Bartenwerfer v. Buckley

Issues

If a member of a partnership did not know of fraud committed by their partner, does the debt of the innocent partner due to that fraud remain even after filing for bankruptcy?

Oral argument:

December 6, 2022

Court below:

United States Court of Appeals for the Ninth Circuit

This case asks the Supreme Court to decide whether a member of a partnership is prohibited from discharging debt fraudulently incurred by their partner without their knowledge. Kate Bartenwerfer argues that the Court cannot prohibit her from discharging debts in bankruptcy merely because those debts were obtained by her partner’s imputed fraud that she was not responsible for. Kieran Buckley counters that the Bankruptcy Code asks only whether debts were obtained by fraud and does not draw distinctions based on whether any individual debtor is responsible for that fraud. This case has implications for prioritizing relief to debtors or creditors in bankruptcy and for the liabilities of individuals in a marriage or domestic partnership.

Questions as Framed for the Court by the Parties

Whether an individual may be subject to liability for the fraud of another that is barred from discharge in bankruptcy under 11 U.S.C. § 523(a)(2)(A), by imputation, without any act, omission, intent or knowledge of her own.

Facts

Kate Bartenwerfer and her then-boyfriend, David Bartenwerfer, bought a house in San Francisco, CA with the intent to remodel it. In re Bartenwerfer, 596 B.R. 675, 677 (Bankr. N.D. Cal. 2019). Neither Mr. nor Mrs. Bartenwerfer had a contracting license or any experience with contracting, but Mr. Bartenwerfer nonetheless began managing the extensive renovations full-time. Id. at 677–78. The Bartenwerfers moved out of the house in April 2007 during the renovation and listed the house for sale in November 2007. Id. at 678.

In November 2007, the Bartenwerfers completed a Real Estate Transfer Disclosure Statement, which consisted of checkboxes to disclose the condition and possible defects of the house. Id. at 678–79. Mrs. Bartenwerfer checked for defects with a visual inspection. Id. at 680. As for structural defects that could not be seen, Mrs. Bartenwerfer relied on Mr. Bartenwerfer’s assurance that there were none. Id. The Bartenwerfers did not disclose any house defects, and both signed the statement. Id. at 679. However, there were actually many defects with the house, and lawsuits filed by the buyer, Kieran Buckley, ultimately revealed that Mr. Bartenwerfer knew about the defects and did not disclose them. Id. at 680.

The Bartenwerfers completed the sale to Buckley in 2008. In re Bartenwerfer, 549 B.R. 222, 225 (Bankr. N.D. Cal. 2016). Shortly after completion of the sale, Buckley sued the Bartenwerfers in California state court for several claims related to nondisclosure of the defects. In re Bartenwerfer, 860 F. App'x 544, 545 (9th Cir. 2021). A jury found in favor of Buckley and awarded him substantial damages. Id. Then, the Bartenwerfers filed for bankruptcy jointly as spouses, though they remained “individual debtors” for determining which of their debts could be discharged. Brief for Petitioner, Kate Bartenwerfer at 10.

In U.S. Bankruptcy Court, Buckley argued that the state court damages were nondischargable debts because 11 U.S.C. § 523(a)(2)(A) prohibits the discharge of debt incurred due to fraud. In re Bartenwerfer, 860 F. App'x at 545–46. The bankruptcy court agreed, finding that Mr. Bartenwerfer knew about the misrepresentation of the defects, and this fraud was imputed to Mrs. Bartenwerfer because they were partners on the renovation and sale. Id. at 546. On appeal, the Ninth Circuit Bankruptcy Appellate Panel (BAP) reversed the finding that the fraud was imputed to Mrs. Bartenwerfer. Id. BAP remanded and required the bankruptcy court to instead consider whether Mrs. Bartenwerfer “knew or should have known” of the fraud. Id. On remand, the bankruptcy court found that Mrs. Bartenwerfer did not know of the fraud; therefore, the state court debt could be discharged for her. Id. BAP affirmed. Id.

Buckley appealed to the Ninth Circuit. Id. In a brief decision, the Ninth Circuit reversed the ruling that Mrs. Bartenwerfer’s debt could be discharged. Id. at 547. The Ninth Circuit rejected the “knew or should have known” analysis for Mrs. Bartenwerfer’s liability. Id. Instead, the court applied partnership law, holding that, regardless of knowledge of the fraud, a partner is liable for the fraud of other partners. Id. at 546.

