Cases & Deals

Husky International Electronics prevails before U.S. Supreme Court in bankruptcy discharge bar case

Clients Husky International Electronics, Inc.

Jones Day represented Husky International Electronics, Inc. before the Supreme Court of the United States in a case involving the scope of the "actual fraud" bar to discharge under section 523(a)(2)(A) of the Bankruptcy Code. This case arises from Husky's sale of goods to Chrysalis Manufacturing Corporation. Chrysalis never fully paid Husky because one of its owners, Daniel Lee Ritz., Jr., bankrupted Chrysalis, draining it of its assets and funneling them to other companies he controlled. Husky sued Ritz, arguing that he was personally liable for Chrysalis's debt to Husky because he used Chrysalis to perpetrate a fraud for his own benefit. Ritz then filed for bankruptcy, and Husky initiated an adversary proceeding to bar discharge of his debt because it was for property that Ritz obtained by actual fraud. The Supreme Court granted certiorari to resolve a split among the courts of appeals as to whether the discharge bar applies only when the debtor has made a false representation, or whether it also applies when the debtor has knowingly obtained money through a fraudulent-transfer scheme that was actually intended to cheat a creditor.

On May 16, 2016, the Supreme Court issued a decision ruling in Husky's favor by a vote of 7-1. The Court agreed with Husky that "actual fraud" does not require a false representation; rather, "anything that counts as "'fraud' and is done with wrongful intent is 'actual fraud.'" Indeed, the Court explained, "actual fraud" has "long encompassed ... a transfer scheme designed to hinder the collection of debt" -- exactly the sort of conduct that Husky alleged Ritz engaged in here. The text of the discharge bar confirms that Congress used the phrase "actual fraud" according to its ordinary meaning: When Congress amended the discharge bar to add the phrase "actual fraud," the provision already barred discharge of debts arising from false representations and false pretenses. That amendment must be given meaning, the Court concluded, and Husky's interpretation is the only one that does so.

The Court accordingly rejected Ritz's argument that "actual fraud" requires that the debtor induce a creditor to part with property through a misrepresentation. "Nothing in the text of s. 523(a)(2)(A)," the Court explained, "supports that additional requirement." It was likewise unpersuaded by Ritz's argument that "'actual fraud' was inserted as the last item in a disjunctive list--'false pretenses, a false representation, or actual fraud'--in order to make clear that the 'false pretenses' and 'false representation[s]' covered by the provision needed to be intentional." "That is an argument," the Court explained, "that defeats itself."

The Supreme Court's decision reaffirms the purposes of the Bankruptcy Code, to give a fresh start only to honest but unfortunate debtors. As one court observed, accepting Ritz's contrary interpretation would have created a blueprint for a "two-step routine" "in which Debtor A transfers valuable property to B for nothing in order to keep it out of the hands of A’s creditor and B then sells the property and declares bankruptcy in an effort to shield herself from liability for having colluded with A to defeat the rights of A’s creditor." McClellan v. Cantrell, 217 F.3d 890, 893 (7th Cir. 2000). The Supreme Court rejected Ritz's invitation to turn the Bankruptcy Code into an engine for fraud.

Husky Int'l Electronics, Inc. v. Ritz, No. 15-145 (U.S.)