Filed: Jul. 01, 2015
Latest Update: Mar. 02, 2020
Summary: Sauer, 505 B.R., Even so, Ms. Lawson argues and the bankruptcy court found, that our inquiry is foreclosed by controlling Supreme Court and, First Circuit precedent in Field v. Mans, 516 U.S. 59 (1995), and, In re Spigel, 260 F.3d 27 (1st Cir. 23 discharge debts obtained by fraudulent conveyance.
United States Court of Appeals
For the First Circuit
No. 14-2058
IN RE: CARRIE D. LAWSON,
Debtor
--------------------
SAUER INCORPORATED, d/b/a Sauer Southeast,
Appellant,
v.
CARRIE D. LAWSON,
Appellee.
APPEAL FROM THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Diane Finkle, U.S. Bankruptcy Judge]
Before
Lynch, Thompson, and Kayatta,
Circuit Judges.
Michael J. Jacobs and LaPlante Sowa Goldman, on brief for
appellant.
Christopher M. Lefebvre, with whom Claude Lefebvre,
Christoper Lefebvre, P.C., John Boyajian, and Boyajian,
Harrington, Richardson & Furness were on brief, for appellee.
July 1, 2015
LYNCH, Circuit Judge. Sauer Incorporated ("Sauer")
filed an adversary proceeding objecting to the discharge of a debt
owed by Carrie Lawson ("Ms. Lawson") that she allegedly obtained
as part of a fraudulent scheme to prevent Sauer from collecting a
previous judgment from her father, James Lawson. See 11 U.S.C.
§§ 523(a)(2)(A), 523(a)(6). The bankruptcy court dismissed for
failure to state a claim on the ground that a debt for value
"obtained by . . . actual fraud" under § 523(a)(2)(A) is limited
to debts for value obtained through fraudulent misrepresentations.
The court felt First Circuit precedent in the line of Palmacci v.
Umpierrez, 121 F.3d 781, 786 (1st Cir. 1997), required such a
conclusion. See Sauer, Inc. v. Lawson (In re Lawson),
505 B.R.
117, 125-26 (Bankr. D.R.I. 2014) (citing McCrory v. Spigel (In re
Spigel),
260 F.3d 27, 32 (1st Cir. 2001); Palmacci,
121 F.3d 781);
see also
id. (citing Field v. Mans,
516 U.S. 59 (1995)).
On direct appeal, we are asked to resolve this narrow
but significant issue of whether a debt that is not dischargeable
in Chapter 13 bankruptcy as a debt for money or property "obtained
by . . . actual fraud" extends beyond debts incurred through
fraudulent misrepresentations to also include debts incurred as a
result of knowingly accepting a fraudulent conveyance that the
transferee knew was intended to hinder the transferor's creditors.
- 3 -
See 11 U.S.C. § 523(a)(2)(A). We join the Seventh Circuit in
concluding that it does. See McClellan v. Cantrell, 217 F.3d 890
(7th Cir. 2000).1
Having adopted this new standard, we vacate and remand
for further proceedings consistent with this opinion. We decline
to reach the issue of the adequacy of Sauer's pleadings of actual
fraud under Rule 9(b), and the possibility of amendment if
inadequate. Because we have adopted a new standard, the bankruptcy
court should address these issues in the first instance. Cf.
N. Am. Catholic Educ. Programming Found., Inc. v. Cardinale, 567
F.3d 8, 16-18 (1st Cir. 2009) (Boudin, J.).
I.
We recount the facts as alleged in Sauer's First Amended
Complaint, accepting them as true and drawing "all reasonable
inferences" in Sauer's favor. See Ruivo v. Wells Fargo Bank, N.A.,
766 F.3d 87, 90 (1st Cir. 2014). In brief, Sauer alleges that Ms.
Lawson incurred the debt at issue by knowingly receiving a
fraudulent conveyance from her father, James, that was designed to
1
We are aware the Fifth Circuit, in a post-argument decision,
has disagreed with McClellan and our analysis here. See Husky
Int'l Elec., Inc. v. Ritz (In re Ritz), -- F.3d --, 2015 WL 3372812
(5th Cir. May 22, 2015).
- 4 -
prevent Sauer from collecting a judgment against him. The details
are as follows.
In January 2007, Sauer sued James in Providence Superior
Court based on their previous business dealings. Three years
later, on February 5, 2010, the Superior Court found those
transactions to be fraudulent, and awarded Sauer a judgment against
James in the amount of $168,351.59, including punitive damages.
Just before the judgment was entered, Ms. Lawson had
formed a shell entity, Commercial Construction M&C, LLC
("Commercial Construction").2 Upon entry of judgment, James
transferred $100,150 to Commercial Construction, allegedly to
impede Sauer's collection. Commercial Construction is owned by
Ms. Lawson, but controlled by James.3
Ms. Lawson then transferred $80,000 of the $100,150 from
Commercial Construction to herself sometime over the course of the
following year, from February 2010 through early 2011. In March
2011, James filed for Chapter 13 bankruptcy.
