Supreme Court Reverses Fifth Circuit's Interpretation Of 'Actual Fraud'

Richard Lear is a Partner in Holland & Knight's Washington D.C. office

HIGHLIGHTS:

In a resounding 7-1 decision, the U.S. Supreme Court ruled in favor of the petitioner in Husky Int'l Electronics, Inc. v. Ritz, reversing the decision of the U.S. Court of Appeals for the Fifth Circuit. The Supreme Court determined that "actual fraud" under Section 523(a)(2)(A) of the U.S. Bankruptcy Code does not require that a debtor make a false representation to a creditor in order for a debt to be nondischargeable under that section. As grounds for its decision, the Supreme Court considered the history of Section 523(a)(2)(A) and the historical meaning of "actual fraud," rejecting the need to precisely define "fraud" for all times and circumstances. In a resounding 7-1 decision, the U.S. Supreme Court resolved an existing split among the U.S. Circuit Courts of Appeal, determining that "actual fraud" under Section 523(a)(2)(A) of the U.S. Bankruptcy Code does not require that a debtor make a false representation to a creditor in order for a debt to be nondischargeable under that section. In a decision written by Justice Sonia Sotomayor, the Supreme Court ruled in favor of the petitioner in Husky Int'l Electronics, Inc. v. Ritz1, reversing the decision of the U.S. Court of Appeals for the Fifth Circuit and remanding the case for further proceedings.2

Case History

In Husky, the petitioner, Husky International Electronics Inc., argued that "actual fraud" as used in Section 523(a)(2)(A) of the Bankruptcy Code does not require a false representation but instead encompasses other traditional forms of fraud, such as a fraudulent conveyance of property made to evade payment to creditors.3 The Supreme Court granted certiorari to resolve the split between the Circuit Courts.

Petitioner Husky is in the business of selling components used in electronic devices. For a number of years, Husky sold its product to Chrysalis Manufacturing Corp, and Chrysalis incurred a debt to Husky of approximately $164,000. During the relevant time period, Daniel Ritz Jr. was a director of Chrysalis and owned not less than 30 percent of the common stock in Chrysalis. There is no dispute that during the same period that Chrysalis incurred the debt to Husky, Ritz drained Chrysalis of assets it could have used to pay its debts to creditors, such as Husky, by transferring large sums of Chrysalis' funds to other entities Ritz controlled.

In May 2009, Husky filed a lawsuit against Ritz...