Supreme Court Makes Significant Fraudulent Transfer Ruling

June 2, 2016
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Major fraudulent transfer ruling made by U.S. Supreme Court

Recently, there was a significant fraudulent transfer ruling made based on whether the actual fraud bar to discharge under Section 523(a)(2)(A) of the Bankruptcy Code applies solely if a debtor has made a false representation, or also if he or she obtained money through a fraudulent asset transfer scheme to deliberately defraud a creditor. The Supreme Court reversed previous decisions after it ruled that an actual fraud exception to bankruptcy debt discharge does in fact include fraudulent asset transfers, Courthouse News reported.

The background of the case

The case involved Husky International Electronics and Chrysalis Manufacturing Corp. According to The Wall Street Journal, Husky claimed that Chrysalis owed it $164,000 for goods delivered as part of a contract. However, from 2006 to 2007, Daniel Ritz, the director of Chrysalis, transferred money from the company to other entities he owned. Due to this, Husky then sued Ritz for the outstanding $164,000. In response, Ritz filed for Chapter 7 bankruptcy protection in 2009.

Subsequently, the bankruptcy court ruled in favor of Ritz because he did not falsely represent his company. What this meant was that he did not perpetrate a fraudulent transfer scheme against Husky. At the time, the determination of a fraudulent asset transfer scheme was dependent on the identification of false representation. So the court asserted that Ritz did not commit actual fraud against Husky under Texas’ “piercing the corporate veil” law.

A Southern Texas district court later affirmed this decision after it agreed that Husky did not clearly identify false representation or actual fraud. In fact, in May of last year, the Fifth Circuit court upheld these prior decisions after it found no exceptions to the false representation rule. The court asserted that there were no applicable exceptions to discharge the alleged debt from Chapter 7 bankruptcy protection. However, this decision may have triggered a key turning point after Judge Carolyn King stated that there were applicable exceptions in the bankruptcy code that may have helped Husky’s case, but they were not raised in the case.

The Supreme Court reverses their frauduluent transfer ruling decision

Following the Fifth Circuit court’s decision, Husky then filed a petition for writ of certiorari with the U.S. Supreme Court – a case the high court subsequently agreed to hear. The justices then reversed the Fifth Circuit’s decision by ruling 7-1 that actual fraud does include fraudulent transfer schemes, even if those tactics do not involve false representation.

The high court claimed that Ritz’ interpretation of the actual fraud law created an applicable exception to discharge the alleged debt from bankruptcy. In its ruling, the Court explained that it treated Ritz just as it would a fiduciary professional who created a fraudulent transfer scheme – therefore, it did not need to create an artificial definition of actual fraud to apply it to this case.

Furthermore, the Court also identified flaws in the reasoning of Ritz’ argument that actual fraud in the federal bankruptcy code was designed to limit the reach of debt discharge exceptions. False pretenses, false representation and actual fraud are not made clear by the definition in the bankruptcy code, and therefore they are not required to determine fraudulent transfer.

Significance of the decision

The high court’s ruling expands the previous perspectives on fraud and what types of fraudulent transfers will prevent a debtor from getting a fresh start by filing for bankruptcy protection. This is regarded as both a positive and negative development in the legal sector. Some critics feel the Court’s opinion has the potential for consequences in the expansion of the actual fraud definition. Others in favor of the decision claim that it is a step in the right direction toward eliminating bankruptcy as a mechanism for fraud.