Argument analysis: Court hard to read on scope of “actual fraud” in Bankruptcy Code
on Mar 1, 2016 at 11:25 pm
For lawyers and lay people who generally don’t immerse themselves in the interstices of bankruptcy law, the most interesting part of today’s oral argument in Husky International Electronics v. Ritz may well have been the extent to which the case reflected the ever-increasing presence (dominance?) of the Supreme Court bar. Specifically, the dispute arose from petitioner Husky’s efforts to recover from respondent Daniel Ritz a debt of just under $164,000 owed to it for electronic device components that it supplied to the now-defunct Chrysalis Manufacturing Corp., which Ritz controlled and partly owned. That $164,000 is, make no mistake, hardly chump change. But in the world of Supreme Court litigation, in which partners routinely bill at more than a thousand dollars per hour, that sum likely wouldn’t come close to covering the costs of having a high-powered team of lawyers handle the Supreme Court proceedings in the case. But that is exactly what happened, as the Justices heard three top-notch arguments – two by partners in prestigious Supreme Court practices, and the other from a lawyer representing the federal government – in the case today.
As I explained in my preview of the case, the issue before the Court was the scope of Section 523(a)(2)(A) of the Bankruptcy Code, which bars a debtor from discharging “any debt . . . for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by . . . false pretenses, a false representation, or actual fraud.” Ritz argued that this provision applies only when the debtor makes a false representation to the creditor (which he maintains he did not), while Husky maintained that it also bars discharge when – as Husky alleges here – the debtor has obtained money through a “fraudulent conveyance” to avoid paying the debt.
Arguing for Husky, Shay Dvoretzky focused on Congress’s 1978 addition of the phrase “actual fraud” to Section 523(a)(2)(A). That addition, Dvoretzky emphasized, codified a “term of art that includes a recipient’s knowing participation in a deliberate fraudulent transfer” and expanded “the scope of the discharge bar.”
Chief Justice John Roberts was skeptical that the statute’s bar would extend to the transfers at issue in this case. The Court’s case law, he suggested, indicates that “[s]ome degree of reliance is required to satisfy the element of causation inherent in the” provision’s use of “the phrase ‘obtained by.’” But Dvoretzky pushed back, telling Roberts that what the phrase “obtained by” instead “requires . . . causation. In the context of a fraudulent transfer where the recipient knowingly participates in a deliberate fraudulent transfer, centuries of common law established that he commits actual fraud himself.”
Justice Elena Kagan also challenged Husky’s reading of the discharge bar. Your interpretation, she told Dvoretzky, “does make the language ‘false pretenses’ or ‘false representations’ completely superfluous,” because the phrase “actual fraud” would encompass both of those. Dvoretzky conceded that it does, but stressed that “actual fraud” “also expands on that language,” while the Fifth Circuit’s interpretation also makes the two phrases “superfluous without giving Congress’s amendment any additional work to do” – in essence, an argument that, even if Husky’s interpretation of Section 523(a)(2)(A) is imperfect, it is less flawed than the other side’s reading.
Dvoretzky also ran into questions from several Justices about whether, even if his interpretation were correct, Husky could ultimately prevail in its dispute with Ritz. Justice Ruth Bader Ginsburg told him, for example, that “you would have to show down the road . . . that the money was obtained by Ritz” – a point with which Dvoretzky agreed. Dvoretzky also agreed with Justice Anthony Kennedy that, under Texas law, Husky would have to show both that it could hold Ritz responsible for Chrysalis’s debts and that there was fraud under state law. Ginsburg summed up what, in her view, Husky was asking the Court to do: “So you . . . would like the Court to . . . hold that ‘actual fraud’ means something other than false pretenses or misrepresentation; that it’s . . . a broader term” that “includes things that were not already included, period, and then whatever other issues would be . . . resolved on remand?”
“That’s correct,” Dvoretzky responded.
Justice Stephen Breyer asked Assistant to the Solicitor General Sarah Harrington, representing the federal government, to address something that was “still gnawing at me” – precisely which debtors and conduct are encompassed by Section 523(a)(2)(A). He told Harrington, “You’re talking about” the person to whom the money is transferred, “and you’re saying here, the transferee’s participation in the transferor’s effort to defraud his creditor is something that also survives” bankruptcy.
Harrington explained that “there are two distinct debts.” There is the original debt to the creditor, as well as the new debt created when the debtor transfers money to someone else if the transferee “shares that intent” to defraud the creditor. She also reminded the Court that “the second overarching purpose of the Bankruptcy Code is to let creditors get their money back when they can. And so it makes sense that Congress would have wanted to give maybe a stronger remedy . . . against the person who actually has the stuff at the end of the day” – a response that seemed to satisfy Breyer.
Harrington also addressed concerns raised during Dvoretzky’s argument that Husky’s reading of Section 523(a)(2)(A) would make other provisions in Section 523 redundant. She emphasized that Congress “used broad words like ‘fraud’” because it was trying “to be comprehensive in preventing dishonest debtors from discharging their debts in bankruptcy.” “That’s going to create overlap,” she acknowledged. “But that’s a feature of the system, and not a flaw in the system.”
Arguing for Ritz, Erin Murphy reiterated that Section 523(a)(2)(A) “applies to a specific type of debt, a debt for something with which the debtor has fraudulently induced the creditor to part.” But that prompted Kagan to remark that the language of the provision “just seems a lot more simple than you’re making it.” Kagan ticked off the list of the statute’s requirements, all of which she seemed to regard as met in this case: there is a debt; the debt is for money; the money has to be obtained by actual fraud – which it was, through a fraudulent conveyance. “So whether or not the creditor has been induced and whether or not the money has come from the creditor,” she concluded, “seems to be irrelevant.”
Murphy also challenged Husky’s reliance on the common-law meaning of “actual fraud.” The relevant question, she argued, is “what did these terms mean in this statute?” “And when you look at this statute,” she continued, “Congress put the term ‘actual fraud’ next to a bunch of terms that by their nature speak of inducement.”
Kagan was unconvinced. It would be strange, she told Murphy, for Congress to use the phrase ‘actual fraud’ when it wanted to “make it really clear that this should be only intentional, false pretenses and false representation.”
Ginsburg focused on the precise text of the statute, telling Murphy that, “whatever may have been said in the course of the legislative history, the statute says ‘or,’” but Ritz’s reading would “convert ‘or’ into ‘by’” – “that is, misrepresentation, false pretenses by actual fraud.”
This was a hard argument to handicap. All of the Justices were relatively subdued, and two – Justices Samuel Alito and Clarence Thomas – did not ask any questions at all. On net, it seemed to me that the Justices were less skeptical of Husky’s interpretation of the statute. But on the other hand, the Justices allowed Erin Murphy to speak (effectively) at length, and it appeared that Murphy sat down early, which can often be a favorable sign. We’ll have to wait and see.