2
Although the complaint does not allege when Ms. Lawson
formed Commercial Construction, Ms. Lawson's affidavit, which she
appended to her motion to dismiss Sauer's First Amended Complaint,
indicates that she formed the entity in January 2010.
3
The present ownership of Commercial Construction is a matter
of some dispute, but it does not affect our analysis.
- 5 -
Pursuant to the Rhode Island Uniform Fraudulent Transfer
Act, R.I. Gen. Laws § 6-16-1 et seq. ("UFTA"), Sauer traced
portions of its original judgment against James first to Commercial
Construction, and then to Ms. Lawson. The Providence Superior
Court found these transfers to be fraudulent under the UFTA, and
issued executions against both Commercial Construction and Ms.
Lawson for the full amounts transferred ($100,150 and $80,000,
respectively). The latter judgment entered against Ms. Lawson is
the debt at issue.
Ms. Lawson filed for Chapter 13 bankruptcy the same month
that the Providence Superior Court issued the execution against
her, in March 2013. Sauer initiated this adversary proceeding in
June 2013, objecting to the discharge of this debt under
§ 523(a)(2)(A) as being for money "obtained by . . . actual fraud."4
In particular, Sauer alleged that because Ms. Lawson "knowingly
receiv[ed]" the fraudulent transfer and acted in a "willful and
malicious" manner toward Sauer, her acceptance of the fraudulent
conveyance constitutes actual, not merely constructive, fraud.5
4
Sauer also objected to discharge under § 523(a)(6), but the
bankruptcy court correctly held that this provision does not bar
Chapter 13 discharge. Sauer, 505 B.R. at 119 n.4; see 11 U.S.C.
§ 1328(a)(2).
5
We do not address the adequacy of this pleading under the
heightened pleading standard of Rule 9(b), but assume its adequacy
- 6 -
The bankruptcy court dismissed Sauer's adversary
proceeding. The court reasoned that it was constrained by First
Circuit and Supreme Court precedent to find that a
misrepresentation is a required element of "actual fraud" under
§ 523(a)(2)(A). See Sauer, 505 B.R. at 118, 125-26 (citing Field,
516 U.S. 59;
Spigel, 260 F.3d at 32). Because Sauer concededly
could not allege that Ms. Lawson had made a misrepresentation,
Sauer could not establish that § 523(a)(2)(A) barred discharge of
Ms. Lawson's debt. See
id. at 126.
Sauer appealed to the Bankruptcy Appellate Panel and,
shortly thereafter, petitioned for direct appeal to the First
Circuit. See 28 U.S.C. § 158(d)(2). The Panel granted
certification on the ground that the order "involves a matter of
public importance," 28 U.S.C. § 158(d)(2)(A)(i), and agreeing, we
granted authorization.
II.
The sole issue on appeal is whether the bankruptcy court
erred in concluding that "a misrepresentation by a debtor to a
creditor is an essential element of establishing a basis for the
nondischarge of a debt under § 523(a)(2)(A)." Sauer, 505 B.R. at
for purposes of resolving the appeal. Cf. N. Am. Catholic Educ.,
567 F.3d at 16.
- 7 -
118. This is a question of law, which we review de novo. See
N. Am. Catholic Educ., 567 F.3d at 12; United States v. Nippon
Paper Indus. Co.,
109 F.3d 1, 3 (1st Cir. 1997).
A. The Fraud Exception of § 523(a)(2)(A)
The Bankruptcy Code aims to strike a balance between
providing debtors with a fresh start by discharging debts upon
plan confirmation, and avoiding abuse of the system. See Spigel,
260 F.3d at 31-32. To this end, the Code exempts from discharge
certain types of debt in an attempt to "limit[] th[e] opportunity
[for discharge] to the 'honest but unfortunate debtor.'"
Id. at 32
(second and third alteration in original) (quoting Brown v. Felsen,
442 U.S. 127, 128 (1979)). Such exceptions are "narrowly construed
. . . and the claimant must show that its claim comes squarely
within an [enumerated] exception."
Id. (first alteration in
original) (quoting Century 21 Balfour Real Estate v. Menna (In re
Menna),
16 F.3d 7, 9 (1st Cir. 1994)).
This case concerns an exemption to Chapter 13 discharge.
Although "discharge under Chapter 13 'is broader than the discharge
received in any other chapter,'" Chapter 13 still "restricts or
prohibits entirely the discharge of certain types of debts."
United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260, 268
(2010) (quoting 8 Collier on Bankruptcy ¶ 1328.01 (rev. 15th ed.
- 8 -
2008)). As relevant here, Chapter 13 does not discharge any debt
"for money . . . to the extent obtained by . . . false pretenses,
a false representation, or actual fraud . . . ." 11 U.S.C.
§ 523(a)(2)(A) (emphasis added); id. § 1328(a)(2) (making
§ 523(a)(2)(A) expressly applicable to Chapter 13).
