California Business Divorce: Partner Fraud and Personal Liability - Important Lessons from Bartenwerfer v. Buckley

The Story Behind the Case

Kate and David Bartenwerfer started their business with a straightforward plan. The couple decided to renovate and sell a house they jointly owned in San Francisco. David handled the remodeling work, while Kate remained largely uninvolved in the day-to-day operations. When it came time to sell, David handled the required property condition disclosures without Kate's participation or oversight. These disclosures would later prove problematic when Buckley, the buyer, discovered they contained false information, leading to a lawsuit in California state court.

The Legal Proceedings

The lawsuit resulted in a judgment against both Kate and David on multiple grounds, including breach of contract, negligence, and fraud for failing to disclose material facts about the property. Faced with this judgment, the Bartenwerfers both sought Chapter 7 bankruptcy protection. However, the buyer pursued them into bankruptcy court, filing an adversary proceeding to have the debt declared non-dischargeable under Section 523(a)(2)(A) of the Bankruptcy Code—the provision barring discharge of debts obtained through fraud.

The case's journey through the courts took several turns. Initially, the bankruptcy court ruled that David's fraud should be imputed to Kate, making the debt non-dischargeable for both of them. Kate appealed to the Bankruptcy Appellate Panel (BAP), which sent her case back to the bankruptcy court with instructions that discharge should depend on whether she knew or had reason to know of the fraud. The bankruptcy court then found in Kate's favor, concluding she lacked such knowledge. The BAP affirmed. However, when the case reached the Ninth Circuit Court of Appeals, that court reversed, and the U.S. Supreme Court subsequently agreed to hear the appeal. The Supreme Court ultimately affirmed the Ninth Circuit’s decision, holding that the fraudulent nature of the debt, not the debtor's personal culpability, determines whether it can be discharged in bankruptcy.

Drawing on the 1885 precedent of Strang v. Bradner, the Supreme Court emphasized that the Bankruptcy Code's fraud exception focuses on how the money was obtained, not who committed the fraud. The opinion made clear that if fraud was involved in creating the debt, that debt cannot be discharged in bankruptcy—regardless of whether the debtor personally participated in or even knew about the fraudulent conduct.

Risk Management for Business Owners

While the Bartenwerfer case arose from a real estate transaction, its implications reach far beyond that context. The decision highlights a universal principle that every business owner should take to heart: when you go into business with someone, their actions can create personal liability for you. This reality demands that business owners not only choose their partners wisely but also remain vigilant throughout the business relationship.

Do your due diligence before entering any business relationship, particularly if you haven’t done business with someone before. Research a potential partner’s business track record, financial/legal history, and reputation in the industry. Establish clear expectations about roles, responsibilities, and oversight mechanisms from the outset, and document these in writing.

Even if you're not involved in day-to-day operations, maintain regular visibility into the business's activities through periodic reports, meetings, and reviews. Consider implementing internal controls such as requiring multiple approvals for significant transactions or establishing regular compliance checks. While you can't contract away fraud liability entirely, you can include provisions in your agreements that require partners to maintain certain standards of transparency and accountability. Finally, explore insurance options that might provide some protection against fraud-related losses.

Regular oversight as a business owner is critical not only because it can help prevent fraudulent actions, but it can also help catch honest mistakes before they become serious problems, improve business operations, and strengthen partner relationships through clear communication. While implementing these safeguards requires time and effort, it's far less costly than dealing with the aftermath of partner fraud. As the Bartenwerfer case shows, the alternative could be facing liability that follows you even through bankruptcy.

Conclusion

Going into business with a partner requires striking a delicate balance. You need to maintain a productive business relationship while implementing sufficient oversight to protect yourself from potential fraud and other risks. This doesn't mean approaching every business relationship with suspicion, but rather establishing clear protocols and maintaining appropriate involvement in your business operations. The ultimate lesson from Bartenwerfer isn't that partnerships are too risky to pursue—it's that they require careful consideration, proper structures, and ongoing attention to protect everyone involved.