Ruling in favor of the debtor on an issue similar to the question before the Supreme Court this coming term in Bartenwerfer, Bankruptcy Judge Joshua P. Searcy of Tyler, Texas, held that a debt is nondischargeable under Section 523(a)(19) only with regard to “debts owed by debtors who themselves committed a securities violation.”
The Supreme Court granted certiorari in Bartenwerfer v. Buckley, 21-908 (Sup. Ct.), to resolve a split of circuits and decide whether a debtor is saddled with a nondischargeable debt for a false representation or actual fraud under Section 523(a)(2)(A) based entirely on the fraud of a partner or an agent. In other words, does the imputation of liability for fraud also result automatically in nondischargeability, or must the debtor have some degree of scienter? To read one of ABI’s stories on Bartenwerfer, click here.
Some of the subsections in Section 523(a) make a debt nondischargeable only if there was an act by the debtor. For example, a debt is nondischargeable under subsection (a)(6) on account of a willful and malicious injury “by the debtor.” Likewise, a debt arising from wrongful death or personal injury is nondischargeable under subsection (a)(9) only if it was caused by “the debtor’s operation of a motor vehicle.”
Does the absence of a reference to an act by the debtor in subsections (a)(19) and (a)(2) mean that liabilities for actual fraud or violations of securities law are nondischargeable regardless of the debtor’s fault? Is the statute clear one way or the other? Will the Supreme Court base its decision on “policy”?
Last week, the U.S. Solicitor General filed an amicus brief in Bartenwerfer telling the justices that vicarious liability is enough to justify nondischargeability, based on the “text, context, history, or sound bankruptcy policy.”
The briefs on Bartenwerfer have been filed. Argument could take place in November, with a decision perhaps in February or thereabouts, depending on whether the justices are of one mind.
The Case Before Judge Searcy
The debtor was a fabulously successful investor until she wasn’t. Unknowingly, she invested in a Ponzi scheme. Before the fraud was shut down by the Securities and Exchange Commission, she took out over $30,000 in cash for having invested only $1,500, making her a so-called net winner.
In closing down the Ponzi scheme, the SEC alleged that the perpetrators violated securities laws but said that the investors were unaware of the fraud. The federal court appointed a receiver at the behest of the SEC. The receiver mounted a class action against all net winners.
The receiver obtained a judgment against all net winners, including a $42,000 judgment against the woman who filed a chapter 7 petition in Judge Searcy’s court to discharge the judgment.
Meanwhile, the receiver sold the judgment, and the new owner of the judgment filed a complaint seeking to declare that the judgment was nondischargeable under both subsections (a)(19) and (a)(2)(A) of Section 523. For whatever it was worth, the debtor received a general discharge covering other debts.
Section 523(a)(19)(A)
The owner of the judgment filed a motion for summary judgment. Judge Searcy first dealt with claims under Section 523(a)(19)(A). It bars discharge of any judgment before filing by a state or federal court for:
(i) the violation of any of the Federal securities laws . . ., any of the State securities laws, or any regulation or order issued under such Federal or State securities laws; or
(ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security.
There was the required judgment, leaving Judge Searcy to decide whether the debt was “from a violation of state or federal securities law, or” was a judgment “for common law fraud, deceit, or manipulation in connection with the sale of any security.” He further defined the question as whether the debt was “‘for’ a securities law violation when the debt stems from a violation not committed by the Debtor.”
Judge Searcy lined up the circuit split. He said that the Ninth and Tenth Circuits render the debt nondischargeable only if the debtor committed the violation. The Ninth Circuit, he said, found the statute to be ambiguous, while the Tenth Circuit saw the statute as unambiguous.
The Eleventh Circuit sits on the other side of the fence with Lunsford v. Process Technologies Servs. (In re Lunsford), 848 F.3d 963 (11th Cir. 2017). An arbitrator had found that the debtor committed securities fraud. On that basis, the appeals court said that the debt was nondischargeable.
