Revised February 6, 2001
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 99-60904
In the Matter of:
M.M. WINKLER & ASSOCIATES, BILL MORGAN, AND OKEE MCDONALD,
Debtors.
BRUNO DEODATI,
Appellant,
v.
M.M. WINKLER & ASSOCIATES, BILL MORGAN, AND OKEE MCDONALD,
Appellees.
Appeal from the United States District Court for the
Northern District of Mississippi
February 1, 2001
Before JOLLY, JONES and SMITH, Circuit Judges.
EDITH H. JONES, Circuit Judge:
At issue is whether a debtor whose partner committed
fraud may discharge in bankruptcy the liability to the fraud
victim. The bankruptcy and district courts held that 11 U.S.C. §
523(a)(2)(A) does not bar innocent partners from discharging fraud
liability unless 1) they benefitted from the fraud; and 2) the
perpetrator of the fraud acted in the ordinary course of
partnership business. Fraud victim Bruno Deodati (“Deodati”)
appeals. We reverse and remand for entry of judgment in favor of
appellant.
FACTS
The facts of this case are undisputed. Bill Morgan, Okee
McDonald, and Patsy McCreight formed the Mississippi accounting
partnership M.M. Winkler and Associates (“Partnership”). Deodati
became a client of McCreight. Only McCreight worked on Deodati’s
file.
Deodati authorized the Partnership to buy and sell
certificates of deposit on his behalf. McCreight used the
authorization to place Deodati’s money in her personal bank
account. She generated fictitious income statements to conceal the
fraud. Morgan and McDonald (“the Innocent Partners”) were unaware
of the fraud and did not receive any of the stolen money
individually or through the Partnership.
The Partnership did receive roughly $3,500 from Deodati
for “accounting services rendered.” These services were related to
certificate of deposit transactions and inflated tax returns that
McCreight filed for Deodati.
Morgan discovered the fraud and reported it to Deodati.
Deodati filed suit in state court. In their answer, the Innocent
Partners admitted to the vicarious liability imposed by law.
Deodati filed an unopposed motion for partial summary judgment.
The court granted the motion and imposed joint and several
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liability against the Partnership and the individual partners for
over $ 290,000. The $3,500 in accounting services was not part of
this judgment. The Innocent Partners filed for bankruptcy under
Chapter 7, and Deodati sought to prevent them from discharging this
debt because it arose from fraud.
Citing Luce v. First Equip. Leasing Corp. (In re Luce),
960 F.2d 1277, 1283 (5th Cir. 1992), the bankruptcy court applied
a three-part test to determine whether the debt was
nondischargeable under § 523(a)(2)(A), (4), and (6). It looked to
1) whether the Innocent Partners were partners with McCreight; 2)
whether McCreight acted in the ordinary course of business of the
Partnership; and 3) whether the Innocent Partners received a
benefit from the fraud. The court, finding that Deodati failed to
establish the second and third elements, permitted the Innocent
Partners to discharge the debt. The district court affirmed.
DISCUSSION
Deodati first argues that § 523(a)(2)(A) of the
Bankruptcy Code bars the Innocent Partners from discharging the
debt even if they did not benefit monetarily from the fraud. We
agree.
Section 523 lists “Exceptions to discharge.” It states:
(a) A discharge . . . does not discharge an individual
debtor from any debt– . . .
(2) for money, property, services, or an extension,
renewal, or refinancing of credit, to the extent
obtained by–
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(A) false pretenses, a false representation,
or actual fraud, other than a statement
respecting the debtor’s or an insider’s
financial condition.
The language of the statute includes no “receipt of
benefit” requirement. The statute focuses on the character of the
debt, not the culpability of the debtor or whether the debtor
benefitted from the fraud. See Lawrence Ponoroff, Vicarious
Thrills: The Case for Application of Agency Rules in Bankruptcy
Dischargeability Litigation, 70 Tul. L. Rev. 2515, 2542 (1996)
(arguing that § 523(a)(2) makes all debts that are the product of
fraud nondischargeable). Thus, the plain meaning of the statute is
that debtors cannot discharge any debts that arise from fraud so
long as they are liable to the creditor for the fraud.
The Supreme Court did not require receipt of benefits in
a similar case. See Strang v. Bradner, 114 U.S. 555, 561 (1885).
The bankruptcy statute at the time barred discharge for a “debt
created by the fraud or embezzlement of the bankrupt.” See id. at
556. The Court stated that each partner was the agent and
representative of the firm, and it imputed fraud by one partner to
the innocent partners. See id. at 561. It stated, “[t]his is
especially so when, as in the case before us, the [innocent
partners] received and appropriated the fruits of the fraudulent
conduct of their associate in business.” See id. The Court barred
the innocent partners from discharging the debt in bankruptcy. See
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id. Strang thus indicates that benefit to an innocent partner is
an aggravating factor and not a requirement to impute
nondischargeable fraud liability.
Strang is still good law. In recent years, this circuit
and others have relied on it to bar discharge on behalf of innocent
debtors for a partner’s fraud. See BancBoston Mortgage Corp. v.
