Resolving a split among the lower courts, the United States Supreme Court has held that a provision of the Bankruptcy Code that prohibits debtors from discharging debts “obtained by…false pretenses, a false representation, or actual fraud,” can include transactions by which a debtor tranfers its assets to a third-party for little or no consideration, i.e., so-called fraudulent conveyances. Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581 (May 16, 2016). This decision addresses the frequent circumstance in which a debtor transfers its assets to related persons or entities for little money and then files bankruptcy to discharge all its debts to creditors.
Husky International Electronics sold its products to Chrysalis Manufacturing which ran up an unpaid debt of $163,999.38. Ritz was the director and shareholder of the debtor and drained it of assets it could have used to pay Husky by transferring the assets to other companies in which he also had an ownership interest. Husky sued Ritz to hold him personally responsible for the Chrysalis’ debts. Ritz filed for Chapter 7 bankruptcy. Husky filed an adversary proceeding against Ritz and argued he could not discharge his liability for the transfers in bankruptcy because of the provision of the Bankruptcy Code. The federal district court said that while Ritz may be liable for the transfers under state law, he could discharge the debt because it was not an “actual fraud.” The Fifth Circuit Court of Appeals affirmed, holding that the liabilities were not actual fraud because they did not involve a false representation by Ritz to Husky.
The Supreme Court said “actual” means done with a “wrongful” intent, as opposed to an “implied” fraud. Since the debtor intends to deprive the creditor of assets that could satisfy the debts, the transfer meets that meaning of “actual.” With respect to “fraud,” the Court said fraudulent conveyances have historically been unlawful as fraud going back to the English Statute of Elizabeth, also known as the Fraudulent Conveyance Act of 1571. The law did not require a showing that the defendant had made a fraudulent representation to the creditor. The Court commented that the recipient of the transfer may also have a debt to the creditor that is non-dischargeable in bankruptcy. It remanded the case to the Fifth Circuit to determine whether Ritz “obtained” the debt to Husky through the fraudulent transfer scheme.
The decision is important for businesses that extend credit because it make the law uniform across the country that fraudulent transfers may not be dischargeable in bankruptcy.
The decision, Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581 (May 16, 2016), is available at: http://www.supremecourt.gov/opinions/15pdf/15-145_nkp1.pdf
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