Late this summer, the United States District Court for the Northern District of Illinois, Eastern Division, took on an issue of first impression – whether the fraud of one partner can be imputed to an “innocent” partner in order to render a judgment non-dischargeable. The Court held that fraud committed by a debtor’s business partner could be imputed to the debtor, as one of three members of the partnership, for purposes of excepting the debtor’s joint and several liability to a property owner from discharge and, by its very terms, dischargeability exception for debts for money obtained by “false pretenses, a false representation, or actual fraud” does not require that the debtor perpetrate the fraud.

The successful claimant in arbitration confirmed a judgment against a construction company for breach of contract and fraud and found one of the partner’s of the construction company liable as a partner as well as individually liable for his negligent misrepresentations and contract breaches. The partner subsequently filed for Chapter 7 bankruptcy. The partner listed the judgment among the scheduled debts. The judgment creditor filed an adversary complaint seeking a finding of non-dischargeability of the debt owed by the partner as a result of the arbitration award.

The judgment creditor argued that the fraud of the construction company should be imputed to its partner and, as such, Section 523(a)(2)(A) provides that such debt is not dischargeable. Ultimately, the Court concluded that the “policies underlying Section 523(a)(2)(A) teach that the judgment creditor’s interest in recovering full payment of debts arising from a fraud by a partner outweighs the “innocent” partner’s interest in obtaining a fresh start.” Stated differently, as between the “innocent” partner and the judgment creditor, the innocent partner was in the better position to have ordered his affairs to prevent the fraud and “the congressional policy behind Section 523(a)(2)(A) is meant to discourage a partner from taking an “ostrich” approach with regard to monitoring another partner’s activities.” See Casablanca Lofts, LLC v. Abrham, 436 B.R. 530 (N.D. Ill. 2010).