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BAP Finding Affirms that a Spouse does Not need to be Directly Engaged in Fraud to have their Bankruptcy Discharge denied if the Fraudulent Conduct of the other Spouse can be Imputed to them

In In re: John Shart and Elke Gordon Shardt, an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that chapter 7 co-debtor’s spouse did not directly engage in fraudulent conduct, but remanded the action back to bankruptcy court for consideration and findings as to whether the co-debtor spouse had a partnership or agency relationship with her co-debtor husband such that his fraudulent behavior should be imputed to her for purposes of exception to discharge under §523(a)(2)(4).

Factual Background and Procedural History

Husband entered into various real and personal property transactions with creditors with whom the husband had a personal and business relationship. Creditors sued husband, his wife, and husband’s business in state court.

Husband and wife then filed a chapter 11 bankruptcy, which was converted to a chapter 7 bankruptcy. Creditors filed an adversary proceeding against the husband and wife debtors alleging the debtors: a) made misrepresentations to creditors with the intent to deceive them, b) had engaged in fraud or defalcations as fiduciaries, and c) willfully, maliciously and intentionally injured the creditors and converted their property. The creditors argued that the resulting debt should therefore be excepted from discharge under §523(a)(2)(A), §523(a)(4) and §523 (a)(6). Debtors filed an answer denying the allegations.

The bankruptcy court entered a judgment in favor of creditors against husband and declared that creditors’ claims against wife were discharged. A timely appeal was filed by creditors on September 27, 2012, challenging the part of the judgment holding that the claims against wife were not excepted from discharge.

Holding and Analysis

The BAP reviewed the bankruptcy court’s factual findings for clear error and found that the bankruptcy court did not err in concluding that creditors had not established the elements required for exception to discharge under §523(a)(2)(A) and affirmed the bankruptcy court’s finding that wife did not directly engage in any fraud.

However, with respect to whether husband’s liability could be imputed to wife, the BAP found that the bankruptcy court had made inadequate findings to support its decision not to impute liability to wife for the fraud of her husband. The BAP therefore vacated that portion of the judgment and remanded to the bankruptcy court to make the necessary findings.

The bankruptcy court received substantial briefing on the BAP’s published decision in Tsurukawa v. Nikon Precision, Inc. (In re Tsurukawa), 287 B.R. 515 (9th Cir. BAP 2002) (Tsurukawa II), in which it held that “even in the absence of any direct fraud, imputation of liability was possible in a §523(a)(2)(A) proceeding where the court finds a partnership or agency relationship existed between the spouses.” The BAP found it “problematic” that the bankruptcy court made no finding to support its conclusion that imputation was not appropriate when creditors introduced evidence that could provide a basis for imputing liability. The BAP concluded that the bankruptcy court had not made sufficient findings of fact.

The court in Tsurukawa I held that “a marital union alone, without a finding of a partnership or other agency relationship between spouses, cannot serve as a basis for imputing fraud from one spouse to the other.” The BAP also held that “[i]n a §523(a)(2)(A) action, one spouse’s fraud may be imputed to the other spouse under agency principles when, as in this case, they are also business partners.” Circuits outside the Ninth Circuit have also adopted the BAP’s position in Tsurukawa II that fraud may be imputed to a spouse under partnership and agency principles in a §523(a)(2)(A) action. Whether an agency or partnership relationship exists is a question of fact to be decided under state law.

In California, a partnership is defined as “an association of two or more persons to carry on as co-owners of a business for profit.” In determining whether a partnership exists, California courts consider factors such as whether the persons intended to share in profits, losses and management and control of the enterprise. In this case, the BAP found that there was evidence showing that wife did more than just reap the financial benefits of husband’s actions. The BAP noted that there appeared to be evidence that wife may have, among other things, prepared and mailed allegedly fraudulent accounting statements; maintained one bank account and check register for husband’s business and assisted in preparation of tax returns; reviewed and edited husband’s responses to billing disputes; directed the bookkeeper to ignore creditor’s complaints about bills; provided advice to husband in negotiations with creditor; prepared some of the bills that were sent to creditor; and signed letters on husband’s business letterhead relating to husband’s business matters. The BAP noted that the bankruptcy court may have considered this evidence and discounted it in order to come to its conclusion that liability could not be imputed, but that from the record before it, they simply did not know.

The BAP therefore vacated the portion of the judgment that found that wife’s debts to creditors were discharged and remanded the matter back to bankruptcy court for it to consider and make factual findings as to whether wife was involved in a partnership and whether an agency relationship existed with her husband such that his liability should be imputed to her for the purpose of exception to discharge under §523(a)(2)(A) as set forth in Tsurukawa I and Tsurukawa II.

Commentary

This case is a good reminder that facts make or break a case. Spouses often times help one another where one or both spouses have their own business. It is important to remember that the liability of one spouse may be imputed to the other spouse based on their conduct and actions, regardless of whether or not that spouse intended to create an agency or partnership relationship.