Selecting a business partner, much like selecting a spouse, involves a great deal of trust in the other’s representations and conduct as the actions of one, for better or worse, can be attributed to the other. The intricacies and complications of these two relationships most recently clashed in Bartenwerfer v. Buckley, which has presumably settled the question of whether the debt resulting from the fraud of one legal partner/spouse can be imputed to the fraudster’s innocent wife in the bankruptcy context.
The circumstances giving rise to this case had their origin in San Francisco, California in 2007. David and Kate Bartenwerfer began renovating a house and eventually sold it to Kieran Buckley. Unbeknownst to Buckley and Kate, David failed to disclose several defects in the house. Although Kate had done a visual inspection for defects, it was her husband who made representations that neither of them were aware of any material defects to the property other than those already disclosed to the buyer. After a California state court jury found that the Bartenwerfers had failed to disclose construction defects that they knew or reasonably should have known about, the Bartenwerfers filed jointly for bankruptcy. A back and forth ensued because, although the couple had filed jointly as spouses, they held the status of individual debtors in an attempt to discharge the debts as to Kate due to her alleged lack of knowledge regarding the misrepresentations of her husband.
Initially, the bankruptcy court found that David had actual knowledge of the false representations and did in fact intend to deceive Buckely. In re Bartenwerfer, 860 F. App'x 544, 546 (9th Cir. 2021), cert. granted sub nom. Bartenwerfer v. Buckley, 212 L. Ed. 2d 761, 142 S. Ct. 2675 (2022). The court held that Kate was also responsible for the debt due to legal partnership the spouses held in selling the house. Id. The Bartenwerfer’s appealed the decision to the Ninth Circuit Bankruptcy Appellate Panel (the “BAP”). In adopting the Eighth Circuit’s standard created in Walker v. Citizens State Bank, the BAP held that liability for the debt could only be imputed to Kate if she “knew or should have known” of David’s fraud and, consequently, remanded the case for further proceedings. Id. On remand, the bankruptcy court found that Kate did not know of the fraud, and therefore her husband/partner’s fraud could not be imputed to her. The BAP affirmed this ruling. Id. However, the Ninth Circuit reversed this holding after applying basic partnership principles. Id. Specifically, the Circuit Court quoted Strang v. Bradner, 114 U.S. 555, 561 (1885), which held in relevant part:
if, in the conduct of partnership business, ... one partner makes false or fraudulent misrepresentations of fact to the injury of innocent persons, ... his partners cannot escape pecuniary responsibility therefor upon the ground that such misrepresentations were made without their knowledge. This is especially so when ... the partners, who were not themselves guilty of wrong, received and appropriated the fruits of the fraudulent conduct of their associate in business.
The U.S. Supreme Court granted certiorari and held oral argument on December 6, 2022. The focus of the argument was on the meaning of 11 U.S.C. § 523(a)(2)(A), which prohibits the discharge of an individual debtor “from any debt- for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by- false pretenses, a false representation, or actual fraud.” Although Mrs. Bartenwerfer argued that innocent partners should not be liable for debts arising from fraud of which they had no knowledge, Buckley advocated for the literal meaning of the text, noting that Kate obtained the money from Buckley through the fraud of her legal partner, and therefore her debt could not be discharged. Notably, Buckley’s argument was supported by Assistant U.S. Solicitor General Erica Ross, who told the Justices that Supreme Court precedent, common law, and partnership laws in all 50-states support the notion that debtors should be held liable for fraud perpetrated by their partners.
On February 22, 2023, the Supreme Court unanimously held that Mrs. Bartenwerfer could not discharge her debt due to her husband’s fraud, regardless of her culpability, or lack thereof. The Court opined that fraud liability under Section 523(a)(2)(A) is not limited to the specific wrongdoer. In holding so, the Court noted linguistic differences in the language of 11 U.S.C. § 523(a)(2)(B) and (C), both of which require culpability specific to the debtor. In support of its decision, the Court pointed to its own precedent in Strang, as discussed above.
The implications of this case reach much further than secrets between spouses and a real estate transaction gone wrong, requiring an interpretation of priorities laid out in the bankruptcy code and common law partnership principles. On one hand, some view modern bankruptcy law as attempting to relieve honest individuals from unfortunate circumstances that could otherwise tether them to life-long debts. On the other side of the coin, is the perspective that statutory exceptions to the discharge of debts due to fraud show a priority to relieve creditors of transactions culminated due to fraud, and that even honest partners should not prosper due to lies perpetuated by their legal partners. As this decision shows, the Supreme Court has interpreted 11 U.S.C. § 523(a)(2)(A) in favor of victims of fraudulent transactions, tipping the scale against debtors who may lack any culpability regarding their partners’ business transactions. As was made painfully clear to Mrs. Bartenwerfer, this case should serve as a signal to conduct thorough due diligence before forming a legal partnership and closely monitor the actions of partners once a legal relationship has been formed to ensure that no fraudulent transactions are taking place on behalf of the partnership.