1. Why did the trial court dismiss Sauer’s adversary proceeding that objected to the discharge of Ms. Lawson’s debt?

2. How did the legislative history of the Bankruptcy Code affect the court’s decision?

3. Could there be any legitimate and ethical reason for the transfers? Why or why not? If the appellate court had agreed with the trial court that fraud cannot exist with misrepresentation, what ethical considerations might be triggered?

Sauer, Inc. (Sauer) sued James Lawson (James) in state court to recover damages related to previous business transactions between the parties and won a judgment against James for $168,351. Just before the judgment was entered, James’s daughter, Carrie Lawson (Ms. Lawson) had formed a shell entity, Commercial Construction M & C, LLC (Commercial Construction). Once the judgment was entered against James by the court, he transferred $100,150 to Commercial Construction, allegedly to impede Sauer’s collection. Commercial Construction is owned by Ms. Law-son, but controlled by James. Ms. Lawson then transferred $80,000 of the $100,150 from Commercial Construction to herself from February 2010 through early 2011. In March 2011, James filed for bankruptcy. In 2013, Sauer successfully sued Ms. Lawson in a state court and obtained a judgment against Commercial Construction and Ms. Lawson after the court ruled that the transfers from James and Ms. Lawson were invalid under Rhode Island’s fraud recovery statute. Ms. Lawson filed a petition for bankruptcy the same month that the state court issued the judgment against her. Sauer initiated an adversary proceeding with the bankruptcy court objecting to any discharge of the Sauer debt due to the fraud provisions of the Bankruptcy Code related to money “obtained by . . . actual fraud.” The bankruptcy court dismissed Sauer’s adversary proceeding, reasoning that misrepresentation is a required element of actual fraud and that there was no allegation that Ms. Lawson had made a misrepresentation in the course of the transfers. Sauer appealed, arguing that because Ms. Lawson knowingly received the fraudulent transfer and acted in a willful and malicious manner toward Sauer, her acceptance of the fraudulent conveyance constituted actual fraud. 

The Court of Appeals for the First Circuit reversed the decision of the bankruptcy court and ruled in favor of Sauer. The court ruled that the bankruptcy court erred in concluding that a misrepresentation by a debtor to a creditor is an essential element of establishing a basis for the nondischarge of a debt under the fraud exception to the Bankruptcy Code. They held that fraud is not limited to misrepresentations and misleading omissions. Rather, actual fraud, by definition, consists of any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another. In this case, Ms. Lawson’s actions were intended to circumvent the court’s judgments and cheat Sauer. 

“We . . . hold that actual fraud under [the Bankruptcy Code] is not limited to fraud effected by misrepresentation. Rather, we hold that actual fraud includes fraudulent conveyances that are ‘intended . . . to hinder [the relevant] creditors.’ . . . That is, the debtor-transferee must herself be guilty of intent to defraud and not merely be the passive recipient of a fraudulent conveyance. Such intent may be inferred from her acceptance of a transfer that she knew was made with the purpose of hindering the transferor’s creditor(s) . . . Our reading is confirmed by the structure of the text and the legislative history. [Congress amended the Bankruptcy Code] so that the fraud provision now explicitly lists both actual fraud and false representations as grounds for denying a discharge.”