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Supreme Court Takes Case on Imputing Fraud in Bankruptcy (1)

May 2, 2022, 1:43 PMUpdated: May 2, 2022, 6:20 PM

The U.S. Supreme Court has agreed to hear a case involving whether a bankrupt debtor can wipe out a debt stemming from another party’s fraudulent act.

Kate Bartenwerfer, a bankrupt California homeowner, appealed after the U.S. Court of Appeals for the Ninth Circuit said she is stuck with a nondischargeable debt, despite her claim that she “had no control or even knowledge” of her husband’s fraudulent conduct in the sale of their home.

The homebuyer sued Bartenwerfer and her husband following the discovery of structural defects in the house in California. The Bartenwerfers jointly declared bankruptcy after losing a jury verdict in 2012.

Debts incurred through fraudulent behavior can’t be discharged through bankruptcy proceedings.

Bartenwerfer contended the Ninth Circuit erred by imputing to her her husband’s liability for making false representations about the home to the buyer.

The Ninth Circuit’s 2021 ruling deepened “an intractable split” among the federal appellate courts, Bartenwerfer said in her December petition for high court review.

Kieran Buckley, the home purchaser, told the justices that the Ninth Circuit got it correct.

Bankruptcy law “excepts from discharge all debts for money that was ‘obtained by’ actual fraud, without regard to the debtor’s involvement in, or state of mind as to, the underlying fraud itself,” Buckley said in a March 21 high court filing.

‘Knew or Should Have Known’

A central factor in Bartenwerfer’s case is an 1885 Supreme Court ruling in Strang v. Bradner that members of a partnership “cannot escape pecuniary responsibility” for the “false or fraudulent misrepresentations” of another partner.

Conflicts between Strang and other Supreme Court opinions have led to competing interpretations of a bankruptcy law provision that exempts a debt procured through fraud from being discharged, according to Bartenwerfer.

The Ninth Circuit erred by rejecting a standard for imputing fraud on whether the party in question “knew or should have known” about the fraudulent activity, as has been accepted in the U.S Court of Appeals for the Eighth Circuit, Bartenwerfer argued.

The “more modern, enlightened approach” is not to hold the innocent spouse liable under these circumstances, Bartenwerfer’s attorney, Iain A. Macdonald of Macdonald Fernandez LLP, said. “One spouse should not bear the burden of the flaws of the other spouse.”

Buckley said in court filings that the the circuit conflict on the issue “is lopsided and longstanding.”

An attorney for Buckley didn’t immediately respond to a request for comment.

The case is Bartenwerfer v. Buckley, U.S., No. 21-908, cert. granted 5/2/22.

(Updated with additional reporting)

To contact the reporter on this story: Alex Wolf in New York at awolf@bloomberglaw.com

To contact the editors responsible for this story: Roger Yu at ryu@bloomberglaw.com; Keith Perine at kperine@bloomberglaw.com