Available at: https://scholarlycommons.law.emory.edu/ebdj/vol42/iss3/5
Abstract:
This Article defends the priority treatment of fraud claims in bankruptcy. The Article offers a new normative defense of priority, arguing that priority for fraud claims should be rooted not merely in the involuntariness of the victim's transfer but in the wrongfulness of fraud itself—specifically, the principle that no party, including innocent creditors, should profit from intentional deception at the expense of the victim.
The Article also challenges the main existing vehicle for fraud priority: constructive trust and its associated tracing requirement. Under current law, fraud victims can achieve priority only if they can identify, or trace, specific assets acquired through fraud, a condition that can fail to reflect whether the bankruptcy estate has actually been enriched. The tracing requirement is thus in tension with the prevailing justification for constructive trust, namely combating unjust enrichment.
The Article critiques the tracing requirement as an inapt tool for combating unjust enrichment. It revisits the once-popular "swollen-assets" theory, which presumes continued enrichment based on a showing of initial enrichment and thus did not require tracing in the current sense. The Article proposes either statutory priority for fraud claims or expansion of constructive-trust doctrine, potentially through revival of the swollen-assets theory.
The Article calls for a shift in doctrinal focus from tracing the proceeds of fraud to measuring and remedying unjust enrichment, thereby aligning bankruptcy outcomes more closely with foundational principles of fairness and restitution.
Summary:
Professor John P. Hunt's thoughtful article explores a longstanding tension in bankruptcy law: should victims of fraud receive priority over other unsecured creditors?
Current bankruptcy law generally does not grant statutory priority to fraud claims. Instead, fraud victims typically rely on two principal protections. First, many fraud debts are excepted from discharge under 11 U.S.C. § 523(a). Second, in limited circumstances, a victim may obtain a constructive trust if the fraudulently obtained assets (or their proceeds) can be traced into the bankruptcy estate. Professor Hunt argues that this tracing requirement is often arbitrary and fails to answer the real question—whether the bankruptcy estate was unjustly enriched by the fraud.
Rather than focusing on tracing technicalities, the Article contends that intentional fraud itself provides the moral justification for priority. Innocent creditors should not benefit from assets obtained through deliberate deception, and bankruptcy law should either expand constructive trust principles or create a new statutory priority for fraud claims. Although Professor Hunt acknowledges that constructive trusts are most often discussed in business bankruptcy cases and that fraud priority is less significant in consumer bankruptcies because of the prevalence of no-asset Chapter 7 cases and the availability of nondischargeability, he maintains that statutory priority would be the cleaner solution.
Commentary:
This is an excellent and carefully reasoned article. Professor Hunt raises difficult questions about fairness, restitution, and the sometimes artificial nature of tracing rules. It is certainly understandable why someone intentionally defrauded by a debtor would argue that they deserve something more than standing in line with ordinary unsecured creditors.
That said, before Congress were ever to consider creating a new priority category for fraud claims, it should carefully consider the consequences in consumer bankruptcy cases, particularly Chapter 13.
One of the central premises of the Article is that nondischargeability alone may not provide sufficient protection for fraud victims. That may be true in some Chapter 11 business cases, where distributions to unsecured creditors can be substantial. Consumer Chapter 13, however, presents a very different landscape.
Congress has already substantially limited the old Chapter 13 "superdischarge." Today, 11 U.S.C. § 1328(a)(2) excepts from a Chapter 13 discharge many of the debts described in § 523(a), including numerous fraud claims. In other words, if the debtor successfully completes a Chapter 13 plan, many fraud creditors already emerge from bankruptcy with enforceable claims that survive the discharge.
If Congress were to go one step further and classify fraud claims as priority claims under § 507, the consequences would be significant. Section 1322(a)(2) requires that a Chapter 13 plan "shall provide for the full payment, in deferred cash payments, of all claims entitled to priority under section 507," unless the creditor agrees otherwise.
That would mean many fraud claims would have to be paid in full during the life of the Chapter 13 plan.
For many consumer debtors, that would make confirmation impossible.
Chapter 13 already struggles under the weight of domestic support obligations, taxes, secured debt, rising mortgage payments, increasing insurance costs, and other mandatory plan expenses. Adding another broad category of mandatory priority claims would not simply reduce distributions to general unsecured creditors—it would frequently destroy plan feasibility altogether.
Ironically, that could leave fraud victims worse off. A debtor unable to propose a confirmable Chapter 13 plan may instead file Chapter 7, where there are often no nonexempt assets to distribute. The fraud claim may remain nondischargeable, but collection after bankruptcy is often difficult against an already insolvent debtor.
There is also a broader policy question. Bankruptcy has always balanced competing equities. Every new priority claimant necessarily pushes someone else further back in line. Congress has traditionally been cautious about expanding § 507 because priorities are exceptions to the Bankruptcy Code's general principle of equal treatment among similarly situated unsecured creditors.
Professor Hunt's proposal deserves serious discussion in the context of business reorganizations and constructive trust doctrine. But extending statutory priority to fraud claims in consumer cases would represent another substantial erosion of Chapter 13's rehabilitative purpose.
Congress has already determined that many fraud claims should survive a Chapter 13 discharge. Whether those same claims should also receive mandatory full payment through § 1322(a)(2) is an entirely different question—and one that could fundamentally change the affordability and accessibility of Chapter 13 for financially distressed families.
As with many proposals that seek greater fairness for one group of creditors, the difficult question is not whether the goal is admirable. It is whether the costs imposed on the bankruptcy system—and ultimately on debtors trying to repay what they reasonably can—would outweigh the benefits. On that point, Professor Hunt's otherwise compelling article leaves room for a healthy debate.
To read a copy of the transcript, please see:
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