By: Donald L Swanson
The U.S. Supreme Court does not like bankruptcy benefits for individual debtors. It really doesn’t.
An example from a couple years ago is Fulton v. City of Chicago, where the U.S. Supreme Court finds a way to declare:
- an impound lot refusing debtor’s demand to surrender possession of debtor’s impounded car is not an “act to . . . exercise control” over the car.
In doing so, the Court rejects the plain meaning of statutory words (in § 362(a)(3)), using analytic gymnastics around § 542 turnover provisions.
A couple weeks ago, the U.S. Supreme Court does it again:
- this time it denies the discharge of an honest debtor for someone else’s fraud (in Bartenwerfer v. Buckley, decided 2/22/2023); and
- this time, the analytic gymnastics combine a “passive-voice” in statutory language with California’s law of agency and partnership.
Punishment Policy
For centuries past, bankruptcy laws are part of the criminal law and focus on punishing debtors.
A prime example is debtor’s prison. Such prisons were notoriously unjust—but still existed in these United States well into the 1800s.
In 1877 the U.S. Supreme Court rejects the punishment policy, explaining that imprisonment for debt:
- “is a relic of ancient barbarism” that has “descended with the stream of time” and “is a punishment rather than a remedy”;
- “is right for fraud, but wrong for misfortune”;
- “breaks the spirit of the honest debtor, destroys his credit, which is a form of capital, and dooms him, while it lasts, to helpless idleness”; and
- “is the opposite of a remedy” when “there is no fraud.”[Fn. 1]
It seems that bankruptcy policy in these United States is reverting back toward the punishment policy for individual debtors—and away from the policy of protecting and rewarding honesty.
Protecting “Honest But Unfortunate” Debtors
Over the past century and more, bankruptcy laws in these United States have protected the “honest but unfortunate” debtor.
Here’s how the U.S. Supreme Court explains that sentiment back in 1915:
- “It is the purpose of the Bankrupt Act to convert the assets of the bankrupt into cash for distribution among creditors and then to relieve the honest debtor from the weight of oppressive indebtedness and permit him to start afresh”; and
- “nothing is better settled than that statutes should be sensibly construed, with a view to effectuating the legislative intent.”[Fn. 2]
In the midst of the Great Depression (1934) the U.S. Supreme Court explains again:
- “One of the primary purposes of the bankruptcy act is to relieve the honest debtor from the weight of oppressive indebtedness”;
- “This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor . . . a new opportunity in life”; and
- “The various provisions of the bankruptcy act were adopted in the light of that view and are to be construed when reasonably possible in harmony with it so as to effectuate the general purpose and policy of the act.”[Fn. 3]
As late as 2007, the U.S. Supreme Court declares, anew—this time under the Bankruptcy Code instead of the prior Bankruptcy Act:
- “The principal purpose of the Bankruptcy Code is to grant a ‘fresh start’ to the ‘honest but unfortunate debtor.’”[Fn. 4]
Bartenwerfer v. Buckley
Against that backdrop, a unanimous U.S. Supreme Court takes a different course in Bartenwerfer v. Buckley: it denies an honest but unfortunate debtor’s discharge because of someone else’s fraud.
–Facts
Before getting married, David and Kate Bartenwerfer form a legal partnership to fix up and sell a house: David does the work, and Kate is largely uninvolved.
They sell the fixed up house to Buckley. After closing, Buckely finds a bunch of problems that David did not disclose: leaky roof, defective windows, missing fire escape, permit problems.
David and Kate, now married, file bankruptcy, and Buckley objects to their discharge for fraud.
The Bankruptcy Court finds: (i) David knowingly defrauded Buckley, (ii) Kate did not defraud anyone, and (ii) Kate had no knowledge of David’s fraud.
–The Supreme Court’s Ruling
Justice Sotomayor’s concurring opinion summarizes the Court’s unanimous ruling in Bartenwerfer v. Buckley like this:
- “11 U. S. C. §523(a)(2)(A) bars debtors from discharging a debt obtained by fraud of the debtor’s agent or partner.”
And here’s how the same concurring opinion summarizes the Court’s unanimous rationale:
- “Congress incorporated into the statute the common-law principles of fraud, . . . which include agency and partnership principles”;
- “This Court long ago confirmed that reading when it held that fraudulent debts obtained by partners are not dischargeable, Strang v. Bradner, 114 U. S. 555, 559–561 (1885)”;
- “Congress ‘embraced’ that reading when it amended the statute in 1898”; and
- “Because petitioner does not dispute that she and her husband acted as partners, the debt is not dischargeable under the statute.”
In its Bartenwerfer v. Buckley opinion, the U.S. Supreme Court gives no credence to Kate being an “honest” or an “honest but unfortunate” debtor.
It does, however, acknowledge and specifically reject Kate’s “fresh start” policy defense. Here’s how.
- Bartenwerfer invokes the “fresh start” policy of modern bankruptcy law—saying that a discharge denial to a “faultless debtor” for liabilities run up by an associate would be inconsistent with that policy.
- The Bankruptcy Code balances multiple, often competing interests . . . if a fresh start were all that mattered, §523 would not exist.
- No statute pursues a single policy at all costs, and we are not free to rewrite this statute (or any other) as if it did.
- §523(a)(2)(A) does not define the scope of one person’s liability for another’s fraud; that is the function of the underlying law (here, the law of California extends liability to honest partners).
- Bartenwerfer’s fairness-based critiques are better directed toward the state law that imposed the obligation on her in the first place.
- Ordinarily, a faultless individual is responsible for another’s debt only when the two have a special relationship, and even then, defenses to liability are available. For example:
- an employer is not liable for the actions of an employee committed outside the scope of employment; if one partner takes a wrongful act without authority or outside the ordinary course of business, then the partnership—and by extension, the innocent partners—are generally not on the hook;
- partnerships and other businesses can also organize as limited liability entities that insulate individuals from personal exposure to the business’s debts. [Note: this organization distinction suggests that, if the arrangement between David and Kate had been an LLC or corporation instead of partnership, the result on the same facts would have been the opposite!]
- All of this said, innocent people are sometimes held liable for fraud they did not personally commit, and, if they declare bankruptcy, §523(a)(2)(A) bars discharge of that debt.
- So it is for Bartenwerfer, and we are sensitive to the hardship she faces.
- But Congress has evidently concluded that the creditors’ interest in recovering full payment of debts obtained by fraud outweighs the debtors’ interest in a complete fresh start; and
- it is not our role to second-guess that judgment.
Conclusion
So . . . there we have it. The word of authority is spoken by the U.S. Supreme Court.
For all you “honest but unfortunate debtors”: beware!
———————–
Footnote 1. These quotes are from a single paragraph in Edwards v. Kearzey, 96 U.S. 595, 602 (1877) (emphasis added).
Footnote 2. These quotes are from a single paragraph in Williams v. United States Fidelity & Guaranty Co., 236 U.S. 549, 554-55 (1915) (emphasis added).
Footnote 3. These quotes are from a single paragraph in Local Loan Co. v. Hunt, 292 U.S. 234, 244-45 (1934) (emphasis added).
Footnote 4. This quote is from Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365, 367 (2007) (emphasis added).
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