Although many courts have "assume[d] that fraud [under
this provision] equals misrepresentation," McClellan, 217 F.3d at
892-93 (collecting cases), it remains an open question in this
circuit whether "actual fraud" includes fraud effected by means
other than fraudulent misrepresentation, such as through schemes
of fraudulent conveyance,
Spigel, 260 F.3d at 32-33 n.7 (expressly
declining to reach the issue).6
6 This surprising gap has an explanation:
Until 1970, the courts tasked with enforcing a creditor's
claim also determined whether the judgment thereby rendered was
nondischargeable under the fraud exception. See Brown, 442 U.S.
at 129-30 (citing Section 17 of the former Bankruptcy Act)
("Typically, that court was a state court."). This proved
problematic: creditors were frequently successful in obtaining
nondischargeable default judgments in state courts under the
exception. Id. at 135-36. To avoid creditor abuse, Congress
amended the statute to require creditors seeking to bar discharge
under the fraud exception to file directly with the bankruptcy
court. See
id. But in the cases since, we did not reach the issue
of whether "actual fraud" is limited to fraud effected by
misrepresentation because misrepresentation was the only type of
fraud charged. See
McClellan, 217 F.3d at 892-93 (collecting
cases); see, e.g.,
Field, 516 U.S. at 70; Palmacci,
121 F.3d 781;
see also, e.g., Anastas v. Am. Sav. Bank (In re Anastas),
94 F.3d
1280, 1285 (9th Cir. 1996) (finding an "implied representation of
- 9 -
an intent" to repay a credit card charge (emphasis added)); Rembert
v. AT&T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277,
281 (6th Cir. 1998) (same); AT&T Universal Card Servs. v. Mercer
(In re Mercer),
246 F.3d 391, 403 (5th Cir. 2001) (en banc) (noting
that implying misrepresentation under the Palmacci test is
"appropriate for determining card-dischargeability because . . .
card-use lends itself to that analysis").
Even so, Ms. Lawson argues -- and the bankruptcy court found
-- that our inquiry is foreclosed by controlling Supreme Court and
First Circuit precedent in Field v. Mans, 516 U.S. 59 (1995), and
In re Spigel,
260 F.3d 27 (1st Cir. 2001). But these cases are
inapposite.
Field did not address whether "actual fraud" is limited to
fraud based on fraudulent misrepresentation. Field, 516 U.S. at
61. Rather, the Court there addressed the requirements when the
actual fraud alleged was fraudulent misrepresentation. See
id.
(addressing the type of reliance required). At no point does the
Supreme Court state or even consider that "actual fraud" could be
limited to fraudulent misrepresentation. To the contrary, the
Court directs us to rely upon the Second Restatement of Torts
which, as will be discussed, identifies multiple forms of "fraud."
See
Field, 516 U.S. at 70; Restatement (Second) of Torts § 871
cmts., index (1977); cf. In re
Mercer, 246 F.3d at 403 (recognizing
that the Restatement "does not define 'fraud'" but discusses
particular forms thereof).
Spigel, far from foreclosing our inquiry, expressly left it
open. See Spigel, 260 F.3d at 32-33 n.7. That case did not
concern whether a misrepresentation was required, but the
relationship between the "fraudulent conduct" and the debt.
Id.
at 32-35 (holding that the debt must be a "direct result" of
fraudulent conduct intended to swindle the relevant creditor).
Not only did we decline to reach the question of the scope of
"actual fraud," we expressed doubt that the Palmacci test for debt
obtained through fraudulent misrepresentations was the "exclusive
test" for nondischargeability under § 523(a)(2)(A).
Id. at 32-33
n.7 (citing
McClellan, 217 F.3d at 892-95); cf. In re
Mercer, 246
F.3d at 403 & n.3 (noting disagreement).
- 10 -
The Supreme Court has directed us that in construing the
meaning of "actual fraud" under this provision, we are to rely on
the common law "concept of 'actual fraud' as it was understood in
1978 when that language was added to § 523(a)(2)(A)." Field, 516
U.S. at 70. "Then, as now, the most widely accepted distillation
of the common law of torts was the Restatement (Second) of Torts
(1976), published shortly before Congress passed the Act."
Id.
Accordingly, we look to the same Restatement as relied upon in
Field.
That Restatement recognizes several types of "fraud,"
including both fraudulent misrepresentations and "fraudulent
interference with [property rights]," a tort that is broader than
misrepresentation itself. See Restatement (Second) of Torts,
index, "Fraud" (1977); see also id. § 871 ("One who intentionally
deprives another of his legally protected property interest or
causes injury to the interest is subject to liability to the other
if his conduct is generally culpable and not justifiable under the
circumstances."). The comments to the relevant Restatement
provision, § 871, make clear that this includes fraudulent
conveyance, like that alleged here. Id. § 871 cmt. a ("[T]he rule
applies when title to land has been obtained by fraud . . . and
has been transferred to one other than a bona fide purchaser, in
- 11 -
which case, until its sale by the transferee, the original owner's
sole redress against the transferee is by an action seeking its
recovery."). That is, the common law concept of "fraud" as
distilled by the Restatement to which the Court directs us extends
beyond fraudulent misrepresentations to at least include
fraudulent conveyances. See id.; see also id. § 871 cmt. e.