Mrs. Bartenwerfer appealed the Ninth Circuit’s decision, and the Supreme Court granted certiorari on May 2, 2022.

Analysis

INDIVIDUAL DEBTORS AND INNOCENT PARTNERS

Bartenwerfer asserts that the statutory text maintains a clear focus on the individual debtor. Brief for Petitioner, Kate Bartenwerfer, at 16. In bankruptcy, a discharge permanently releases a debtor from personal liability for certain types of debts. Chapter 7 bankruptcy specifically allows individual debtors to discharge all debts except those covered by § 523 of the United States Bankruptcy Code. See 11 U.S.C.S. 727(a), (b). Under § 523, an “individual debtor” cannot discharge debts to the extent that they are obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.” 11 U.S.C. § 523(a)(2)(A). Imposing debt on her, Bartenwerfer contends, would establish a policy of saddling innocent debtors with debts arising from the fraud of others, contrary to the Code’s overarching purpose. Brief for Petitioner at 16–17. Bartenwerfer notes that the 1978 Bankruptcy Act, under Marrama v. Citizens Bank of Massachusetts, serves to give the “honest but unfortunate debtor” a fresh start. Id. at 16. Bartenwerfer similarly predicates her argument on the principle, recognized in Bullock v. BankChampaign, N.A., that exceptions to discharge should be recognized only when plainly expressed. Id. at 17. Bartenwerfer argues that § 523 does not plainly express a rule that individual debtors cannot discharge debts attributed to another person’s fraud. Id. Accordingly, Bartenwerfer maintains that the lack of a clear rule to that effect resolves this case. Id.

Bartenwerfer supports her argument with a textual analysis of § 523. Id. at 18. Specifically, Bartenwerfer submits that § 523 focuses on individual debtors and evaluates each debtor on an individual basis, without regard for what their partners, affiliates, or spouses have done. Id. Reading § 523 to contemplate fraud by anyone but the individual debtor, Bartenwerfer continues, would “turn the Code on its head.” Id. Bartenwerfer finds support in several sections of the Bankruptcy Code, which she argues plainly distinguish between individual debtors and other affiliates, unlike § 523. Id. at 18–19.

Buckley counters that Bartenwerfer’s reading of § 523 would “rewrite the statutory text.” Brief for Respondent, Kieran Buckley, at 37. Buckley contends that Bartenwerfer is not innocent because she is responsible for the fraud under long standing principles of vicarious liability and agency law. Id. at 24. Throughout bankruptcy law’s history, Buckley argues, Congress has protected innocent fraud victims rather than debtors who have defrauded them. Id. at 42. Buckley claims that all debts for money obtained through fraud are not dischargeable under § 523. Id. at 16. To find otherwise, Buckley argues, would be to read an “unstated exception” into the statute. Id at 17. Specifically, Buckley contends that the statutory meaning is evident under Cohen v. de la Cruz, which states that “any debt” arising from fraud is not dischargeable. Id. at 14. Debt “obtained by” fraud, Buckley maintains, simply means debt obtained through fraud or as a consequence of it. Id. at 14–15.

Buckley argues that Strang v. Bradner already rejected the contention that a lack of knowledge or intent serves as a basis to discharge debt incurred by a partner. Id. at 20–21. While Strang interpreted an earlier bankruptcy statute, Buckley argues that Congress never departed from Strang’s holding when making statutory revisions, and in fact adopted it by omitting a prior statutory reference to fraud “of the bankrupt.” Id. at 19–20. Under United States v. Gonzales, “any” fraud, Buckley asserts, means any fraud, regardless of who committed the fraud. Id. at 16–17. Moreover, Buckley contends, because § 523 explicitly exempts statements about a debtor’s financial condition from fraud, under Hillman v. Maretta, when there are explicit exceptions, other exceptions cannot be read into the statute absent clear indication of legislative intent to make such exceptions. Id. at 17. Since there is no clearly stated exception for unintentional fraud, Buckley argues, the Court cannot read one into § 523. Id.

