Resolving One “Actual Fraud” Nondischargeability Problem But Creating Another: U.S. Supreme Court in Husky International v. Ritz

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Not very helpful: sign says, “Peanuts, Contains Peanuts”

By Donald L. Swanson

Have you ever solved one problem but created another in the process?  That’s, of course, not very helpful.

But that’s exactly what the U.S. Supreme Court did a couple years ago in Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581 (2016).  And ramifications continue, to this day, in a three-way split on nondischargeability.

The Question

The question before the Court in Husky was this:

Can a fraudulent conveyance scheme qualify as “actual fraud” for nondischargeability, under § 523(a)(2)(A)?

11 U.S.C. § 523(a)(2)(A) provides:

Bankruptcy “does not discharge an individual debtor from any debt . . . for money . . . obtained by . . . actual fraud.”

Here’s how the question works:

(i) “Actual fraud” involves a false statement that induces someone to part with value; but
(ii) When a fraudulent conveyance occurs after someone already parted with value, how can “actual fraud” exist for nondischaregeability under § 523(a)(2)(A)?

The Answer — And the New Question/Problem

The Supreme Court answers the Husky question like this:

–The term “actual fraud” in § 523(a)(2)(A) does encompass fraudulent conveyance schemes.

But then it creates the new question/problem:

–What about the § 523(a)(2) requirement that value must be “obtained by” the fraudulent conveyance scheme to create nondischargeability?

Remanding the New Problem

The Supreme Court does not solve the new question. Instead, it remands the new problem back to the courts below. Here’s what the Supreme Court says on this remand problem:

“It is of course true that the transferor does not ‘obtai[n]’ debts in a fraudulent conveyance”;

“But the recipient of the transfer—who, with the requisite intent, also commits fraud—can ‘obtai[n]’ assets ‘by’ his or her participation in the fraud”;

“If that recipient later files for bankruptcy, any debts ‘traceable to’ the fraudulent conveyance . . . will be nondischargable under §523(a)(2)(A)”;

“Thus, at least sometimes a debt ‘obtained by’ a fraudulent conveyance scheme could be nondischargeable under §523(a)(2)(A)”;

Such circumstances may be rare because a person who receives fraudulently conveyed assets is not necessarily (or even likely to be) a debtor on the verge of bankruptcy” [emphasis added]; and

We “leave it to the Fifth Circuit to decide on remand whether the debt to Husky was ‘obtained by’ Ritz’s asset-transfer scheme.”

So . . . are we to take it that fraudulent conveyance schemes render debts nondischargeable only in “rare” circumstances? Or is the “rare” circumstance merely an illustration of a broader concept?

The Husky Facts

Before filing his own Chapter 7 bankruptcy, Daniel Ritz transferred large amounts of money out of one corporation he controlled into accounts of several other companies he controlled. This drained all cash out of the transferor corporation, and its creditors could not be paid.

One of those creditors, Husky International, sued Ritz in Bankruptcy Court alleging: (a) the corporate veil can be pierced, making Ritz liable for Husky’s claims; and (b) such liability is nondischargeable under § 523(a)(2)(A) for “actual fraud.”

On Remand

The Husky case gets remanded all the way back to the Bankruptcy Court for the Southern District of Texas, which issues a new opinion on April 19, 2017.

The new opinion is 91-pages long. It says that “three views” have emerged in bankruptcy court rulings, since the Supreme Court’s Husky opinion, on types of benefits-obtained that satisfy § 523(a)(2)(A) requirements. Here are the three views (and which circuit courts of appeals have adopted them):

View #1: The debtor must personally receive the money he/she obtained by actual fraud (no circuit has adopted this view);

View #2: The debtor must “derive a benefit from the money” that he/she obtained by actual fraud (11th and 9th circuits have adopted this view); and

View #3: The debtor must create a benefit for “anyone” from the money he/she obtained by actual fraud, whether debtor received any benefit or not (5th circuit has adopted this view).

Since the Southern District of Texas is in the 5th Circuit, the Bankruptcy Court applies View #3 and reaches the following conclusions.

To achieve nondischargeability under § 523(a)(2)(A), Husky’s evidence must establish these elements:

–Money was obtained through the debtor’s actual fraud and, as a result of these circumstances, a personal debt of the debtor was created.

Regarding these elements, the Bankruptcy Court found:

Money was “obtained” for Ritz’s benefit by transferring cash from one Ritz-controlled corporation into accounts of other Ritz-controlled entities, including (i) a corporation whose debts he had “personally guaranteed,” and (ii) another corporation in which “he held a 100% interest”;

Ritz committed “actual fraud” by orchestrating the transfers, as demonstrated by the “badge of fraud analysis”; and

Ritz incurred a personal debt to Husky under Texas’s veil-piercing statutes by orchestrating the fraudulent transfers.

