A bankruptcy debtor cannot discharge debts incurred by false representation or actual fraud. Appellate court decisions split as to whether a debt incurred as part of a fraudulent transfer of assets is included in the category of “actual fraud” that may not be discharged in bankruptcy. Some courts have held that actual fraud in the bankruptcy Code refers to common law tort of misrepresentation and deceit, whereas other appellate courts interpret “actual fraud” more broadly to include a transfer to hinder or delay creditors that is reversible under fraudulent conveyance laws.
The U.S. Supreme Court has held in a case decided May 16, 2016, that non-dischargeable “actual fraud” in the Bankruptcy Code includes debts incurred in the course of a fraudulent transfer. In this case, an individual Texas businessman owned and/or controlled a corporation that had judgment creditors. In order to deter the corporation’s judgment creditor the individual transferred corporate assets to non-debtor companies. A Texas court held the individual owner liable for the corporation’s judgment under a Texas fraudulent conveyance law. The individual filed Chapter 7 bankruptcy and sought to discharge his debt to the debtor corporation’s creditors.
The Supreme Court said the individual debt imposed by the Texas court could not be discharged under Section 523(a)(2)(A) of the Bankruptcy Code because the debt was incurred by “actual fraud”, that being the individual’s assistance of asset transfers from the debtor corporation.
The Court noted that this ruling would not apply to transferors of fraudulent conveyances because they do not obtain their debt by fraud, but that the ruling does affect recipients of the transfers. The recipients, or transferees, become indebted to the creditor for the property they receive or the value of the property. The Court recognized that rarely will transferees of fraudulent transfers be” on the verge of bankruptcy.” In this particular case, the Texas court held that the debtor both made the transfer and was the transferee because the transfers were made to other companies he controlled.