This comports with other examples of the common
understanding of "fraud." See McClellan, 217 F.3d at 893 ("No
learned inquiry into the history of fraud is necessary to establish
that [fraud] is not limited to misrepresentations and misleading
omissions."). As the leading treatise on bankruptcy explains,
"[a]ctual fraud, by definition, consists of any deceit, artifice,
trick, or design involving direct and active operation of the mind,
used to circumvent and cheat another . . . ." 4 Collier on
Bankruptcy ¶ 523.08[1][e] (A.N. Resnick & H.J. Sommer, eds., 16th
ed. 2015). This "generic term" has frequently been used to
"embrace[] all the multifarious means which human ingenuity can
devise and which are resorted to by one individual to gain an
advantage over another by false suggestions or by the suppression
of truth." McClellan, 217 F.3d at 893 (quoting Stapleton v. Holt,
250 P.2d 451, 453-54 (Okla. 1952)). And, as relevant here, "when
a debtor transfers property to a third party without adequate
- 12 -
consideration" to hinder her creditors, this "is deemed fraud on
[her] creditors." Id. at 894 (collecting cases); see also, e.g.,
R.I. UFTA, R.I. Gen. Laws § 6-16-1 et seq. (providing remedies for
fraudulent conveyances); Spaziano v. Spaziano,
410 A.2d 113, 114-
15 (R.I. 1980); Jorden v. Ball,
258 N.E.2d 736, 737 (Mass. 1970).7
We adopt this common law understanding and hold that
"actual fraud" under § 523(a)(2)(A) is not limited to fraud
effected by misrepresentation. See Field, 516 U.S. at 73-74
(applying the "established practice of finding Congress's meaning
in the generally shared common law" to § 523(a)(2)(A)). Rather,
we hold that "actual fraud" includes fraudulent conveyances that
are "intended . . . to hinder [the relevant] creditors."
McClellan, 217 F.3d at 894. Consistent with our precedents, our
holding is limited to cases of actual, as opposed to merely
constructive, fraud. See
Spigel, 260 F.3d at 32 ("[W]e have said
7
Even the early Bankruptcy Acts characterized "fraudulent
conveyances" as a form of "fraud." See, e.g., Bankruptcy Act of
1867, ch. 176, § 35, 14 Stat. 517, 534 ("[I]f such sale,
assignment, transfer, or conveyance [made to evade attachment in
bankruptcy] is not made in the usual and ordinary course of
business of the debtor, the fact shall be prima facie evidence of
fraud." (emphasis added)); Bankruptcy Act of 1898, ch. 541,
§ 29(b), 30 Stat. 544, 554 ("A person shall be punished . . . upon
conviction of the offense of having knowingly and fraudulently
. . . received any material amount of property from a bankrupt
after the filing of the petition, with the intent to defeat this
Act . . . ." (emphasis added)).
- 13 -
that the statutory language does not 'remotely suggest that
nondischargeability attaches to any claim other than one which
arises as a direct result of the debtor's [fraudulent conduct].'"
(quoting Century 21, 16 F.3d at 10));
Palmacci, 121 F.3d at 788
(emphasizing that § 523(a)(2)(A) "requires a showing of actual or
positive fraud, not merely fraud implied by law" (quoting Anastas
v. Am. Sav. Bank (In re Anastas),
94 F.3d 1280, 1286 & n.3 (9th
Cir. 1996))). That is, the debtor-transferee must herself be
"guilty of intent to defraud" and not merely be the passive
recipient of a fraudulent conveyance. See
McClellan, 217 F.3d at
894 (noting that fraud is "constructive if the only evidence of it
is the inadequacy of the consideration"). Such intent may be
inferred from her acceptance of a transfer that she knew was made
with the purpose of hindering the transferor's creditor(s), but it
may not be implied as a matter of law. See Neal v. Clark,
95 U.S.
704, 707-09 (1877) (distinguishing "actual fraud" from
"constructive fraud" which "may exist without the imputation of
bad faith or immorality").
Our reading is confirmed by the structure of the text
and the legislative history. "'[A]ctual fraud' [was] added as a
ground for exception from discharge" under § 523(a)(2)(A) in 1978.
S. Rep. No. 95-989, at 78 (1978); H.R. Rep. No. 95-595, at 364
- 14 -
(1977). That provision now "explicitly lists both 'actual fraud'
and 'false representations' as grounds for denying a discharge."
Spigel, 260 F.3d at 33 n.7. We agree with the Seventh Circuit
that this distinction must have meaning, and that the most obvious
meaning is the one that comports with common law understanding:
"actual fraud is broader than misrepresentation."
McClellan, 217
F.3d at 893.
Indeed, this is confirmed by the Legislative Statements
concerning the change, which reveal that the drafters specifically
contemplated not only a broader reading of "actual fraud," but
that debt incurred through (actually) fraudulent conveyances would
be barred from discharge under § 523(a)(2)(A). The Legislative
Statement concerning § 523(a)(2)(A) is express that the addition
"is intended to codify current case law, [like] Neal v. Clark, 95
U.S. 704 (18[7]7)." See 11 U.S.C. § 523, Legislative Statements
(explaining that § 523(a)(2)(A) is limited to "actual or positive
fraud rather than fraud implied by law"). That case, Neal v.
