Individual Debtor’s Discharge & An 1885 Precedent At U.S. Supreme Court (Bartwenwerfer v. Buckley)

By: Donald L Swanson

Here are a couple long-standing and foundational policies for the entire bankruptcy system:

• Bankruptcy laws protect the honest but unfortunate debtor; and
• Discharge exceptions are to be strictly construed against the objecting creditor and liberally construed in favor of debtor.

So, for all my decades of practice under the Bankruptcy Code, this idea has held sway: an honest debtor is entitled to a bankruptcy discharge.

Never in farthest-flung imaginings did it ever occur to me that an honest debtor could be denied a discharge under § 523(a)(2)(A) because of someone else’s fraud.

Looks like I was wrong.  This is a stunner!!

Surprise!

It is a huge surprise, reading oral arguments of December 6, 2022, before the U.S. Supreme Court in Bartenwerfer v. Buckley, Case No. 21-908,[fn. 1] and realizing: 

• They’re actually going to do this!!
• They’re actually going to deny a debtor’s discharge, for fraud, without any proof that the debtor actually committed fraud . . . or participated in any fraud . . . or knew anything about any fraud.

What the justices are likely to do, it appears, is deny the debtor a discharge based on vicarious liability: i.e., based on someone else’s fraud.

An 1885 Precedent!

One of the opinions discussed extensively in Bartenwerfer is Strang v. Bradner, 114 U.S. 555, 5 S.Ct. 1038 (1885), decided under the Federal Bankruptcy Act of 1867.

The 1867 Act said: “no debt created by the fraud or embezzlement of the bankrupt shall be discharged by the proceedings in bankruptcy.”  Yet, the Supreme Court, in Strang, held the obligation of an honest debtor to be nondischargeable because of the fraud of the debtor’s partner.  That happened, despite the plain statutory language requiring an act “of the bankrupt.”

Harsh Bankruptcy Laws in 1800s = Trouble for Today

Citing Strang for today’s dischargeability law is like citing those wall-hanging and hand-cranking phones of the 1950s for today’s cell phones.

Today, as an individual debtor in bankruptcy, you know you’re in trouble when Supreme Court justices are citing discharge case law from the 1800s.  That’s because:

• We were still throwing debtors in prison (for an indefinite term, no less!) as late as the 1830s;
• Early bankruptcy laws were created with a heavy thumb on the scale favoring creditors—and against debtors;
• Congress repealed the Bankruptcy Act of 1867 (under which Strang was decided) because “only about one-third of debtors” were granted a discharge under that Act due to its “many exceptions to discharge”[fn. 2]; and
• In 1885, the U.S. Supreme Court ignored the plain “of the bankrupt” statutory text to achieve a harsh application of the fraud exception to discharge in Strang.

But that’s where we are.

Strang Infatuation At Supreme Court

During Bartenwerfer oral arguments, the Supreme Court justices referenced Strang no less than 17 times: and that’s the justices alone, not counting the arguing counsel!  What follows are extracts from those oral arguments in which various justices mention Strang.[Fn. 3]

JUSTICE JACKSON: So, assuming we agree that it has to be the debtor’s fraud, how do you get away from principles of vicarious liability? And I’m not just relying on Strang. I’m relying on Field v. Mans, which held that fraud in the Bankruptcy Code is defined by common law principles. And we do have in the common law this notion that people are held responsible for the fraud of agents.

JUSTICE JACKSON: So you’re saying the whole principle of Strang is gone, the idea that vicarious liability does apply per the common law in this situation?

JUSTICE ALITO: Could I take you back to Strang and inquire about your grounds for distinguishing it? You mentioned very briefly that we shouldn’t be concerned about it because it was interpreting the bankruptcy law in effect in 1885. But the statute in effect there was more hostile to your position than the statute in effect here because it said “by the fraud or embezzlement of the bankrupt.” And then you have another argument in your brief, which is that Strang was federal common law. If it was a question of federal common law under the pre-Erie regime whether the the dischargeability of a debt by one partner is dischargeable against the other partner, would we not look to what has taken the place of federal common law under Erie, which would be state law, so we would look to state liability law?

JUSTICE KAGAN: ­I’m not quite sure I understand your theory of Strang and what happened afterward, because I would have thought that whatever the differences in the Strang statute that was a more hostile statute to your position. And afterwards, what Congress does is it amends the statute so that the text of the statute actually reflects better the Strang holding. So shouldn’t we take from that that, you know, Congress looked at the Strang holding and basically said let’s fix the statute so that we can reflect that holding quite clearly?

JUSTICE KAVANAUGH: Just quickly so I understand, they have two basic arguments, a Strang argument and a state law argument. You’re saying Strang doesn’t apply because the statute’s changed. The state law doesn’t govern because this is a federal law question. On federal law, “individual debtor” is the key phrase. Is that the basics?

JUSTICE JACKSON: Why wouldn’t the text just lend itself to the kind of Strang analysis of vicarious liability where we look at 523(a).  Why wouldn’t we say just that the individual debtor’s liability can arise through vicarious liability, see Strang.  Why would we have to go further and say it could be anyone’s fraud for the purpose of this case. Strang seems to be a narrower way to do this.

JUSTICE SOTOMAYOR: Except that it’s not [the debtor’s] fraud. He wasn’t a partner with [the one] who committed the fraud. He didn’t even know about the transaction that it was fraudulent. So why should he be held liable? That’s the advantage of Justice Jackson’s approach, isn’t it?  And somebody will have to explain to me why we can add that vicarious liability or did under Strang.

JUSTICE JACKSON: Isn’t it narrower to say even assuming she’s right about it needing to be the debtor’s fraud, that at least carries with it vicarious liability through Strang.

JUSTICE SOTOMAYOR: And I guess the best way to deal with this is to say something like the debtor’s fraud is what’s at issue, but it includes the alter ego of the debtor, such as partners and agents of the debtor.  Because that’s what Strang and Field did.

Conclusion

I’ve got a bad feeling about this.

Honest but unfortunate debtors are about to get screwed at the U.S. Supreme Court

——————

Footnote 1: The official transcript of oral arguments in Bartenwerfer v. Buckley is linked here.

Footnote 2:  These quotes are from “A Relatively Short History of the Bankarputcy Laws in the United States,” published by NCBJ Blog (February 27, 2019).

Footnote 3:  I’ve taken the liberty of editing the justice’s comments to condense, remove extraneous words, and focus on the Strang reference.  Reference should be made on each statement to the actual text of the oral arguments transcript linked in footnote 1 above.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.