[ed] the debt by actual fraud or that the debt be for something the debtor obtained by actual fraud.” The award to which the creditor is entitled is not limited to compensatory damages and is not limited by the value of the thing obtained by the creditor as a result of the fraud.[42] It includes all damages proximately caused by the fraud.

Same as It Ever Was?

In the end, the cases all tend to describe (or define) “actual fraud” in similar terms to that used in McClellan, Husky and other cases. The courts will be forced to continue determining whether fraud exists on a case-by-case basis, based on all the circumstances — in other words, a “totality of the circumstances” approach — until further clarity is provided by the Supreme Court or the circuit courts.[43] Even in Thompson, where the court stated its three-part test, it also reviewed the totality of the circumstances in determining whether fraud existed.[44] Although the test established in Thompson is a good place to start in regards to defining the elements of “actual fraud,” it appears that the courts will continue to review the facts and circumstances of each case to determine whether fraud has been perpetrated by using a “know it when I see it” approach.