A central purpose of bankruptcy is to grant debtors a fresh start – in bankruptcy terms, a “discharge” of existing debts.  But not all debts are dischargeable.  Bankruptcy Code § 523(a)(2)(A), for example, prevents the discharge of debts resulting from “false pretenses, a false representation, or actual fraud . . . .”  What if a principal incurs a large debt based not on his own fraud, but on the fraud of his agent?  Is that debt dischargeable?  That was the question addressed recently by the Ninth Circuit Bankruptcy Appellate Panel inIn re Huh, BAP No. CC-12-1633, 2014 WL 936803 (9th Cir. B.A.P. March 11, 2014). Download In re Huh 2014 WL 936803 9th Cir BAP 2014.

Benjamin Huh was a real estate broker who ran a real estate and business brokerage business as a sole proprietor.  He hired an agent, Jay Kim, who did not hold a brokerage license of his own and so relied on Huh’s brokerage license.  Kim sold a shopping market (the “Market”) to an out-of-country investor looking for a profitable investment that required minimal personal involvement.  It turned out that the Market was quite unprofitable and required substantial personal involvement.  Its gross sales were significantly lower than Kim represented, and it was subject to so many code violations that its business license was revoked. 

The investor sued Kim for fraud in state court and prevailed.  The investor then successfully moved the state court to add Huh to the judgment.  Huh thereby became jointly and severally liable on the judgment of approximately $1 million, based upon his agent’s fraud.

Huh filed for chapter 7 bankruptcy relief.  The investor filed a complaint under Bankruptcy Code § 523(a)(2)(A), asking the court to except his state court judgment from discharge.  The investor argued that under basic agency principals, a principal is liable for the torts of his agents, and therefore Kim’s liability should be imputed to Huh for purpose of discharge.  Notably, the state court findings of fact were not binding on the bankruptcy court, which made its own findings.  It found that Huh had no involvement with Kim’s sale of the Market, and was totally unaware of the Market until after the sale closed.  In short, he had not personally engaged in any culpable conduct.  Thus, the judgment debt would be dischargeable in Huh’s bankruptcy unless Kim’s fraud was imputed to Huh for purposes of § 523(a)(2)(A). 

The bankruptcy court dismissed the investor’s nondischargeability complaint, and the BAP, sitting en banc, affirmed.  The BAP held that “more than a principal/agent relationship is required to establish a fraud exception to discharge . . .  The creditor must show that the debtor knew, or should have known, of the agent’s fraud.”  In reaching this result, the BAP examined various approaches taken by circuit courts, and a recent United States Supreme Court case that granted a discharge exception under another subsection only if the creditor could establish a debtor’s “culpable state of mind.”  See  Bullock v. BankChampaign, N.A., 133 S.Ct. 526 (2013). 

Because Huh was not aware of the Market sale or of his agent’s false representations until after the sale closed, Huh’s liability on the state court judgment was dischargeable in his chapter 7 case.