U.S. Supreme Court and Statute of Frauds for Nondischargeability (§ 523(a)(2)): In re Appling

On Friday, January 12, 2018, the U.S. Supreme Court granted certiorari in Lamar, Archer & Cofrin, LLP v. Appling (In re Appling), Case No. 16-1215, to resolve an indistinct legal standard. The case is about a statute of frauds for nondischargeability.

Generally, a statute of frauds requires that certain promises be in writing to be enforceable, such as a promise to sell real estate. The word “frauds” gets into the name because a writing minimizes opportunities for fraud.

Statute of Frauds for Nondischargeability

The bankruptcy Code has its own statute of frauds for nondischargeability claims based on actual fraud. Sec. 523(a)(2) requires that:

—a false statement “respecting the debtor’s financial condition” must be in writing to be nondischargeable.

The operative (and slightly-convoluted) language of § 523(a)(2) is this (emphasis added):

“A discharge . . . does not discharge an individual from any debt” . . . [for obtaining property] . . . (A) by fraud, “other than a statement respecting the debtor’s or an insider’s financial condition;” or (B) by use of a fraudulent statement in writing “respecting the debtor’s or an insider’s financial condition.” [Fn. 1]

So, the obvious question is this: What qualifies as “a statement respecting . . . financial condition” that must be in writing for nondischargeability? Two views have developed on this question:

—“Broad view” says the “respecting” statement can be about any asset. The practical effect is that oral-and-fraudulent statements about individual assets will be nondischargeable only when made in writing; and

— “Narrow view” says the “respecting” statement must be about the overall financial condition—like a balance sheet. The practical effect is that oral-and-fraudulent statements about individual assets will create nondischargeability.

Here’s a follow-up question: might there be a different/third view for evaluating the same “respecting . . . financial condition” standard under a variety of considerations, instead of the overall-condition v. any-asset distinction? Such a view would, presumably, replace the thin, fine and bright line approach, represented by each of the two views noted above, with a fatter, broader and less distinct approach that evaluates each situation under a variety of factors.

Forumlas

So . . . here are three formulas that show the Supreme Court’s statute of frauds choices for nondischargeability in the In re Appling case:

Broad view + oral fraudulent statement = claim is discharged

Narrow view + oral fraudulent statement = claim is not discharged

Different view + oral fraudulent statement = ???

Application in Circuit-Split Cases

Circumstances in which the § 523(a)(2) statute of frauds is applied are often blurry and indistinct. Here’s how the two statute of frauds views play out in actual cases that create a split of authority among the circuit courts of appeals.

–Broad View

In re Appling, 848 F.3d 953 (11th Cir. 2017). Appling hired a law firm to defend him in a lawsuit. When unpaid fees piled up, Appling said he expected a $100,000 tax refund and would use it to pay fees. So the firm kept working. Instead, Appling used the refund for operating expenses. Appling then filed bankruptcy, and the firm sued for nondischargeability based on fraud, under § 523(a)(2). The Eleventh Circuit applied the broad view, holding that the oral tax refund statements are “respecting the debtor’s financial condition” and, therefore, must be in writing to be nondischargeable.

Engler v. Van Steinburg, 744 F.2d 1060 (4th Cir. 1984). Engler loaned Van Steinburg $5,000 based on Van Steinburg’s false oral assurances that Engler would have a first lien to secure the loan. The Fourth Circuit held that such assurances are not merely statements “respecting his financial condition” but “may be the most significant information about his financial condition.” Accordingly, such assurances “must be in writing to bar” discharge under § 523(a)(2).

