The U.S. Supreme Court issued a ruling this month that expands the definition of fraud in bankruptcy cases and it means a debtor can’t move money around and then claim insolvency.
The high court reversed an appellate court ruling that a debt obtained through fraud can still be wiped away in bankruptcy as long as an individual debtor didn’t directly lie to their creditor. In the 7-1 decision handed down on May 16, 2016, the case Husky International Electronics, Inc. v. Ritz, essentially expands the meaning of fraud, and now includes fraudulent conveyance as actual fraud — even when the fraudulent conveyance doesn’t involve false representation — for the purpose of non-dischargeable debt in bankruptcy.
Basically, the Supreme Court said fraud may take other forms rather than a lie, and a debtor should remain on the hook for debts that arose in this manner. The ruling will now deny an individual debtor from taking advantage of the fresh start offered by bankruptcy if fraudulent conveyance has been determined to take place in an effort to avoid repayment to creditors.
Fraudulent conveyance is an attempt to avoid debt by transferring money to another person or company. It is a civil cause of action and arises in debtor/creditor relations, particularly with reference to insolvent debtors. The case at hand involved a man named Lee Ritz, Jr. who was a director and part owner of a company called Chrysalis Manufacturing Corp.
During the course of its operations, Chrysalis incurred debt to one of its suppliers, Husky International Electronics, Inc. In an apparent effort to avoid repaying debts to Husky International, which exceeded $160,000 over the course of four years, according to the complaint, Ritz transferred more than $1 million of Chrysalis’s assets to other companies where he held an ownership interest.
Husky sued Ritz on a state law theory that [Ritz] was personally liable on the debt owed to it by Chrysalis, but before the judge in that case could issue a ruling, Ritz filed for individual chapter 7 bankruptcy.
Husky sued Ritz in bankruptcy court, claiming that Ritz should be forced to pay the debt because he “defrauded” Husky by moving Chrysalis’s funds out of its reach. A bankruptcy court found in 2011 that although Chrysalis didn’t benefit from the transfer of its funds, and although Mr. Ritz wasn’t a “credible witness,” his conduct didn’t meet the definition of “actual fraud” for one reason: He didn’t lie to Husky. The Fifth U.S. Circuit Court of Appeals affirmed Ritz’s defense.
In reversing that decision, and writing for the majority, Justice Sonia Sotomayor disagreed and broadened the definition of fraud: “The term ‘actual fraud’…encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation,” she wrote.
Focusing on the fraudulent transfer context, the Court stated, “In such cases, the fraudulent conduct is not in dishonestly inducing a creditor to extend a debt. It is in the acts of concealment and hindrance.” By holding that “actual fraud” includes fraudulent transfer schemes, the Supreme Court clarified that the exceptions to discharge for individual debtors are broader than the Fifth Circuit appeals court had previously determined.
As a result, in instances where personal liability can be attached to corporate insiders for fraudulent transfers (and other types of conduct designed to hinder and impair the rights of creditors), the Supreme Court made clear that creditors have a wider range of remedies than had previously been presumed.
By Carina Kraatz, attorney at Resnick Law, P.C., in Bloomfield Hills, Mich. For
more information on this or other bankruptcy matters, please contact Ms. Kraatz
at (248) 642-5400 or by email at ckraatz@resnicklaw.com.
