Bankruptcy Does Not Shield a Spouse from Debt Fraudulently Accrued by their Partner

Earlier this year, the United States Supreme Court unanimously ruled that a woman in California can’t use bankruptcy to dodge her husband’s fraudulent debts.

The Bartenwerfer v. Buckley ruling is significant because the woman was innocent and unaware of her husband’s fraud. However, the court assigned the husband’s deceptive intent to the wife because the two had entered a business partnership.

This set a clear legal precedent: that the fraudulent activities of one individual in a partnership can taint their innocent partner.

A Clash of Competing Canons 

The U.S. treated bankruptcy as a crime for half of its history. The tide turned in the late 1800s when the Supreme Court decided debtors’ prisons were unjust. Since 1915, the high court has maintained that bankruptcy should “relieve the honest debtor from the weight of oppressive indebtedness.” (Local Loan Co. v. Hunt, U.S., 1934)

But … what about relief for the creditor? More specifically: what about relief for the creditor that has won a judgment against a debtor who defrauded them? After all, debt incurred by fraud is not dischargeable in bankruptcy.

Under 11 United States Code § 523(a)(2), debts resulting from deceptive practice cannot be discharged in bankruptcy. Such practices include:

• false pretenses
• false representations
• actual fraud
• materially false written statements

The question before the court in late 2022 was: is the innocent partner in a fraudulent business scheme an “honest debtor” or a co-conspirator?

Case Background: Bartenwerfer v. Buckley 

David and Kate Bartenwerfer formed a partnership to flip real estate for profit. They bought a property together, and then David handled its renovation and sale. David soon found a buyer, Kieran Buckley.

Both Bartenwerfers signed the mandatory disclosure statement asserting that all leaks and defects on the property had been repaired. However, David had deceived both his wife/business partner and the buyer.

Buckley discovered multiple problems with the property, such as a leaking ceiling, defective windows, and no fire escape. He sued the Bartenwerfers and was awarded a $200,000 judgment against them.

Bartenwerfers File Chapter 7 

Kate and her husband filed for bankruptcy. The court initially ruled that Kate’s debt was dischargeable, as she’d been unaware of her spouse’s fraud. However, the Ninth Circuit later reversed this decision, holding her liable as a business partner despite her innocence.

The Bartenwerfers appealed to the U.S. Supreme Court.

Nine to Zero 

Can an unaware individual be held liable for their business partner’s fraud? The question merited a hearing in the nation’s highest court. The answer was surprisingly decisive: Bankruptcy cannot erase fraudulently incurred debts, regardless of one’s personal involvement in the deception.

Associate justices Amy Coney Barrett and Sonia Sotamayor both supported the ruling. Barrett wrote that, while Kate didn’t know about her husband’s dishonesty, she still “received and appropriated the fruits of (David’s) fraudulent conduct.”

Sotomayor concurred, adding, “Because petitioner does not dispute that she and her husband acted as partners, the debt is not dischargeable under the statute.”

• Bartenwerfer v. Buckley (U.S., Feb. 22, 2023)

What the Decision Means for You 

The ruling should be a warning to those in agency or partnership relationships: if one member of your agency or partnership is found liable for fraud, you are liable by association. Bankruptcy discharge of any resulting monetary judgment will not be possible.

Therefore, you should know some ways to insulate or protect yourself from possible liability just in case.

Protection Against Fraud Debt 

Trust, but verify. If you’re going into business with someone, know who you’re dealing with. Remember, even if you’re married to the potential business partner, he or she can still deceive you.

The Supreme Court offered more advice, such as:

• if you’re an employer, you are not liable for an associate’s fraud if you can prove their deception was committed outside the scope of their employment.
• in a partnership, you can avoid liability if you prove your partner acted beyond your authority and outside the normal course of business.
• organize as a limited liability entity or LLC to insulate yourself from exposure to debts incurred by the business.

Relief for Fraud Victims

Fraudulent debts were already non-dischargeable in bankruptcy. However, allowing one partner — innocent or not — to discharge a partnership debt judgment halves the victim’s rights to relief.

The recent SCOTUS decision improves the odds that fraud victims will receive the compensation to which they’re entitled.

Justice Barrett, expressing sympathy for Kate Bartenwerfer, acknowledged that an honest debtor deserves relief in most situations. However, “No statute pursues a single policy at all costs.”

Do You Need a Lawyer?

Does this recent U.S. Supreme Court ruling have you wondering if you should protect yourself? If you’re a recent victim of fraud, or worse, the innocent partner to a con artist, don’t wait for the other shoe to drop. Call (303) 688-0944 for a case assessment.