Based on the “natural breadth of the passive voice” used in Section 523(a)(2)(A), the Supreme Court held yesterday in a unanimous opinion by Justice Amy Coney Barrett that a partner who herself was innocent of fraud is nonetheless saddled with a nondischargeable debt resulting from the fraud of her partner.
The opinion is a reaffirmation of the Court’s holding in Strang v. Bradner, 114 U.S. 555 (1885).
In a concurring opinion, Justices Sonia Sotomayor and Ketanji Brown Jackson endeavored to limit the scope of the holding by saying that they understood the outcome to be based on the existence of a partnership under state law.
The Partner’s Fraud
Before marrying, a couple formed a partnership to buy, refurbish and sell a home. Judge Barrett said the woman was “largely uninvolved” in the remodel and sale.
Alleging that the disclosure statement failed to list defects in the home, the buyer filed suit after purchasing the home. A jury found the man and woman liable for $200,000 in damages for breach of contract, negligence and nondisclosure of material facts.
The couple filed a chapter 7 petition. The buyer filed an adversary proceeding contending that the judgment was nondischargeable under Section 523(a)(2)(A) as a debt resulting from “false pretenses, a false representation, or actual fraud.” After a bench trial, the bankruptcy court ruled that the debt was nondischargeable as to both.
The Bankruptcy Appellate Panel for the Ninth Circuit reversed as to the woman, saying she had no reason to know of the man’s fraudulent intent. Relying on Strang, the Ninth Circuit reversed the BAP, reinstating the nondischargeability judgment with respect to the woman. According to Justice Barrett, the Court of Appeals reasoned that “a debtor who is liable for her partner’s fraud cannot discharge that debt in bankruptcy, regardless of her own culpability.”
The woman filed a petition for certiorari, which the Court granted to resolve a split among the circuits. The Second, Fourth, Seventh and Eighth Circuits require scienter before the debt is deemed nondischargeable, while the Fifth, Sixth, Ninth and Eleventh Circuits don’t.
An Opinion Based on Grammar
Judge Barrett held that the “text” of Section 523(a)(2)(A) barred the woman from discharging the debt “[b]y its terms.” Based on the “basic tenets of grammar,” she said that the statute’s use of the “[p]assive voice pulls the actor off the stage.”
Although the debt must result from fraud, Justice Barrett said that “Congress was ‘agnosti[c]’ about who committed it. Watson v. United States, 552 U.S. 74, 81 (2007).” The “context” of the statute, she said, “does not single out the wrongdoer as the relevant actor.”
Justice Barrett said that “the common law of fraud . . . has long maintained that fraud liability is not limited to the wrongdoer.” Citing a commentator from 1841 and state supreme court decisions from the nineteenth century, she listed courts that “have traditionally held principals liable for the frauds of their agents.”
The debtor contended that the interpretation of Section 523(a)(2)(A) should be informed by subsections (B) and (C), which require a culpable act by the debtor. Justice Barrett rejected the argument, saying that the “more likely inference is that (A) excludes debtor culpability from consideration given that (B) and (C) expressly hinge on it.”
The Court’s Precedent
“Our precedent,” Justice Barrett said, “eliminates any possible doubt about our textual analysis.”
At the time of Strang, the statute required fraud “of the bankrupt.” Nonetheless, the Court held in Strang that the “fraud of one partner . . . is the fraud of all because ‘[e]ach partner was the agent and representative of the firm with reference to all business within the scope of the partnership.’” Strang, supra, 114 U.S. at 561.
Thirteen years after Strang, Justice Barrett said that Congress “overhauled the bankruptcy law,” this time deleting “‘of the bankrupt’ from the discharge exception for fraud, which is the predecessor to the modern § 523(a)(2)(A).”
“The unmistakable implication,” Justice Barrett said, “is that Congress embraced Strang’s holding — so we do too.”
Justice Barrett ended her opinion for the Court by saying she was “sensitive to the hardship that the debtor faces,” but she went on to say that “innocent people are sometimes held liable for fraud they did not personally commit, and, if they declare bankruptcy, § 523(a)(2)(A) bars discharge of that debt.”
The Court affirmed the Ninth Circuit’s judgment that the debt was nondischargeable.
The Concurrence
Joined by Justice Jackson, Justice Sotomayor concurred, saying that the “Court correctly holds that 11 U.S.C. § 523(a)(2)(A) bars debtors from discharging a debt obtained by fraud of the debtor’s agent or partner.” Citing Strang, she said that the “Court long ago confirmed that reading when it held that fraudulent debts obtained by partners are not dischargeable.”
Justice Sotomayor noted that the woman and her husband incurred the debt after forming a partnership. She said that the “Court here does not confront a situation involving fraud by a person bearing no agency or partnership relationship to the debtor.”
She joined the Court’s opinion with the “understanding” that it concerns fraud only by “agents” and “partners within the scope of the partnership.”
Application to Section 523(a)(19)
Justice Sotomayor’s understanding of the opinion, if adopted by other courts, may affect the application of Section 523(a)(19). That subsection bars the discharge of judgments by state or federal courts for violation of state or federal securities laws, but it too is in the passive voice and does not in its language demand a violation committed by the debtor.
Presumably, a court influenced by Justice Sotomayor’s concurrence would make a debt nondischargeable as to an innocent debtor only if there were an agency or partnership.
Observations
Justice Barrett rejected the debtor’s reliance on Bullock v. BankChampaign, N. A., 569 U.S. 267 (2013). There, the Court held that under Section 523(a)(4) the term “defalcation”
includes a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase. We describe that state of mind as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.
Id. at 269.
Bullock means that defalcation cannot be derivative, but the Court yesterday held that a fraudulent representation or actual fraud can be derivative.
Curiously, Strang cited and discussed Neal v. Clark, 95 U.S. 709 (1877). The Strang court paraphrased Neal as saying that
the term “fraud,” in the clause defining the debts from which a bankrupt is not relieved by a discharge under the bankrupt act, should be construed to mean positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, and not implied fraud or fraud in law, which may exist without the imputation of bad faith or immorality.
Neal required “positive fraud, or fraud in fact,” but the Court yesterday imposed nondischargeability when the debt was derived from someone else’s fraud.
With respect, this writer sees the Court as being selective in citing nineteenth century precedent for the idea that innocent individuals can be saddled with nondischargeable debts.
True, common law for centuries has held that one partner is liable for another partner’s fraud, but nondischargeability and derivative liability for fraud are different questions under a different statute.
However, Congress adopted Section 523(a)(2)(A), presumably knowing what Strang says. Still, this writer is troubled by the notion that contemporary courts are so bound by nineteenth century precedent.
Based on the “natural breadth of the passive voice” used in Section 523(a)(2)(A), the Supreme Court held yesterday in a unanimous opinion by Justice Amy Coney Barrett that a partner who herself was innocent of fraud is nonetheless saddled with a nondischargeable debt resulting from the fraud of her partner.
The opinion is a reaffirmation of the Court’s holding in Strang v. Bradner, 114 U.S. 555 (1885).
In a concurring opinion, Justices Sonia Sotomayor and Ketanji Brown Jackson endeavored to limit the scope of the holding by saying that they understood the outcome to be based on the existence of a partnership under state law.