However, the Eleventh Circuit went on to rule alternatively that the debt was nondischargeable regardless of the debtor’s conduct. To read ABI’s report on Lunsford, click here.
Judge Searcy said that he did “not find Lunsford particularly persuasive.” Siding with the majority, Judge Searcy held that “Section 523(a)(19)(A) only applies to except from discharge debts owed by debtors who themselves committed a securities violation.” For that reason, he denied the plaintiff’s motion for summary judgment under Section 523(a)(19)(A)(i).
Next, Judge Searcy dealt with the plaintiff’s contention that the debt was nondischargeable under Section 523(a)(19)(A)(ii) for the commission of common law fraud in connection with the sale of securities. He said that the plaintiff could not prevail on summary judgment because there was no evidence that the debtor herself committed common law fraud.
Judge Searcy cited two bankruptcy court cases involving the same plaintiff who was seeking nondischargeability judgments against other investors in the same Ponzi scheme, based on the same class action judgment. The plaintiff lost both times. The courts found no common law fraud.
Like the other two courts, he found no factual basis in the class action judgment to support a finding of nondischargeability for commission of a common law fraud in connection with the sale of securities.
(Note: The debtor had not cross moved for summary judgment. Had there been a cross motion, Judge Searcy might have dismissed the claims under Section 523(a)(19). As it was, he could only deny the motion for summary judgment.)
Section 523(a)(2)(A)
The plaintiff claimed a right to summary judgment under Section 523(a)(2)(A) on the theory that the judgment was based on “actual fraud.” The section bars the discharge of a debt for money or property obtained by “false pretenses, a false representation, or actual fraud . . . .”
More particularly, Judge Searcy said that the plaintiff contended that the debtor “committed actual fraud by being the recipient of fraudulent transfers from” the Ponzi scheme.
Surely, the Ponzi scheme was an “actual fraud,” but was the actual fraud committed by the debtor? The outcome turned on the Supreme Court’s definition of “actual fraud” taken from Husky Intern. Electronics, Inc. v. Ritz, 578 U.S. 356 (2016). To read ABI’s report on Husky, click here.
Judge Searcy quoted Husky for saying that “anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.’” Id. at 360. He interpreted Husky to mean that there must be “a showing of wrongful intent on the part of the Defendant” for “the fraud to be actual.”
Since fraud may be inferred from the circumstances, Judge Searcy found disputed issues of fact precluding summary judgment under 523(a)(2)(A).
Judge Searcy denied the motion for summary judgment under both Sections 523(a)(2)(A) and 523(a)(19).
Observation
Judge Searcy is in good company. Bankruptcy Judge Peter D. Russin of Fort Lauderdale, Fla., reached virtually the same result in April in another case brought by the same plaintiff against a different debtor, but arising from the same judgment.
Judge Russin dismissed the claims under Section 523(a)(19) but found disputed issues of fact under Section 523(a)(2)(A). Nationwide Judgment Recovery Inc. v. Reefe (In re Reefe), 638 B.R. 834 (Bankr. S.D. Fla. April 28, 2022). To read ABI’s report, click here.
Ruling in favor of the debtor on an issue similar to the question before the Supreme Court this coming term in Bartenwerfer, Bankruptcy Judge Joshua P. Searcy of Tyler, Texas, held that a debt is nondischargeable under Section 523(a)(19) only with regard to “debts owed by debtors who themselves committed a securities violation.”
The Supreme Court granted certiorari in Bartenwerfer v. Buckley, 21-908 (Sup. Ct.), to resolve a split of circuits and decide whether a debtor is saddled with a nondischargeable debt for a false representation or actual fraud under Section 523(a)(2)(A) based entirely on the fraud of a partner or an agent. In other words, does the imputation of liability for fraud also result automatically in nondischargeability, or must the debtor have some degree of scienter?