Imagine discovering that your business partner’s fraudulent actions have left you with a debt you can’t escape – even through bankruptcy. This scenario was at issue in the 2023 U.S. Supreme Court’s unanimous decision in Bartenwerfer v. Buckley, which serves as a warning for business owners who have business partners: you can be held liable for your partner’s fraud even if you were completely unaware of it—and that liability can’t be discharged in bankruptcy. The Court’s decision makes it clear that fraud liability isn’t just about your own actions—it’s about the actions of everyone you choose to partner with in your business.
The Case and Its Impact
In this case, Kate Bartenwerfer learned a costly lesson about partnership liability. She and her then-boyfriend David joined forces to renovate and sell a house. While Kate was minimally involved in the project, David managed the renovation and, during the sale, failed to disclose several property defects to the buyer. When the buyer discovered these issues and successfully sued, both partners were held liable for fraud.
When the Bartenwerfers sought bankruptcy protection, the Bankruptcy Court ruled that Kate couldn’t discharge the debt because David’s fraud could be imputed to her through their partnership. However, the Bankruptcy Appellate Panel disagreed and sent the case back to determine if Kate personally knew about the fraud. The Bankruptcy Court found that Kate had no knowledge of the fraud and ruled her debt dischargeable. The Ninth Circuit Court of Appeals then reversed, holding that a debtor’s lack of knowledge doesn’t matter—they can still be liable for a partner’s fraud, and they can’t discharge that debt in bankruptcy.
The Supreme Court’s unanimous decision settled the matter definitively, affirming the Ninth Circuit’s decision. The Court held that under Section 523(a)(2)(A) of the Bankruptcy Code, which prohibits discharging debts obtained by “false pretenses, a false representation, or actual fraud,” the debt couldn’t be discharged regardless of Kate’s personal knowledge. The Court emphasized that if a debt results from fraud, it’s non-dischargeable under bankruptcy law—regardless of who committed the fraud or whether the debtor knew about it.
What This Means for Michigan Business Owners
This decision has important implications for Michigan business owners who have business partners. Here are some considerations for protecting your business:
Due Diligence in Business Partner Selection
Carefully evaluate potential business partners before entering into something as significant as a formal business arrangement. Review their business history, reputation, and track record of ethical behavior. Remember that their actions can create liabilities that will follow you even through bankruptcy.
Active Oversight and Management
While delegating and dividing responsibilities is common among business partners, maintaining oversight of all significant business operations is crucial. Implement systems to review major transactions and representations made to customers or clients.
Clear Business Agreements and Governance
Develop comprehensive partnership agreements that include:
- Specific roles and responsibilities for each partner
- Required approval processes for major decisions
- Regular reporting requirements
- Indemnification provisions
- Clear procedures for addressing potential misconduct
Risk Management Protocols
Establish strong internal controls and documentation practices:
- Regular meetings with business partners with documented minutes
- Written approval processes for significant transactions
- Clear communication channels between partners
- Regular financial and operational audits
- Insurance to protect against partner misconduct
Signs of Potential Partner Misconduct
Business owners should remain vigilant for early warning signs of potential partner misconduct. A partner’s persistent reluctance to share detailed financial information or documentation deserves particular attention, especially if this represents a change in behavior. Similarly, watch for unusual patterns in business transactions, such as unexpected expenses, new vendors, or financial decisions made without proper consultation. A partner who shows strong resistance to routine oversight or regular audits may also warrant closer scrutiny. Sudden or unexplained changes in business practices, particularly those involving financial matters or customer relationships, could signal underlying issues that need investigation. While these signs don’t necessarily indicate fraud, they merit prompt attention and open discussion among partners to maintain transparency and trust in the business relationship.
Protecting Your Interests
The Bartenwerfer decision serves as a powerful reminder that partnership liability extends far beyond your own actions and can have lasting consequences that even bankruptcy cannot erase. While this may seem daunting, business owners who take proactive steps to protect themselves significantly reduce their risk exposure. The key is establishing robust business practices and governance structures before problems arise.
Given the complexity of forming and running a business, the dynamics between business partners, and the implications of the Bartenwerfer decision, it’s important to engage legal counsel when establishing or updating foundational business agreements and major business protocols. The right legal guidance can help ensure your protective measures are robust and aligned with current law while addressing the specific needs and risks of your business. If you have questions or require assistance, please contact Zana Tomich.