Clark, presumed that the Bankruptcy Code exempted from discharge
as a "debt created by . . . fraud" at least some debts incurred
through receipt of a fraudulent conveyance. See
Neal, 95 U.S. at
706-09 (holding that debt created through receipt of a fraudulent
conveyance must be actual fraud, not merely constructive fraud, to
- 15 -
bar from discharge in bankruptcy); Bankruptcy Act of 1867, ch. 176,
§ 33, 14 Stat. 517, 533; cf. id. ch. 176, § 35, 14 Stat. at 534.8
"The history of the fraud exception reinforces our
reading of § 523(a)(2)(A)." Cohen v. de la Cruz, 523 U.S. 213,
221 (1998). The bankruptcy practices at issue in Neal and codified
by § 523(a)(2)(A) concerned Section 33 of the Bankruptcy Act of
1867, which barred debts "created by . . . fraud." Bankruptcy Act
of 1867, ch. 176, § 33, 14 Stat. at 533. The Bankruptcy Act of
1898 similarly prohibited discharge of debts that "are judgments
in actions for frauds, or obtaining property by false pretenses or
false representations, or for willful and malicious injuries to
the person or property of another" under Section 17(a)(2).9
8
The Supreme Court in Neal was construing the term "fraud"
as it appeared in Section 33 of the Bankruptcy Act of 1867, ch. 176,
§ 33, 14 Stat. at 533. That provision provided in relevant part:
[N]o debt created by the fraud or embezzlement of the
bankrupt, or by his defalcation as a public officer, or
while acting in any fiduciary character, shall be
discharged under this act . . . .
Id. These various bars to discharge have been expanded upon and
now appear as enumerated exceptions.
9
Section 17(a)(4) of the Bankruptcy Act of 1898 also
prohibited discharge of debts "created by [debtor's] fraud,
embezzlement, misappropriation, or defalcation while acting as an
officer or in any fiduciary capacity." 30 Stat. at 550-51. This
appears to be the precursor to § 523(a)(4) of the modern Bankruptcy
Code, which prohibits discharge (including Chapter 13 discharge)
of debts "for fraud or defalcation while acting in a fiduciary
- 16 -
Bankruptcy Act of 1898, ch. 541, § 17(a)(2), 30 Stat. 544, 550;
Cohen, 523 U.S. at 221. Subsequent amendments retained the
"willful and malicious injuries" language until 1970, when
"willful and malicious conversion of the property of another" was
substituted. See 11 U.S.C. § 35(a)(2) (1976); Act of Oct. 19,
1970, Pub. L. No. 91-467, sec. 5-6, §§ 17(a)(2), 17(a)(8), 84 Stat.
990, 992. This substituted language preserved the breadth of the
fraud exception articulated in Section 17(a)(2), the predecessor
of § 523(a)(2)(A).10 Cf. Black's Law Dictionary 406 (10th ed.
2014) (defining "conversion" as "an act or series of acts of
willful interference, without lawful justification, with an item
of property in a manner inconsistent with another's right, whereby
that other person is deprived of the use and possession of the
property").
capacity, embezzlement, or larceny." See 11 U.S.C. §§ 523(a)(4),
1328(a)(2).
10
This "willful and malicious conversion" is distinct from
the exception to discharge now codified at § 523(a)(6) for "willful
and malicious injury by the debtor to another entity or to the
property of another entity." See 11 U.S.C. § 35(a)(8) (1976)
(barring discharge of debts that "are liabilities for willful and
malicious injuries to the person or property of another other than
conversion as excepted under clause (2) of this subdivision"
(emphasis added)).
- 17 -
We "will not read the Bankruptcy Code to erode past
bankruptcy practice absent a clear indication that Congress
intended such a departure." Cohen, 523 U.S. at 221 (internal
quotation marks and citation omitted). The alteration of this
language in 1978 "in no way signals an intention to narrow the
established scope of the fraud exception along the lines suggested
by" Ms. Lawson, nor have the parties identified anything in the
legislative history that would suggest such a change. See
id. at
221-22. Rather, "[§] 523(a)(2)(A) continues the tradition" of
"affording relief only to an 'honest but unfortunate debtor'" by
excepting from discharge any debt obtained by "'false pretenses,
a false representation, or actual fraud.'" See
id. at 217-18
(quoting Grogan v. Garner,
498 U.S. 279, 287 (1991); 11 U.S.C.
§ 523(a)(2)(A)). We hold that the fraud exception to discharge
codified at § 523(a)(2)(A) continues to bar from discharge debts
incurred through knowing and intentional receipt of fraudulent
conveyances as it has since 1867. Cf. 43 R.E. Williams, Am. Jur.
Proof of Facts § 13 (3d ed. 2015) ("[T]here is a great deal of
continuity between the former Bankruptcy Act and the 1978
Bankruptcy Code, and between common-law fraud and
- 18 -
nondischargeability under Code § 523(a)(2). Even the language of
the statute is continuous.").11
B. Declining to "Shoehorn" Fraudulent Conveyance into
§ 523(a)(6)
Ms. Lawson next argues that because her bankruptcy case
arises under the more forgiving provisions of Chapter 13, not
Chapter 7, we should avoid construing § 523(a)(2)(A) to "extend"
beyond fraud effected by misrepresentation.