–Narrow View

In re Bandi, 683 F.3d 671 (5th Cir. 2012). Two Bandi brothers guaranteed a $150,000 loan from Becnel. To get the loan, the Bandi brothers falsely and orally represented that they owned various parcels of real property. They then defaulted on their guarantees and filed bankruptcy. Becnel successfully pursued nondischargeability claims in bankruptcy court. The Fifth Circuit affirmed, declaring that the § 523(a)(2) phrase “respecting the debtor’s . . . financial condition” refers to “the general overall financial condition of an entity or individual” and not to “any and all misrepresentations that pertain in some way to specific assets or liabilities.“

In re Lauer, 371 F.3d 406 (8th Cir. 2004). Lauer purchased limited partnership interests with a promised stream of five annual payments. To secure such payments, Lauer pledged an interest in a nursing home—but he failed to inform the purchaser that the nursing home had already been sold. He thereafter defaulted on the annual payments and filed bankruptcy. The purchasers sought nondischargeability for fraud under § 523(a)(2). The Eighth Circuit rejected the broad view and ruled that Lauer “committed garden variety common law fraud” by “concealing material changes.” Accordingly, it declared the fraud liability “nondischargeable.”

In re Joelson,427 F.3d 700 (10th Cir. 2005). A waitress befriended a single, retired restaurant patron and got a $50,000 loan from him. She told him that she owned various parcels of real estate—and even showed those properties to him. She, of course, did not own them. She then filed bankruptcy, and he brought a nondischargeability claim under § 523(a)(2). The Bankruptcy Court ruled in his favor. On appeal she claimed her representations were oral-only, were “respecting” her “financial condition,” and should be discharged. The Tenth Circuit adopted the narrow view as “most consistent with the text and structure of the Bankruptcy Code” and its legislative history and case law. So, it declared the patron’s claim nondischargeable.

Rationale

Reasons articulated for each of the broad and narrow views, on statute of frauds for nondischargeability under § 523(a)(2), include the following.

–Broad View Rationale (from In re Appling)

Statutory construction: While “financial condition” might mean “the sum of all assets and liabilities,” the word “respecting” includes a statement about a single asset.

Practical effect: The broad view “promotes accuracy and predictability in bankruptcy disputes that often take place years after the facts arose.” A writing requirement to create enforceable legal rights is “not at all unusual.” It “may seem harsh after the fact,” yet it “gives creditors an incentive to create writings before the fact” to provide “reliable evidence” for a nondischargeability decision. And creditors “can easily require a written statement from the debtor before extending credit.” This broad view “strikes a reasonable balance” between the “‘conflicting interests’ of discouraging fraud” and of “providing the honest but unfortunate debtor a fresh start”: the writing requirement “helps both the honest debtor prove his honesty and the innocent creditor prove a debtor’s dishonesty.”

–Narrow View Rationale (from In re Joelson)

Statutory construction: The term “financial condition” refers, in various Bankruptcy Code definitions, to an entity’s overall property and debts.

U.S. Supreme Court: In Field v. Mans, 516 U.S. 59 (1995), the Supreme Court reflects a narrow view of § 523(a)(2), on the subject of justifiable reliance, with these statements:

–Section 523(a)(2)(B) “applies to false financial statements in writing”; and

–It doesn’t make sense to “protect creditors who were not quite reasonable in relying on a fraudulent representation” and to “apply a different rule when fraud is carried to the point of a written financial statement”?

Practical effect: Due to difficulties in portraying accurately “one’s overall financial position,” it is appropriate “to give more leeway” in describing the “overall position orally.” It is also appropriate “to give less leeway” to someone making “a specific oral misrepresentation as to a particular asset, because it is less likely that such a misrepresentation is inadvertent.”

Is There a Middle Ground?

It’s hard to believe that the line between dischargeability and nondischargeability of a fraud claim, based on a statement about one asset, would be thin, fine and bright. Such a line would provide a simple answer to varied and often-complex circumstances.

Perhaps the Supreme Court will come up with a different formulation of a fatter, broader and less distinct line that incorporates a variety of considerations in evaluating the “respecting” standard for nondischargeability.

Conclusion

It will be interesting to see which way the Supreme Court goes on this. Will it stick with its discussion, in Field v. Mans, that reflects a narrow view? Or will it distinguish or clarify those words and adopt the broad view? Or perhaps it will do something entirely different and unexpected–like developing a middle ground? Time will tell.

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Footnote 1: 11 U.S.C. 523(a)(2)(A)&(B) provides:

“(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt— . . . (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—
(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;
(B) use of a statement in writing—(i) that is materially false; (ii) respecting the debtor’s or an insider’s financial condition; (iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and (iv) that the debtor caused to be made or published with intent to deceive.”