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In a unanimous decision, the U.S. Supreme Court in Bartenwerfer v. Buckley, 598 U.S. 69 (2023), found that an innocent partner having no knowledge of the fraud committed by his partner can still be found to have committed fraud based on one partner being the agent of the other. In this situation, the debtor partner committed the fraud via the agency relationship between the debtor and her non-debtor partner, the Supreme Court held that the debt could not be discharged in Bankruptcy under Section 523(a)(2)(A) of the Bankruptcy Code.

Nondischargeable Debt

The fraud arose over the sale of the debtor’s and her husband’s home. The husband failed to disclose certain defects in the home. The debtor had no knowledge nor involvement in the preparation of the disclosure statement. Having discovered defects that should have been disclosed, the homebuyers ended up filing suit alleging $200,000.00 in damages for breach of contract, negligence, and nondisclosure of material facts After the jury found against the debtor and her husband, the debtor filed bankruptcy under Chapter 7. The homebuyer then filed an adversary proceeding alleging that the judgment was nondischargeable under Section 523(a)(2)(A) of the Bankruptcy Code.

Section 523(a)(2)(A) states –

(a)A discharge under section 727, 1141, 1192  1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

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(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;

The Bankruptcy Court found the debt to be non-dischargeble. The Bankruptcy Appellate Panel (BAP) for the Ninth Circuit reversed as to the debtor, saying she had no reason to know of her husband’s fraudulent intent. The Supreme Court reversed the BAP and found that “a debtor who is liable for her partner’s fraud cannot discharge the debt in bankruptcy, regardless of her own culpability.”

The Supreme Court disagreed with the debtor’s contention that there must be a culpable act by the debtor Instead, it noted that “the common law of fraud . . . has long maintained that fraud liability is not limited to the wrongdoer.”

In reviewing Section 523(a)(2), the Court found that (a) the debtor was an individual; (b) the judgment was a debt; and (c) the debt from a fraudulent misrepresentation is a debt “for money . . . obtained by . . . false pretenses, a false representation, or actual fraud.”

Fraud of One is the Fraud of All

The court then cited Strang v. Bradner, 114 U. S. 555 (1885), as precedent. There the Supreme Court held the “fraud of one partner . . . is the fraud of all because ‘[e]ach partner was the agent and representative of the firm with reference to all business within the scope of the partnership.’” Strang, supra, 114 U.S. at 561.

Justice Sotomayor (joined by Justice Jackson) citing Strang concurred with the majority stating that debt may be nondischargeable when the debt arises from the fraud of the debtor’s agent or partner. But, she limited her concurrence to the debt arising from fraud committed by the debtor’s “agents” and “partners within the scope of the partnership” noting that the court was not dealing with a situation of an innocent debtor being implicated in fraud by a person having no agency or partnership relationship to the debtor.

So, the takeaway here is that this ruling may be limited to an innocent debtor implicated in the fraud of his agent or partner. It’s doubtful that it would extend to a truly innocent debtor having no knowledge of the fraud and no agency relationship with the one who committed the fraud. Thus, one needs to be careful in relationships, business or otherwise, that may give rise to an agency or partnership relationship. Remember, partnerships do not necessarily have to be created through a written agreement. In Texas, a partnership is defined as “an association of two or more persons to carry on a business for profit as owners … regardless of whether (1) the persons intend to create a partnership or (2) the association is called a ‘partnership,’ joint venture,’ or other name.” Tex. Bus. Org. Code § 152.051.

This definition is similar in other States. Some states might require the partners to have equal control or they not only share in the profits but also the losses. Further, one does not necessarily have to be a partner of the person who committed the fraud. Yet, if a partnership can be proved, the element of proving an agency is easily proven. So, at the end of the day, the court will examine whether an agency relationship existed — partnership or no partnership.

ABOUT THE AUTHOR:

Avatar of Bill Siegel
William L. (Bill) Siegel is a Shareholder and Section Head of the Cowles and Thompson Bankruptcy and Creditors’ Rights Practice Group as well as a member of the Corporate and Business Practice Group. His experience includes representing individuals and business entities in their corporate and transactional affairs, including drafting and negotiating agreements of all types, and representing individuals and business entities in disputes that may arise in litigation in State and Federal Courts. He also represents debtors, creditors, Trustees, and Committees in bankruptcy matters in Chapter 7 liquidations and Chapter 11 reorganizations. His clients include small and medium-sized businesses, start-up technology companies, and partnerships. He frequently publishes articles and content regarding trends in bankruptcy law, the economy, commercial real estate, and retail-related matters.