Ledford (In re: Ledford), 970 F.2d 1556, 1561 (6th Cir. 1992) (no
dischargeability where debtor benefitted from partner’s fraud);
Luce, 960 F.2d at 1282. Section 523(a)(2)(A) applies even more
directly to innocent partners than the statute in Strang, since now
the “bankrupt” need not perpetrate the fraud.
A more recent Supreme Court case also suggests that
receipt of benefits is irrelevant to whether innocent debtors may
discharge fraud liability. In Cohen v. de la Cruz, the Court held
that § 523(a)(2)(A) prevents debtors from discharging statutory and
punitive fraud damages. See Cohen v. de la Cruz, 523 U.S. 213, 220
(1998). The Court rejected a fraud perpetrator’s contention that
he could discharge any liability above the amount he received. See
id. at 222. It held that “[o]nce it is established that specific
money or property has been obtained by fraud . . . ‘any debt’
arising therefrom is excepted from discharge.” Id. at 218-19. It
relied on a “straightforward reading” of the statute and on
legislative intent to make fraud victims whole. See id. at 217-
220. Cohen indicates that whether the debt arises from fraud is
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the only consideration material to nondischargeability. It also
indicates that we should not read requirements like receipt of
benefits into § 523(a)(2)(A) and that the discharge exceptions
protect fraud victims rather than debtors.
This court’s decision in Luce v. First Equip. Leasing
Corp. (In re Luce), 960 F.2d 1277, 1283 (5th Cir. 1992), is not
necessarily inconsistent with Cohen and, in any event, is
superseded by Cohen to the extent of any inconsistency. In Luce,
a debtor tried to discharge imputed fraud liability because she was
unaware of her partner/husband’s fraud. Relying principally on the
imputed partnership liability discussion in Strang, the court held
that Mrs. Luce was responsible under § 523(a)(2)(A) regardless of
her knowledge or involvement. See Luce, 960 F.2d at 1282.
Mrs. Luce also argued that the discharge exception did
not apply because she never actually obtained money for herself by
fraud. See id. at 1283. The court stated,
[t]he test under section 523(a)(2)(A), however, is not
whether the debtor actually procured the money, property,
services or credit for him or herself. 3 Collier on
Bankruptcy § 523.08[1] (15th ed. 1991). Rather, the Code
dictates that a particular debt is nondischargeable ‘[i]f
the debtor benefits in some way” from the money,
property, services or credit obtained through deception.’
Century First Nat’l Bank v. Holwerda (in re Holwerda), 29
B.R. 486, 489 (Bankr. M.D. Fla. 1983) (holding that
debtor who was a principal of a corporation “‘obtained
money” within the meaning of § 523(a)(2)’” when the
creditor approved a loan to the corporation).
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Id. The court then rejected this argument because Mrs. Luce shared
in the fraud proceeds through the Luce partnership.
The court was not creating a receipt of benefit test.
There was no question that Mrs. Luce had indirectly benefitted
through the partnership. Mrs. Luce was making the distinct
argument that she could discharge the debt unless she directly
obtained money for herself through fraud. See Holwerda, 29 B.R. at
489 (discussing a line of cases that supports this view, but
ultimately rejecting the argument). The court rejected Mrs. Luce’s
argument by observing that even an indirect benefit is sufficient.
It cited Holwerda and Collier § 523.08[1], which reject
distinctions between direct and indirect benefits. See Holwerda,
29 B.R. at 489; 4 Collier on Bankruptcy § 523.08[1] (rev. 15th ed.
2000). In Holwerda, for instance, the debtor who was a corporate
principal “obtained money” within § 523(a)(2) when the creditor
lent money to the corporation.
While Luce does not discuss pure imputed liability among
partners, its finding of an indirect benefit is consistent with a
recognition that a partnership that actually benefits from a fraud
inherently benefits its members. As in Strang, the presence of
some personal, albeit indirect benefit supplemented but was not a
precondition for Mrs. Luce’s imputed partnership liability.
Luce, therefore, stands at least for the proposition that
where a partner’s fraud benefits the partnership, all other
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partners necessarily receive a benefit from the fraud. To the
extent that Luce does not specifically hold that a partner is
deemed to benefit even absent a showing of actual benefit to the
partnership, that gap is amply filled by the Supreme Court’s
superseding decision in Cohen.
The Sixth Circuit has nonetheless interpreted Luce to
establish a receipt of benefit test. In BancBoston Mortgage Corp.
v. Ledford (In re Ledford), 970 F.2d 1556, 1561 (6th Cir. 1992), an
innocent partner received fraud proceeds through a partnership and
sought to discharge liability. The court understood Luce to bar
innocent debtors from discharging imputed fraud debts when: 1) the
debtor and perpetrator of the fraud are partners; 2) the
perpetrator acts in the ordinary course of partnership business;
and 3) the innocent debtor receives a benefit from the fraud. It
“adopted” this analysis, and held that § 523(a)(2)(A) prevented the
innocent partner from discharging the debt because he received a
benefit. See id. at 1561.
