Wow. When New York’s highest court renders a decision providing guidance on civil fraud claims, it’s exciting (and instructive). (See New York High Court Reinforces Justifiable Reliance and Loss Causation in Fraud.) But when the United States Supreme Court gets into the act, it’s truly momentous … at least for someone who studies every tidbit of fraud jurisprudence that comes around.
In Bartenwerfer v. Buckley, 598 U. S. ____ (2023), the Supreme Court ruled that a debtor in bankruptcy cannot discharge a debt that arose from the fraudulent conduct of the debtor’s partner, even if the debtor did not personally participate in or even know about that fraud. The decision has impact in New York because partners of a general partnership and joint venturers are personally liable for the torts (including fraud) of their agents acting on behalf of the partnership or joint venture.
The parties in Bartenwerfer lived in California, where the litigation ensued. Kate Bartenwerfer, the petitioner before the Supreme Court, purchased a house with her then boyfriend, David. Acting as “business partners,” they decided to remodel the house and try to sell it for a profit. David handled the renovations, with Kate “largely uninvolved.” When they were selling the house, Kate and David attested that they had disclosed all material facts relating to the property. After buying the property, the purchaser claimed he overpaid for the house by relying on misrepresentations of Kate and David, and sued in California state court. The jury found in the purchaser’s favor on his claims for “breach of contract, negligence, and nondisclosure of material facts, leaving David and Kate jointly responsible for more than $200,000 in damages.”
David and Kate then both filed for bankruptcy under Chapter 7 seeking to discharge their debts, including this $200,000 liability. However, under Section 523(a)(2)(A) of the Bankruptcy Code, there is an exception to the discharge of “any debt . . . for money . . . to the extent obtained by . . . false pretenses, a false representation, or actual fraud.” That presented the issue in the case: While David’s active fraud was clearly within the exception to discharge, could Kate also lose the benefit of discharge even if she did not know about or participate in David’s fraud?
The Supreme Court read the statute in a straightforward manner, noting that there was no explicit language requiring the debtor to be involved in or participate directly in the “false pretenses,” “false representations” or “actual fraud.” Key to the decision was the basis by which Kate was held liable for the misrepresentations – under California law, general partners are liable for the tortious conduct of any partner acting in furtherance of the partnership in the ordinary course of business.
New York Application
As the Supreme Court in Bartenwerfer observed, whether liability for fraud extends to an otherwise innocent party is governed by state law. The law in New York is similar to the California law that applied to the facts in Bartenwerfer. That is, partners and joint venturers are liable for the fraud committed by any partner or joint venturer in the course of the ordinary business endeavors of the partnership/joint venture. As nicely explained in Dupree v Voorhees, 68 A.D.3d 807, 809-10 (2d Dep’t 2009):
[New York] Partnership Law § 24 provides that “[w]here, by any wrongful act or omission of any partner acting in the ordinary course of the business of the partnership, or with the authority of his copartners, loss or injury is caused to any person, not being a partner in the partnership, or any penalty is incurred, the partnership is liable therefor to the same extent as the partner so acting or omitting to act” (Partnership Law § 24 [emphasis added] ). Partnership Law § 26(a)(1) provides that “all partners are liable … [j]ointly and severally for everything chargeable to the partnership under section [ ] twenty-four.” The pivotal test for liability in this regard is whether the wrong was committed on behalf of and within the reasonable scope of the partnership business, not whether the wrongful act was criminal in nature, or whether the other partners condoned the offending partner’s actions (see *810 Rudow v. City of New York, 642 F.Supp. 1456, affd. 822 F.2d 324; Muka v. Williamson, 53 A.D.2d 950, 385 N.Y.S.2d 639; see also Clients’ Sec. Fund v. Grandeau, 72 N.Y.2d 62, 530 N.Y.S.2d 775, 526 N.E.2d 270).
In accordance with the principle of mutual agency, the partnership, including each of its members, is liable for torts committed by one of the partners acting in the scope of the firm business even though they do not participate in, ratify, or have knowledge of such torts.
15A N.Y. Jur. 2d Business Relationships § 1670.
The same principles apply to joint ventures, as explained by the Court of Appeals in Gramercy Equities Corp. v Dumont, 72 NY2d 560, 565 (1988):
A joint venture is a “ ‘special combination of two or more persons where in some specific venture a profit is jointly sought’ ” (Forman v. Lumm, 214 App.Div. 579, 583, 212 N.Y.S. 487). It is in a sense a partnership for a limited purpose, and it has long been recognized that the legal consequences of a joint venture are equivalent to those of a partnership (see, Pedersen v. Manitowoc Co., 25 N.Y.2d 412, 419, 306 N.Y.S.2d 903, 255 N.E.2d 146).
And such liability extends to claims of fraud:
It is undisputed that the cooperative tenants could have brought suit for Dumont’s fraud against the joint venture, or even against Russo [joint venturer] individually, and recovered their damages. As agents for each other, partners and joint venturers are jointly and severally liable to third parties for “any wrongful act or omission of any partner acting in the ordinary course of the business of the partnership”. (Partnership Law §§ 24, *566 26 ; see also, Royal Bank & Trust Co. v. Weintraub, Gold & Alper, 68 N.Y.2d 124, 506 N.Y.S.2d 151, 497 N.E.2d 289; Pedersen v. Manitowoc Co., supra.).
Id. at 565-566.
So, as shown in Bartenwerfer, doing business in New York in the form of a general partnership or a joint venture not only exposes each partner and coventurer to liability for the fraud committed by any of the partners or coventurers, but also prevents any such liability from being discharged in bankruptcy. This is why the preferred form of doing business is through limited liability companies, corporations, and limited partnerships, which add protections and insulate owners from liability apart from the entity’s liability. Of course, any individual who personally participates in fraudulent conduct can be held liable for such wrongful conduct. See Officers, Directors, Employees Are Personally Liable for Fraud in Which They Participate. Similarly, liability for fraud can also extend to those who aid and abet the fraud of others. See Claims of Aiding and Abetting Fraud Require Proximate Cause.