It is not often that the U.S. Supreme Court takes on a case with entity type ramifications, but they did just that in the recent 2023 decision of Bartenwerfer v. Buckley. In Bartenwerfer, the all-too-common partnership to flip houses goes awry when one of the partners commits fraud and the innocent partner tries to limit her liability. The Court found that the fraud of one partner is the fraud of all because “each partner is an agent and representative of the firm with reference to all business within the scope of the partnership.” The Court goes on to state that the innocent partner could have protected herself, if only it were an LLC.
Bartenwerfer: Facts
Kate Bartenwerfer and her husband David Bartenwerfer formed a partnership and remodeled a house they jointly owned to sell for profit. David took charge of the project while Kate remained largely uninvolved. They eventually sold the house to Kieran Buckley. With the sale, Kate and David attested that they had disclosed all material facts related to the property. However, after the purchase Buckley discovered several defects that the Bartenwerfers had failed to disclose or concealed. Buckley sued in California state court and won, leaving the Bartenwerfers jointly responsible for more than $200,000 in damages. Unable to pay the judgment, the Bartenwerfers filed for bankruptcy. However, there is an exception to dischargeability (fraud) that disallows debts procured by fraud to be discharged.
The Bankruptcy Court found that David had committed fraud and therefore imputed his fraud to Kate because the two had formed a partnership to renovate and sell the property. The Bankruptcy Appellate Panel disagreed as to Kate’s culpability, holding that § 523(a)(2)(A) barred her from discharging the debt only if she knew or had reason to know of David’s fraud. On remand, the Bankruptcy Court determined that Kate lacked such knowledge and could therefore discharge her debt to Buckley. The Bankruptcy Appellate Panel affirmed. The Ninth Circuit reversed in relevant part. Invoking Strang v. Bradner, 114 U.S. 555, 5 S.Ct. 1038, 29 L.Ed. 248, the court held that a debtor who is liable for her partner’s fraud cannot discharge that debt in bankruptcy, regardless of her own culpability.
Bartenwerfer: Holding
Section 523(a)(2)(A) of the Bankruptcy Code prevents Kate Bartenwerfer from discharging in bankruptcy a debt obtained by fraud, regardless of her own culpability.
Considerations and Takeaways
The Court affirmed that Section 523(a)(2)(A) does not limit fraud liability to the wrongdoer. This section imposes liability on a debtor for fraud that she did not personally commit, such as deceit practiced by a partner or agent. In other words, Section 523(a)(2)(A) focuses on how the money was obtained, not who committed fraud to obtain it.
The Court provided a list of potential defenses to this liability, depending on the circumstances. The Court noted that Kate could have protected herself by forming an LLC, where she would not have had liability for her partner’s fraud because members of an LLC are not personally liable for the LLC’s debts. If only the partnership had been an LLC, Kate Bartenwerfer would not have been liable for her partner’s fraudulent actions.
Even in simple partnerships between husband and wife, an LLC often provides the solution. There is a joke about my advice in my firm: my solution typically involves forming an LLC.
For any questions regarding The U.S. Supreme Court Agrees: “…If only it was an LLC, email me at info@beresfordlaw.com or give me a call at (425) 776-4100.