Her argument, charitably read, begins with the assertion
that Ms. Lawson's alleged conduct more readily falls within the
nondischargeability provision of 11 U.S.C. § 523(a)(6).12 Cf.
McClellan, 217 F.3d at 896 (Ripple, J., concurring). Because that
provision bars discharge of any debt "for willful and malicious
11
This treatise is another example of one that appears to
assume, as many cases do, that § 523(a)(2)(A) requires a
misrepresentation. It does not directly address the distinction
between "false pretenses, [and] false representation[s]" and
"actual fraud," or discuss the McClellan standard except in
passing. See, e.g., id. § 13; but see
id. (collecting cases
following McClellan without expressly identifying the issue).
12
To the extent Ms. Lawson argues that we should read the
same provision differently depending on the type of bankruptcy
proceeding, her argument is a nonstarter. Chapter 13 provides a
broader discharge than Chapter 7 because fewer exemptions have
been made applicable, not because those that are should be
construed more narrowly. See 11 U.S.C. § 1328(a)(2) (making
§ 523(a)(2) expressly applicable as a reason to bar discharge of
certain debts in a Chapter 13 proceeding while rendering
inapplicable other reasons for denying discharge under § 523(a)).
- 19 -
injury by the debtor to another entity," 11 U.S.C. § 523(a)(6),
Ms. Lawson argues that it "provides a far more direct avenue for
dealing with a situation such as [this]" where the debtor allegedly
accepted a fraudulent conveyance specifically to impede the
injured party's attempt to collect from another. McClellan, 217
F.3d at 896 (Ripple, J., concurring). As Judge Ripple observed,
§ 523(a)(6) has been used to prevent discharge of exactly this
sort. See
id. at 898 (discussing Murray v. Bammer (In re Bammer),
131 F.3d 788 (9th Cir. 1997) (en banc)); but see
id. at 899 n.1
(conceding that the Ninth Circuit later limited its holding where
the fraudulent transferee filed for bankruptcy before the
plaintiff, who did not have a security interest, obtained a
judgment against the transferee for the transfer).
Against this backdrop, Ms. Lawson argues that the
distinction between Chapter 13 and Chapter 7 discharge provides a
reason to follow Judge Ripple's suggested construction, and to
find the alleged conduct to be covered under § 523(a)(6), not
§ 523(a)(2). This is because Chapter 13, which provides for a
broader discharge than Chapter 7, does not bar the discharge of
debts specified in § 523(a)(6), except in limited circumstances
- 20 -
not relevant here.13 See 11 U.S.C. § 1328(a)(2); United Student
Aid Funds, 559 U.S. at 268 ("[D]ischarge under Chapter 13 'is
broader than the discharge received in any other chapter.'"
(quoting 8 Collier on Bankruptcy ¶ 1328.01 (rev. 15th ed. 2008))).
This argument is foreclosed by the statutory history of
§ 523(a)(6), "the historical pedigree of the fraud exception [in
§ 523(a)(2)(A)], and the general policy underlying the exceptions
to discharge." See Cohen, 523 U.S. at 223. We begin with the
history of the proposed alternative, § 523(a)(6).
The discharge of debts for "willful and malicious
injuries to the person or property of another" was originally
included in the fraud exception of Section 17(a)(2). That changed
in 1970, when the provision that is now codified in § 523(a)(6)
was added to the statute as Section 17(a)(8). See Act of Oct. 19,
1970, sec. 5-6, §§ 17(a)(2), 17(a)(8), 84 Stat. at 992 (formerly
codified at 11 U.S.C. § 35(a)(8) (1976)).
However, that amendment did not completely remove all
"willful and malicious injuries" to a creditor's property from the
scope of the fraud exception in Section 17(a)(2). Rather, Section
17(a)(2) continued to bar discharge of liabilities "for willful
13
See 11 U.S.C. § 1328(b), (c) (providing for a hardship
discharge except for "any debt" specified in § 523(a)).
- 21 -
and malicious conversion of the property of another," like willful
and malicious receipt of a fraudulent conveyance. See Black's Law
Dictionary 406 ("[C]onversion . . . . include[s] such acts as
taking possession, refusing to give up on demand, disposing of the
goods to a third person, or destroying them." (quoting W. Geldart,
Introduction to English Law 143 (D.C.M. Yardley ed., 9th ed.
1984))); cf. Neal, 95 U.S. 704. By contrast, the new provision
that preceded § 523(a)(6) barred discharge of debts that "are
liabilities for willful and malicious injuries to the person or
property of another other than conversion as excepted under clause
(2) of this subdivision." See 11 U.S.C. § 35(a)(8) (1976)
(emphasis added).
The notes to the re-codification of these provisions
under the Bankruptcy Reform Act of 1978 do not clearly indicate an
intention to alter their relative scope with respect to the means
by which fraud may be perpetrated. "[A]ctual fraud" was added to
§ 523(a)(2)(A) expressly for the purpose, as discussed, of
"codify[ing] current case law" concerning fraud. See 11 U.S.C.