Additionally, Buckley points out that Congress has separately immunized rental car companies from vicarious liability suits, which Buckley refers to as evidence that Congress could have clearly excluded vicarious liability from § 523 had it wanted to. Id. at 24. Buckley similarly argues that other provisions in the Bankruptcy Code make debts for money acquired by willful and malicious injury and intentionally false written statements nondischargeable. Id. at 24–25. Critically, Buckley stresses, such language is absent in § 523. Id. at 25. Buckley places emphasis on the fact that both “fraud” and “debt” are communicated by passive voice, arguing that as a logical consequence, the dispositive question is only whether the money at issue was obtained by fraud. Id. at 26.

THE ROLE OF STATE AND COMMON LAW

Regardless of how state law treats the relationship between an individual debtor and such other persons, Bartenwerfer contends, the Code plainly differentiates between them. Brief for Petitioner at 19. Bartenwerfer relies on § 523’s use of the words “obtained by,” asserting that this verb choice focuses on one individual actor. Id. at 20. Conceding that these words are presented in passive voice, Bartenwerfer maintains that their meaning is clear; just as saying a clerkship was obtained by a student necessarily implies that the student is the one who obtained it, § 523’s statement that it does not discharge an individual debtor for debt obtained by fraud clearly contemplates that the individual debtor is the one who committed the fraud. Id. at 20–21.

Bartenwerfer further notes that false representations and pretenses, as well as actual fraud, are all common law torts with intent requirements. Id. at 21–22. Congress’ choice to include such offenses, Bartenwerfer argues, “underscored the focus” on the individual debtor alone. Id. at 22. Moreover, Bartenwerfer points out that other provisions render debts resulting from court orders, penalties, fines, and other binding decrees nondischargeable. Id. at 26–27. Accordingly, Bartenwerfer contends, Congress knew how to explicitly hold debtors liable for misdeeds other than their own and chose not to do so in § 523. Id. at 27.

Further, Bartenwerfer argues that Strang is inapposite because it established a general federal common law rule that no longer has force after the development of the Erie Doctrine. Id. at 40. Because the Erie Doctrine has been taken to repudiate federal common law rules, such as in Atherton v. FDIC, Bartenwerfer asserts that it cannot be relied on in this case. Id. at 42–43.

Buckley counters that liability for debts obtained by fraud depends on state law. Brief for Respondent at 17–18. Buckley argues that Congress deferred to state law to determine liability for debts obtained by fraud. Id. at 16. Here, Buckley argues, because the fraud occurred within the scope of the Bartenwerfers’ partnership, Bartenwerfer is liable for the fraud under both state law and § 523. Id. So long as money was obtained by fraud, Buckley contends, any state law liability that arises as a consequence of that fraud cannot be discharged in bankruptcy. Id. at 14. This is the case, Buckley argues, because per Butner v. United States, Congress drafted the Bankruptcy Code under a state law backdrop which it generally left undisturbed. Id. at 21. Accordingly, Buckley claims, vicarious liability for obtaining money through fraud constitutes a debt for money obtained through fraud under § 523 because it is liability arising from fraud. Id. at 16. Thus, Buckley concludes, since Bartenwerfer is liable for her husband’s fraud under state law, she cannot discharge debt arising from that fraud under § 523. Id.

Moreover, Buckley argues, there is no clear language or change in practice indicating that Congress abrogated Strang. Id. at 21. To the contrary, Buckley maintains, Congress adopted its reasoning when it amended § 523’s predecessor statute to remove its reference to fraud “of the bankrupt.” Id. This choice, Buckley asserts, “reflected Strang’s focus” on the existence of liability for fraud irrespective of who personally committed such fraud. Id. Additionally, Buckley argues, even if the question of whether Bartenwerfer were specifically responsible for the fraud did matter, the scope of “actual fraud” remains an acceptable federal common law question today under Field v. Mans. Id. at 39. Therefore, even under federal common law, Buckley claims, the rule remains the same: a partner’s fraud is imputed to other partners. Id.

