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R.I. Bankruptcy Court Holds Debtor's Receipt of Fraudulent Transfer Is Dischargeable If Debtor Made No Misrepresentation

In an apparent case of first impression in Rhode Island, the bankruptcy court has held that the debtor's receipt of a fraudulent transfer is a dischargeable debt in the absence of evidence that the debtor made a misrepresentation. The court aligned itself with two Bankruptcy Court decisions from Massachusetts in predicting how the First Circuit would rule on the issue and rejected holdings to the contrary by the Seventh Circuit and two bankruptcy appellate panels.

The creditor sued the debtor's father in Superior Court alleging various claims including fraud and obtained a $168,000 judgment. The father immediately transferred $100,000 to a corporation he controlled. The debtor transferred $80,000 of those funds from the corporation to herself. The father filed a Chapter 13 petition. The creditor initiated an adversary proceeding objecting the discharge of the father's debt to the creditor. The creditor also pursued a claim in Superior Court that the father's transfer of money to the corporation was fraudulent and obtained a judgment against the corporation. The bankruptcy court issued a default judgment against the father in the adversary proceeding. The Superior Court then found that the transfer of the funds from the corporation to the debtor was fraudulent. The debtor filed a Chapter 13 petition. The creditor filed an adversary proceeding objecting to the discharge of the debtor's debt because it was fraudulent.

The debtor moved to dismiss the adversary proceeding alleging that the creditor had failed to state a claim because the adversary complaint did not allege that the debtor had made any misrepresentation to the creditor. The court said the First Circuit has previously said for a debt to be non-dischargeable due to fraud the creditor must show: 1) the debtor made a knowingly false statement or one made in reckless disregard of the truth; 2) the debtor intended to deceive; 3) the debtor intended to induce the creditor to rely upon the false statement; 4) the creditor actually relied upon the false statement; 5) the creditor's reliance was reasonable; and 6) the reliance caused damage.

The creditor argued the court should deny the motion based on the rulings of the Seventh Circuit, McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000), and two bankruptcy appellate panels, Diamond v. Vickery (In re Vickery), 488 B.R. 680 (10th Cir. B.A.P. 2013); Mellon Bank v. Vitanovich (In re Vitanovich), 259 B.R. 873 (6th Cir. B.A.P. 2001), holding that fraudulent transfers fall within the "actual fraud" component of Section 523(a)(2)(A). The debtor argued that the First Circuit had taken no position on the issue but that two Bankruptcy Court decisions from Massachusetts had held to the contrary. Morrissette v. Sorbera (In re Sorbera), 483 B.R. 580 (Bankr.D.Mass. 2012); Balcksmit Investments, LLC v. Woodford (In re Woodford), 403 B.R. 177 (Bankr.D.Mass. 2009). The court concluded that the Massachusetts cases were better decided than the other courts' based on the common law understanding of "actual fraud" and held that the adversary complaint should be dismissed for failure to state a claim.

In re Carrie D. Lawson, BK Nos. 13-10752, 13-01037, 2014 WL 351997 (Bankr.D.R.I. Feb. 3, 2014)

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