§ 523, Legislative Statements (citing Neal, 95 U.S. 704 (holding
that receipt of a fraudulent conveyance must "involv[e] . . .
intentional wrong" to be nondischargeable)). Although there is
some ambiguity about which "willful and malicious conversion[s]"
- 22 -
are subsumed under § 523(a)(6) rather than § 523(a)(2),14 there is
not "a clear indication that Congress intended . . . a departure"
that would limit the means by which fraud might be perpetrated for
purposes of § 523(a)(2)(A). See Cohen, 523 U.S. at 221-22.
Accordingly, we decline to find one. See
id. (noting that absent
such an indication, we should not "read the Bankruptcy Code to
erode past bankruptcy practice").
The continued inclusion of (actual) fraudulent
conveyance within § 523(a)(2) is consistent with Congress's
"conclu[sion] that preventing fraud is more important than letting
defrauders start over with a clean slate." McClellan, 217 F.3d at
893 (quoting Mayer v. Spanel Int'l, Ltd. (In re Mayer),
51 F.3d
670, 674 (7th Cir. 1995)); see also
Grogan, 498 U.S. at 286-87.
This is because it prevents Chapter 13, as well as Chapter 7, from
becoming "an engine for fraud" by barring from both types of
14
The Legislative Statements to § 523(a)(6) state that "[t]he
phrase 'willful and malicious injury' covers a willful and
malicious conversion." But the Legislative Statements do not
address the distinction suggested in the previous version of the
statute between those "willful and malicious conversion[s]"
excepted under the fraud exception of Section 17(a)(2) and those
excepted under Section 17(a)(8). Compare 11 U.S.C. § 35(a)(8)
(1976) (qualifying the conversions excluded from Section 17(a)(8)
as being those conversions covered by the fraud exception), with
11 U.S.C. § 523, Legislative Statements (noting that "'willful and
malicious injury' covers a willful and malicious conversion").
- 23 -
discharge debts obtained by fraudulent conveyance. See 11 U.S.C.
§ 1328; cf. McClellan, 217 F.3d at 893. Were we to hold otherwise,
and accept Ms. Lawson's argument that such conduct is covered by
§ 523(a)(6) instead of § 523(a)(2), then the perpetrators of the
"two-step routine" alleged could make "as blatant an abuse of the
Bankruptcy Code as we can imagine" simply by having the second
debtor file for Chapter 13, rather than Chapter 7, bankruptcy.
Cf.
McClellan, 217 F.3d at 893.
Chapter 13, it is true, provides a broader "fresh start"
than Chapter 7 because the debtor attempts to make good on some of
her obligations. But, as the Supreme Court has repeatedly observed
in "addressing different issues surrounding the scope of [this]
exception," we think it "unlikely that Congress . . . would have
favored the interest in giving perpetrators of fraud a fresh start
over the interest in protecting victims of fraud" provided such
perpetrators are especially clever, avoid all misrepresentations,
and file under Chapter 13. See Cohen, 523 U.S. at 223 (alteration
in original) (quoting
Grogan, 498 U.S. at 287). Far from
supporting Ms. Lawson's argument that we should read fraudulent
conveyances to be proscribed by § 523(a)(6), and not
§ 523(a)(2)(A), the distinction between Chapter 13 and Chapter 7
discharge confirms our construction.
- 24 -
C. Narrowness
Finally, there may be some concern that finding that the
Palmacci test is not the exclusive test for "actual fraud" under
§ 523(a)(2)(A) untethers the "actual fraud" requirement from a
narrow, principled approach to its construction. Cf. Blacksmith
Invs., LLC v. Woodford (In re Woodford), 403 B.R. 177, 188-89
(Bankr. D. Mass. 2009); 43 R.E. Williams Am. Jur. Proof of Facts
§ 21 (3d ed. 2015) (discussing the difficulties in applying
§ 523(a)(2)(A) to debts created by credit card fraud). The
Palmacci test provides a narrow construction with clear elements.15
If, as the Seventh Circuit suggests, "[n]o definite and invariable
rule can be laid down as a general proposition defining fraud, and
it includes all surprise, trick, cunning, dissembling, and any
unfair way by which another is cheated," then how is the fraud
exception to be narrowly construed? Cf.
McClellan, 217 F.3d at
893 (quoting
Stapleton, 250 P.2d at 453-54).
15
The Palmacci test applies the "traditional common law rule"
for fraudulent misrepresentation. See Palmacci, 121 F.3d at 786.
Under it, a creditor objecting to a debt "obtained by . . . actual
fraud" effected through a misrepresentation must show that:
1) the debtor made a knowingly false representation or
one made in reckless disregard of the truth, 2) the
debtor intended to deceive, 3) the debtor intended to
induce the creditor to rely upon the false statement, 4)
the creditor actually relied upon the misrepresentation,
- 25 -
We need not and do not decide that question today. We
hold only that the "actual fraud" exception to discharge under
§ 523(a)(2)(A) includes knowing receipt of a fraudulent conveyance
where such receipt constitutes actual (as opposed to constructive)
fraud. Cf. McClellan, 217 F.3d at 894 (emphasizing the requirement
that the transferee have intended to thwart the transferor's
creditor);
Neal, 95 U.S. at 707 (distinguishing between those cases
where receipt of fraudulent conveyance constitutes "actual fraud"
owing to recipient's intent and those where receipt is merely
"constructive fraud" as implied by law). But we make two
observations.