Discussion

PRIORITIZING RELIEF FOR DEBTORS OR CREDITORS

Several groups, including some Law Professors, Retired Judges, and The National Consumer Bankruptcy Rights Center (NCBRC), in support of Bartenwerfer, argue that modern bankruptcy law intends to prioritize relief to the “honest but unfortunate debtor.” Brief of Amici Curiae Law Professors, in Support of Petitioner at 3. The Retired Judges explain that beginning in 1898, Congress shifted bankruptcy law to provide broader discharge of debts in bankruptcy. Brief of Amici Curiae Retired Judges et al., in Support of Petitioner at 19–21. Further, the Retired Judges argue, broad discharge of debts is in the public interest because it allows a struggling debtor to return to being a productive member of society. Id. at 20.

Given this goal of broad discharge under bankruptcy law, the NCBRC argues that exceptions to discharge may only be applied in limited circumstances. Brief of Amici Curiae NCBRC, in Support of Petitioner at 15–16. The Law Professors supporting Bartenwerfer explain that although an “innocent” partner may incur liability under state law for their partner’s fraud, this state law liability does not control the discharge exceptions under federal law. Brief of Law Professors Supporting Petitioner at 2. Thus, these groups maintain that congressional intent and bankruptcy law goals require that an “innocent” debtor be able to discharge any debt incurred by the partner’s fraud. Brief of Retired Judges et al. at 22.

The United States and some Law Professors, in support of Buckley, deny that bankruptcy law is intended to prioritize relief to the “honest but unfortunate debtor.” Brief of Amici Curiae Law Professors, in Support of Respondent at 6; Brief of Amici Curiae United States, in Support of Respondent at 31. In fact, the United States argues, the statutory exceptions to discharge demonstrate Congress’ determination that in some circumstances, repayment to creditors should be prioritized over relief for debtors. Brief of United States at 3. That is the case here, the United States explains, where the exception to discharge expressly prioritizes relief to a victim of fraud over the person or partners who committed that fraud. Id. at 31. The Law Professors supporting Buckley maintain that the nature of the debt, not the honesty of the debtor, determines whether an exception to discharge applies. Brief of Law Professors Supporting Respondent at 8.

Furthermore, the United States and Law Professors supporting Buckley assert that despite federal law governing the bankruptcy discharge exceptions, liability for debt incurred due to fraud is a matter of state law. Brief of United States at 31–32. The Law Professors supporting Buckley explain that state law governs liability for fraud, even for a member of a partnership who did not know of their partner’s fraud, and if such liability exists, that debt is excluded from discharge in bankruptcy. Brief of Law Professors Supporting Respondent at 20–21.

CONSEQUENCES FOR “INNOCENT” SPOUSES OR DOMESTIC PARTNERS

The Law Professors, Retired Judges, and NCBRC, in support of Bartenwerfer, also emphasize the consequences that an adverse holding will have for spouses or domestic partners. Brief of Law Professors Supporting Petitioner at 27. The Retired Judges explain that marriage is a personal, not professional, relationship, and married partners are less able to end their relationship or control a dishonest partner as compared to commercial partnerships. Brief of Retired Judges et al. at 32–33. Therefore, the Retired Judges assert, spouses who are innocent of their partner’s fraud would be unfairly punished for fraud they did not commit. Id. at 32. The NCBRC is particularly concerned for spouses who have suffered from financial abuse and would be unable to escape debt created by their abusive spouse. Brief of NCBRC at 9. The Law Professors supporting Bartenwerfer argue that these innocent spouses are exactly the kind of “honest but unfortunate debtor” whom bankruptcy law is intended to protect. Brief of Law Professors Supporting Petitioner at 29–30.

The United States and Law Professors, in support of Buckley, deny that there will be unfair effects on innocent spouses or domestic partners. Brief of United States at 32. The Law Professors supporting Buckley contend that state law already distinguishes between marital relationships and legal partnerships which give rise to imputed liability for fraud. Brief of Law Professors Supporting Respondent at 21. The Law Professors supporting Buckley explain that no spouse will be liable for fraud simply for being married to a dishonest spouse; the spouse will only be liable if they take additional steps to form a legal partnership. Id. Accordingly, the Law Professors supporting Buckley contend that, if there is any unfairness in holding a person liable for the fraud of their spouse, this unfairness should be addressed through changes to state liability law, not federal bankruptcy law. Id. at 22.