Federal appellate courts have long been split on the scope of the fraud exception to the dischargeability of debts in bankruptcy proceedings. The U.S. Supreme Court recently provided clarity on that issue, holding that debt based on fraud committed by a debtor’s partner or agent is nondischargeable.

In Barternwerfer v. Buckley, the Supreme Court addressed the scope of 11 U.S.C. § 523(a)(2)(A), which exempts from discharge “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[.]” The Court considered whether the fraud must have been committed by the debtor, or that the debtor was at least aware of the fraud, for the debt to be nondischargeable.

The Chapter 7 debtor in Barterwerfer argued she should not be held liable for fraud committed by her husband and business partner because she was not involved in or aware of the fraudulent conduct. The impacted creditor filed an adversary action claiming the debt should not be discharged because the debt was “obtained by” fraud regardless of the debtor’s personal involvement or knowledge. The Supreme Court sided with the creditor.

In a unanimous decision, the Court noted that § 523(a)(2)(A) turns on how the money was obtained rather than on who committed the fraud. The Court focused on the text of the statute and noted it refers to a debt “obtained by” fraud without specifying the bad actor. The Court rejected the debtor’s arguments that, contextually, the section only applies to fraud committed by the debtor. Instead, the Court held that the relevant context is the common law of fraud in which liability is not limited to the wrongdoer and can be imputed to principals, agents, and partners, for example.

It should be noted that the Court’s ruling is confined to situations in which the fraud was committed by a party with an agency or partnership relationship with the debtor. In any event, this case is a win for creditors in South Dakota, as the Eighth Circuit Court of Appeals (which includes South Dakota) previously held that § 523(a)(2)(A) only applies if the debtor “knew or should have known” of the fraud. See Walker v. Citizens State Bank (In re Walker), 726 F.2d 452 (8th Cir. 1984). The broader interpretation espoused by the Supreme Court should assist creditors seeking nondischargeability of debts on the basis the debt was obtained by fraud.

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Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the State’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.