First, we observe that, while there are other ways to
give meaning to the distinction between "actual fraud" and "false
representations" under § 523(a)(2)(A), they are not the most narrow
available, nor are they consistent with the fraud exception's
history. Cf., e.g., Field, 516 U.S. at 70 n.8 (declining to decide
if a different type of reliance is required under "false pretense"
or "false representation"); Mayer v. Spanel Int'l, Ltd. (In re
5) the creditor's reliance was justifiable, and 6) the
reliance upon the false statement caused damage.
Spigel, 260 F.3d at 32 & n.6 (citing
Palmacci, 121 F.3d at 786;
Field, 516 U.S. at 70-71).
- 26 -
Mayer), 51 F.3d 670, 674 (7th Cir. 1995) (Easterbrook, J.)
(suggesting without deciding that "false pretense" or "false
representation" may carry a different scienter requirement);
Restatement (Second) of Torts §§ 525 et seq., 550 et seq. (1977)
(discussing related torts of fraudulent misrepresentation,
nondisclosure, negligent misrepresentation, and innocent
misrepresentation). Rather, reading "false pretenses, false
representations, and actual fraud" to be limited, roughly, to mean
"fraudulent misrepresentation and other actual frauds" would
provide the most consistent and narrow reading of § 523(a)(2)(A)
by barring from discharge only those debts that "'arise[] as a
direct result of the debtor's [fraudulent conduct].'"
Spigel, 260
F.3d at 32 (quoting Century
21, 16 F.3d at 10); cf.
Mayer, 51 F.3d
at 674 (lamenting that courts have consistently read a culpable
intent requirement into the "false pretenses" and "false
representation[s]" language of the fraud exception). We need not
decide today whether to adopt such a reading. Our point is only
that our construction, far from broadening the fraud exception,
permits the most narrow construction possible.
Second, we observe that the dangers to narrowness of
reading "actual fraud" somewhat expansively -- and the abuse by
creditors it might engender -- is protected against by the
- 27 -
provision of fees and costs to the debtor where "a creditor
requests a determination of dischargeability" under § 523(a)(2)
that is ultimately discharged and "the court finds that the
position of the creditor was not substantially justified." 11
U.S.C. § 523(d). Indeed, this is the only exception to discharge
under § 523 for which such debtor protection is afforded, and it
is afforded specifically to discourage creditors from such abuse.
See S. Rep. No. 95-989, at 80 (noting that fees are available "if
the court finds that the proceeding was frivolous or not brought
by its creditor in good faith").
III.
Finally, Ms. Lawson argues in the alternative that
Sauer's complaint fails under our newly adopted standard because
Sauer has alleged only constructive fraud. See McClellan, 217
F.3d at 894. But while our holding is emphatically limited to
cases of actual, as opposed to merely constructive, fraud, and the
heightened pleading requirements for fraud remain applicable, we
decline to reach the issue. See Fed. R. Civ. P. 9(b); Fed. R.
Bankr. P. 7009. Compare
McClellan, 217 F.3d at 894 (noting that
fraud is "constructive if the only evidence of it is the inadequacy
of the consideration"), with Bell Atl. Corp. v. Twombly,
550 U.S.
544, 556 (2007) (requiring under notice pleading standards factual
- 28 -
allegations "suggestive enough" to make a claim for "conspiracy
plausible"). Cf. N. Am. Catholic Educ., 567 F.3d at 16 (refusing
"to assume that no amendment could rescue certain of the claims").
The bankruptcy court and the parties proceeded on the
apparent understanding that the principal obstacle to Sauer's suit
was Sauer's inability to plead misrepresentation.16 Accordingly,
we leave the issues of the adequacy of Sauer's pleading, and the
possibility of amendment, to the bankruptcy court in the first
instance. See N. Am. Catholic Educ., 567 F.3d at 16 ("For
deficiencies under Rule 9(b), leave to amend is often given, at
least for plausible claims."); see also New Eng. Data Servs., Inc.
v. Becher, 829 F.2d 286, 292 (1st Cir. 1987) (noting that the
policy behind Rule 9(b) -- avoiding groundless claims, damage to
a defendant's reputation, and ensuring notice -- must be balanced
against "the policy in favor of allowing amendments and trying
cases on their merits, and against dismissals which would deny
plaintiffs their day in court"); cf. 11 U.S.C. § 523(d) (awarding
costs and attorneys' fees for unsuccessful adversary proceedings
under § 523(a)(2)(A) that are frivolous or brought in bad faith).
16
Ms. Lawson does not appear to have pressed the adequacy
argument before the bankruptcy court, focusing her energies
instead on the failure to allege a misrepresentation under the
Palmacci standard.
- 29 -
Accordingly, we vacate the bankruptcy court's grant of
Ms. Lawson's motion to dismiss, and remand for further proceedings
consistent with this opinion. No costs are awarded.
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