The Eleventh Circuit has also cited receipt of benefits
in a case that did not involve imputed partnership liability. The
debtor perpetrated the fraud but did not directly benefit from it.
The court barred dischargeability of the debt because the debtor
indirectly benefitted from the fraud. See HSSM # 7 Ltd.
Partnership v. Bilzerian (In re Bilzerian), 100 F.3d 890, 891 (11th
Cir. 1996); see also In re Ashley, 903 F.2d 599, 604 (9th Cir.
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1990) (holding that a non-partner benefitted indirectly from his
fraud in a case that preceded Luce). Like the benefits passage in
Luce, these cases reject the idea that a perpetrator of fraud can
discharge liability unless she directly benefits from it.
Ledford and Bilzerian may be distinguishable because
those debtors did benefit from fraud, and Bilzerian did not involve
a partnership. To that extent, both cases were narrowly written
and simply did not decide whether innocent debtors who did not
benefit monetarily from fraud might discharge imputed partnership
liability.
Confronted with this precise question, we hold that
§523(a)(2)(A) prevents an innocent debtor from discharging
liability for the fraud of his partners, regardless whether he
receives a monetary benefit. A rational legislator might conclude
that an innocent debtor should be able to discharge debts in these
situations, but § 523(a)(2)(A) does not permit this. The plain
meaning of the statute, fortified by the Supreme Court’s decisions
in Strang and Cohen, argues against a receipt of benefit
requirement. We have no warrant to add elements to bankruptcy
statutes. See Toibb v. Radloff, 501 U.S. 157, 166 (1991) (relying
on plain meaning to reject an implicit “ongoing business”
requirement for Chapter 11 debtors even though the structure and
legislative history of the statute suggested one).
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For similar reasons, the bankruptcy court erred in adding
an “ordinary course of business” requirement in § 523(a)(2)(A)
imputed partnership liability cases.1 Mississippi law requires
this element to impute fraud to partners, see Miss. Code Ann. § 79-
12-27, but the element is not part of § 523(a)(2)(A). The
Bankruptcy Code gives no indication that the debt must arise in the
ordinary course of business.
Nor did Luce create such a requirement. No existing
state court judgment in that case established the debt, so the
bankruptcy court made its own fact findings. See Luce, 960 F.2d at
1280. It found that Mrs. Luce’s partner acted in the course of
business as a basis for imputed liability. Mrs. Luce argued that
this finding of fact was clearly erroneous, and the court responded
by observing that her partner did act in the course of business.
See id. at 1282-83. The court was refuting Mrs. Luce’s factual
argument, not adding an element to § 523(a)(2)(A).
Finally, it is worth noting the limits of the maxim that
exceptions to dischargeability are to be construed narrowly in
favor of the debtor. See Fezler v. Davis, 194 F.3d 570, 573 (5th
Cir. 1999) (describing the maxim). This maxim cannot overcome the
plain language Congress used to define exceptions from
dischargeability. In § 523(a)(2)(A), Congress chose, as Cohen
1
Strang mentions “in the conduct of partnership business” in its
discussion of imputed liability, not its discussion of bankruptcy discharge. See
Strang, 114 U.S. at 561.
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says, to protect victims of fraud. Further, Congress’s choice of
words effectuates important state law policies regarding imputed
liability. Discharging the debts of the Innocent Partners under
these circumstances would undermine that principle. Like many
states, Mississippi “requires that one partner make good for
another partner’s misappropriation of money or property while in
the custody of the partnership.” Duggins v. Guardianship of
Maurice Kendall, 632 So. 2d 420, 427 (Miss. 1993). States premise
these laws on the notion that partners can best foresee and control
the conduct of their agents. See Lawrence Ponoroff, Vicarious
Thrills: The Case for Application of Agency Rules in Bankruptcy
Dischargeability Litigation, 70 Tul. L. Rev. 2515, 2542 (1996).
Creditors are entitled to rely on the assets of the Innocent
Partners “as a hedge against the perfidy of the agent with whom the
creditor deals.” See id. at 2549. This system of risk allocation
and cost internalization would be subverted by allowing the
Innocent Partners to discharge their fraud liability.
We conclude that if a debt arises from fraud and the
debtor is liable for that debt under state partnership law, the
debt is nondischargeable under § 523(a)(2)(A). Receipt of benefits
and the ordinary course of business are irrelevant to this inquiry
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as matters of federal law. The bankruptcy court erred by requiring
these elements in this case.2
Because of the effect of the state court judgment, there
is no question that the debt to Deodati arose from fraud and that
the Innocent Partners are liable. Section 523(a)(2)(A) prevents
them from discharging this debt. We need not address Deodati’s
§ 523(a)(4) and (6) arguments. We REVERSE and REMAND for entry of
judgment in Deodati’s favor consistent with this opinion.
REVERSED and REMANDED with Instructions.
2
To the extent that Ledford relies on Luce to create a three-part test
for imputed partnership liability under § 523(a)(2)(A), we cordially disagree
with its interpretation.
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