Settlement

Thereafter, it appears that Ritz cries uncle.  The parties reach a settlement, and on July 20, 2017, the Bankruptcy Court enters an “Agreed Final Judgment” against Ritz in the nondischargeable amount of $566,753.94.

Note: the amount of Husky’s proof of claim in Ritz’s bankruptcy is $410,542.54 as of the bankruptcy filing date, December 31 2009. Presumably, Ritz agreed to pay the entirety of Husky’s proof of claim amount plus post-petition interest.

A Current/Pending Case: In re Huszti

Here’s an example of how all this is working out in a current, pending Chapter 11 case: In re Huszti, Case No. 17-43442 in the Eastern District of Michigan.

–Some Facts

It’s alleged that debtor HeChung Huszti purchased a house for $300,000, in cash and without any lien, using a $250,000 gift from her father.  Later, while being sued, HeChung granted a lien to her father for the amount of the gift and granted a $114,400 lien to another person to secure a debt of her husband.  The $114,400 lien was then assigned to an entity controlled by HeChung’s husband.

–Some Litigation — Two Lawsuits

The Chapter 11 Examiner files a Complaint to avoid transfers associated with the liens (Adv.P. # 18-04179).

And parties with a claim of $527,404, saying they are the “largest creditors” in the case, file a nondischargeability Complaint under § 523(a)(a)(2)(A) (Adv.P. # 17-04834).  This nondischargeability case looks like a family squabble, since the caption is William Huszti, Anna Chong-Huszti and BAM Investment Group, LLC v. Michael Huszti and HeChung Huszti.

–Some Husky Rulings in the Huszti Nondischargeability Case

Courts in the Eastern District of Michigan are in the Sixth Circuit, which has yet to rule on the new Husky dischargeability question.  Accordingly, the Bankruptcy Court in Huszti is struggling with what position it should take on Defendants’ Motion to dismiss that’s based on the new Husky question.

Here are three separate-and-consecutive rulings by the Bankruptcy Court on the Motion to dismiss (italics are added for emphasis):

First Ruling:  On March 27, 2018, the Court says:

“following the broad interpretation many courts have afforded Husky Int’l Electronics, Inc. v. Ritz, 136 S.Ct. 1581 (2016), the Court DENIES Debtors’ motion based on Husky. The Court finds Plaintiffs have stated a valid cause of action for actual fraud under section 523(a)(2)(A) provided they can prove Debtors received a benefit–either direct or indirect–from the alleged fraudulent transfers.”

Second Ruling:   The next day, March 28, 2018, the same Court issues an “Order Vacating in Part” the prior day’s ruling and says:

“Upon further review of Husky and its progeny, the Court now reconsiders and vacates its order in part.  . . .  the Supreme Court limited its holding . . . to situations in which the debtor or a debtor-controlled entity is the recipient of the transfer.  . . .  Such circumstances may be rare.  . . . Here, section 523(a)(2)(A) can only plausibly be implicated through alleged fraudulent conveyances Debtors made to corporations or entities in which Plaintiffs allege Debtors have at least a financial interest.”

Third Ruling:  On May 7, 2018, the same Court issues an “Order Granting in Part Debtors’ Motion for Reconsideration,” saying:

“The Court declines to dismiss Plaintiffs’ Complaint. However, on or before May 29, 2018, Plaintiffs must file an amended complaint to include allegations that would permit the corporate veil to be pierced under Michigan law.”

Nothing further has been filed on the Court’s docket, since the May 7 Order, and the amended complaint filing deadline is next week.

–Some Confusion

You’ve gotta’ empathize with the courts in this case.  Assuming the case goes to trial and judgment, the Bankruptcy Court and its appellate overseers are in a no-win position:

No matter what legal position the Bankruptcy Court takes, it will be challenged on appeal, and no one can predict what position the District Court or BAP will take;

The District and BAP appellate courts have no way to predict what position the Sixth Circuit will take; and

The Sixth Circuit has no way to predict what position the Supreme Court will take.

It’s confusing . . . and just a tad troubling.

Conclusion

So . . . here we are. The U.S. Supreme Court made its Husky pronouncement resolving a circuit split on one nondischargeability issue.  But it created confusion and uncertainty on a related issue, on which a three-way and a circuit split already exist.  And the ramifications are percolating as we speak.

Presumably, one day the U.S. Supreme Court will resolve this new split. Hopefully, it won’t create another split in the process.

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