Fifth Circuit Runs Completely Off the Rails in Husky Int’l v. Ritz?...

The question presented to the Supreme Court in Husky Int’l v. Ritz is so bizarre, I just had to dig deeper. The question is whether the exception to discharge in section 523(a)(2)(A) for debts arising from “actual fraud” requires a showing that the debtor’s fraud involved a false representation. Note immediately that section 523(a)(2)(A) excepts from discharge debts arising from “false pretenses, a false representation, OR actual fraud” (emphasis added). This seems like such a simple statutory interpretation exercise (do you see the “OR” sitting there?!), I figured I must be missing something in thinking that the whole dispute is one step shy of contrived. After looking more closely, I still think the Fifth Circuit has run completely off the rails with this one … unless I’m totally missing something here. I’d be grateful if anyone can disabuse me of my ignorance; otherwise, it seems the Supreme Court must have granted certiorari simply to fix an obvious and egregious error that no one but the Supreme Court can fix.

The relevant rules of construction seem largely undisputed: In Field v. Mans, the Supreme Court said we should interpret “actual fraud” in section 523(a)(2)(A) in light of the common law of torts circa 1978, when the Bankruptcy Code was adopted. That common law is reflected in the Restatement (2d) of Torts, so the relevant rules are there. The Fifth Circuit in Ritz read the Supreme Court’s analysis of the Restatement in Field as suggesting that “actual fraud” requires a false representation. Setting aside the fact that Field was a false representation case, so of course that’s where the Court’s focus would be in that case, the Fifth Circuit in Ritz asserted that the Restatement “indicate[s] that a representation is a necessary prerequisite” to actual fraud. Slip Op. at 9 (citing Restatement (2d) Torts section 537).

Um … no, it does not do any such thing. Though the Fifth Circuit in a footnote criticized Husky’s lawyers for failing to point to any other provision of the Restatement that might indicate that any other conduct could constitute common law fraud, Slip Op. at 10 n. 9, there is, of course, exactly such a provision. The crazy thing is that Husky’s lawyers never rose to the challenge of finding this provision, even in their Supreme Court brief.

Only in the amicus brief submitted by several bankruptcy law professors (go, team!!) do we learn, finally, that Restatement (2d) Torts section 871 quite clearly and explicitly identifies fraud not involving false representation, but conduct (see pp. 17-18). Comment e to section 871 is entitled “Fraud” and describes exactly how intentional (that is, actual) fraud might be perpetrated without a representation: intentionally false or misleading conduct. That comment goes on to describe exactly the type of “actual fraud” that occurred in Ritz, a fraudulent transfer scheme! The comment also cross-references the earlier sections on misrepresentation (cited by the Supreme Court in Field and the Fifth Circuit in Ritz), which are therefore obviously not the exclusive form of common law intentional (actual) fraud, but simply one example of it.

How could this oversight have brought this crazy dispute all the way to the Supreme Court? Granted, the Restatement (2d) contains no division or chapter entitled “Fraud” that would neatly bring together all forms of “actual fraud.” And granted, section 871 is buried in a later division called “Miscellaneous Rules” and a chapter vaguely entitled “Rules Applicable to Certain Types of Conduct.” And further granted, the language of section 871 is very vague and general. But the comments make it eminently clear that the dispute in Ritz simply has no foundation: The Fifth Circuit, with no help from Husky's lawyers, just absolutely and embarrassingly got it wrong. I’m just dumbfounded that Husky’s lawyers never offered the correct citation, even to the Supreme Court after the Fifth Circuit prompted them to offer it. Maybe we lay this at the feet of the drafters of the Restatement, who don’t put the relevant rules in easy-to-find black-letter sections, but in the comments, which they say “catalogue [the] methods by which intended torts against property interests may be committed.”

So readers, what am I missing? How did Husky’s lawyers drop the ball so badly here? And how did the Fifth Circuit run so far off the rails—do the law clerks not check these things? Can no one read the Restatement properly? What is going on here?

As an aside, the circuit court opinion that stands for the opposite (and correct) interpretation of “actual fraud” in section 523(a)(2)(A) comes from the Seventh Circuit … written by Posner, no less (McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000)). We’ve seen this time and again: Go up against the 7th Circuit (especially Posner) in a circuit split on statutory interpretation in the Supreme Court, and expect to lose. That must be the inevitable result in Husky Int’l v. Ritz.

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