No Discharge for “Fraud in the Passive Voice” by Thomas A. Gugliotti
Why You Should Have Paid More Attention to Your Elementary School Grammar Lessons: No Discharge for “Fraud in the Passive Voice”
Thinking way back to your elementary school years, maybe even your high school days, you probably recall wondering what use you would ever get out of learning the difference between “active and passive voice” in a sentence! An understanding of this grammatical nuance may be helpful in understanding how to interpret 11 U.S.C. 523(a)(2)(A), which section identifies certain exceptions to the discharge otherwise available to a debtor in a bankruptcy proceeding. The common understanding of this grammatical difference is that in the “active voice”, the focus of a sentence is on the “doer”, whereas in the “passive voice”, the focus is on the target or subject of the action identified by the verb in the sentence. (Are you brought back to Middle School yet!) The focus of the exception to discharge statute therefore is on the act of fraud having been found, not on who exactly perpetrated the fraud.
A new United States Supreme Court decision interpreting that section of the Bankruptcy Code addresses that grammatical question. Having paid attention to that early- learning grammar lesson makes reading the new Supreme Court decision in the case of Bartenwerfer v. Buckley (decided February 22, 2023) a bit easier. The Court in the Bartenwerfer decision sums up the grammatical lesson by stating “Passive voice pulls the actor off the stage.” That statement reflects what the Court saw as the intent of Congress to frame the focus of the fraud and discharge analysis on the event, the “act”, and not on who was the actor. As stated in the decision, “The debt must result from someone’s fraud, but Congress was ‘agnostic’ about who committed it.”
The basic facts in this “fraud discharge case” are that husband (H) and wife (W) worked together to renovate and sell a house. Though not married at the time, they were working together on the project, and subsequently, before their joint bankruptcy petition was filed, they did tie the knot.
It seems that H did not fully disclose all the facts regarding the property to the eventual buyer, as required under California law. According to the decision, W “. . . was largely uninvolved. . . ” in the hands-on activity of the pre-sale renovation project and representations made to the buyer. However, the Supreme Court accepted the lower court’s finding that H & W (even before their marriage) acted “. . . as business partners. . . ”
After being found liable to the buyer in a state court proceeding for damages based upon fraudulent representations regarding the condition of the property, H and W filed a joint Chapter 7 bankruptcy petition, in which H & W sought to have the debt discharged. The plaintiff in the state court proceeding commenced an adversary proceeding against both, objecting to the discharge of the debt that resulted from the fraud and judgment. In responding to that adversary proceeding, W claimed that since she was not an active participant in the fraudulent misrepresentations made by H in the sale of the property, the debt due to the buyer (Plaintiff) based upon the fraud judgment should be dischargeable as to her. The Bankruptcy Court held that neither H nor W were entitled to a discharge of the debt based upon the judgment of fraud rendered by the state court.
After the case went up and down the appellate court elevator, it landed before the United States Supreme Court and was argued on December 6, 2022. The issues considered by the Court pertained only as to W, since in the proceedings in the lower courts, H did not contest that he was not entitled to a discharge on the debt which resulted from his fraud.
In a unanimous decision written by Justice Barrett and decided on February 22, 2023, the Court held that W was not entitled to a discharge of the fraud debt owed to the buyer, even though she did not “actively” perpetrate the fraud. The Court based its decision on the fact that W was in effect the business partner of H, there was fraud in the sale transaction, and so W was liable for the actions of the enterprise and not entitled to escape liability. W argued that since she did not actively participate in the property renovation and subsequent fraudulent representations, she should have been entitled to a discharge of the subject debt.
The Court’s decision “. . . rests on basic tenets of grammar. . . ” That basic tenet of grammar is the distinction between the relevant bankruptcy statute’s (11 U.S.C. §523(a)(2)(A)) use of “passive” vs. “active voice” when describing liability for fraud and any exceptions thereto. The statute, the Court observed, does not rest upon a specific identification of the “fraudulent actor” (which would have displayed an “active voice”). The Court wrote that “. . . passive voice pulls the actor [issue] off the stage.” Instead, the totality of the decision shows that once a fraud is demonstrated by an enterprise, those who are in concert with the “actor” are equally culpable, even if not “on the stage”. The statute says that an individual is not entitled to a discharge of a debt incurred by fraud and does not limit that exclusion to a fraud actually perpetrated by that individual debtor. That would have required the statute to have been worded in the “active voice” – so that the statute would have had to specifically refer to the fraud having been directly committed by that debtor (“active voice”). Instead, in this case, a fraud was indeed committed – by someone – with whom the debtor, W, had a principal-agent relationship. Thus, the language of the statute focuses on the “act”, not the “actors”. Passive voice.
As explained in the decision, a “principal” is liable for the fraud of its “agent”. Also, one “partner” is liable for the fraud of the “other partner.” To paraphrase the decision and the statute, “a non-active debtor (here, W) is not entitled to a discharge of liability for a debt incurred by fraud, because the statute does not focus on “fraud specifically committed by the debtor.” If there was a fraud, and the debtor (W) was part of the business enterprise, that debtor is subject to the non-dischargeable nature of the fraudulent debt as provided in Section 523(a)(2(A). If the debtor was involved in the enterprise, it matters not that the subject debtor was not “actively” involved in the fraud. Active vs. Passive voice.
Justice Sotomayer, joined by Justice Jackson, wrote a concurring opinion, the point of which is to stake out the proposition that this decision applies only to parties who are together involved in the enterprise, and not to parties who have no “partnership” or similar relationship. So, if in this case W had in no way participated with H in the renovation of the house, it is quite likely that W would have been entitled to a discharge of the debt that was otherwise based upon the trial court’s finding of fraud in the sale, which fraud emanated only from the actions of H.
The bottom line of this Supreme Court decision is that it will be more difficult for people acting “in concert” in some fashion, to escape liability for fraud that emanates from the “enterprise”. The Sergeant Schultz defense of “I know nothing” will not be availing.
This case not only further illuminates the limitations of the exceptions to discharge under the Bankruptcy Code, but also the importance of a good foundation in basic grammar. Now, anyone care to “diagram” the previous sentence!
Attorney Gugliotti is a senior principal of Updike, Kelly & Spellacy. He is the past Chair of the Firm’s Creditor’ Rights Practice, former President of the Hartford County Bar Association and has served as Chair of the Connecticut Bar Association’s Commercial Law & Bankruptcy Section.