Defining and Illustrating “Statement Respecting Financial Condition” for Nondischargeability: U.S. Supreme Court (Appling Case)

By: Donald L. Swanson

“a statement about a single asset can be a ‘statement respecting the debtor’s financial condition’ under §523(a)(2) of the Bankruptcy Code.”

U.S. Supreme Court, Lamar, Archer & Cofrin, LLP v. Appling, Case No. 16-1215, June 4, 2018.

One of the frequently-mediated types of disputes in bankruptcy is nondischargeability under 11 U.S.C. § 523(a)(2) for fraudulent misrepresentation.

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Creating a clear path

Yesterday, the Supreme Court clarified a critical issue of law under § 523(a)(2) by defining a previously-ambiguous term and by citing thirteen illustrative cases.

Facts

R. Scott Appling hired the law firm of Lamar, Archer & Cofrin, LLP, to represent him in a business lawsuit.

Appling had trouble paying the firm’s legal fees and, by March 2005, owed more than $60,000 to the law firm.

The law firm threatened to withdraw as his attorney and impose a lien on his assets.

So, Appling promised to pay them from a $100,000 tax refund he expected, and the law firm kept working for him. Appling then belied this promise in two ways:

(i) the refund was only $60,718; and
(ii) Appling spent all of it on his business—none went to the law firm.

The law firm then sued Appling for amounts owed and obtained a $104,179.60 judgment.

Appling then filed Chapter 7 bankruptcy, in which the law firm sued to declare his debt to them nondischargible for “actual fraud.” After trial in Bankruptcy Court, Appling lost. He appealed to the District Court—and lost again. He appealed to the Eleventh Circuit Court of Appeals—and won. So, the law firm appealed to the U.S. Supreme Court, where Appling prevailed because the misrepresentations were not in writing.

Supreme Court Opinion

–The Legal Issue

“The Bankruptcy Code prohibits debtors from discharging debts for money, property, services, or credit obtained by ‘false pretenses, a false representation, or actual fraud,’ 11 U. S. C. §523(a)(2)(A)”; but

–A writing requirement is added if the fraud is a false statement “respecting the debtor’s or an insider’s financial condition,” §523(a)(2)(B).

“This case is about what constitutes a ‘statement respecting the debtor’s financial condition’”:

–“Does a statement about a single asset qualify, or must the statement be about the debtor’s overall financial status?”

–The Practical Difference

“The answer matters” in the Appling case because “the false statements at issue concerned a single asset and were made orally.”

“So, if the single-asset statements here qualify as ‘respecting the debtor’s financial condition,’” §523(a)(2)(B) allows discharge because the statements “were not made in writing”; but

If “the statements fall into the more general category of ‘false pretenses, . . . false representation, or actual fraud,’ §523(a)(2)(A),” for which there is no writing requirement, the associated debt will be nondischargeable.

–The Final Answer

The Supreme Court’s answer is this:

“a statement about a single asset can be a ‘statement respecting the debtor’s financial condition’”; and

“If that statement is not in writing, then the associated debt may be discharged, even if the statement was false.

–The Unanimous Ruling

The Supreme Court’s opinion is unanimous. And all Justices agree on all reasons for the result, except for one item of rationale at the end of the opinion, which is supported by all but two Justices (Thomas and Gorsuch). All Justices agree that the opinion’s conclusion is based upon:

A “main purpose” of the “federal bankruptcy system”;

The “language of the statute itself”;

The likelihood that a contrary interpretation “would yield incoherent results”; and

The “statutory history” of the phrase, “statement respecting financial condition.”

–The Effect

The Appling opinion should result in fewer nondischargeability cases being filed under § 523(a)(2), due to the writing requirement.  That in turn, of course, will lead to fewer mediations.

All of this, however, is a good thing.  The Supreme Court explains why in its final but non-unanimous point:

–Although the Supreme Court’s ruling “heightens the bar” for denying a discharge, that’s “not a shield for dishonest debtors” because it balances the “potential misuse” of oral statements “by both debtors and creditors.”

Congress wanted, for example, to “moderate the burden on individuals” arising from “practices of consumer finance companies” that tried to manipulate and abuse the system and “frustrate the very end Congress sought to avoid.”

Statutory & Judicial History

The “statutory history” of the phrase, “statement respecting financial condition,” is nearly a century old:

The phrase is “traced back to a 1926 amendment to the Bankruptcy Act of 1898,” which prohibited discharge for obtaining money or credit by a false “statement in writing respecting . . . financial condition”;

Congress retained this same “statement in writing respecting financial condition” phrase in a 1960 amendment; and

Congress preserved the phrase, once again, in §523(a)(2)(B) of the modern Bankruptcy Code.

Moreover, Circuit Court opinions, since 1926 and before the modern Bankruptcy Code, “consistently construed” the phrase “to encompass statements addressing just one or some of a debtor’s assets or liabilities.” Footnote 3 of the opinion cites five such Circuit Court opinions from 1939 through 1977.

Thirteen Illustrative Cases

One of the helpful aspects of the opinion is that it provides illustrations of the distinction between statements that are “respecting financial condition” and statements that are not. Here are the thirteen illustrative cases.

–Statements Respecting Financial Condition

In footnote 3, the Supreme Court identifies the following five cases illustrating statements that DO qualify as “respecting financial condition.”

1. Real Property.  Tenn v. First Hawaiian Bank, 549 F.2d 1356 (9th Cir. 1977).

Tenn and Luckfield obtained a loan of $105,219 from First Hawaiian Bank by claiming to own certain real property subject to a life estate in their mother. They had recorded a deed to that effect, and the Bank obtained a title report confirming their claim.

A year after obtaining the loan, Tenn and Luckfield recorded a new deed reconveying title in the real property back to their mother, contending that they had never owned it.

First Hawaiian Bank obtained judgement for the unpaid balance of the loan and attempted to levy on the real property—but were prevented from doing so by the new deed.

Tenn and Luckfield then filed bankruptcy, the Bank objected to their discharge, the Bankruptcy Court denied their discharge, and the District Court affirmed on appeal.

The Ninth Circuit affirmed as well:

“We hold that appellants’ recordation of the [first] deed which they knew was false for the purpose of obtaining an extension of credit on the basis of an asset that they did not own was a false statement of financial condition.”

2. Accounts Receivable.  In re Butler, 425 F. 2d 47 (3rd Cir. 1970).

James P. Butler helped his corporation get a loan that he personally guaranteed. And he delivered false and fraudulent invoices to the creditor to support the loan: the invoices identified accounts receivable that did not exist.

Both the corporation and Butler filed bankruptcy, and the creditor objected to Butler’s discharge.

The Referee denied Butler’s discharge on grounds that Butler “knew or should have known that the accounts were fictitious” and that the assignments of such accounts “constituted materially false statements in writing respecting the financial condition” of the corporation.

The Third Circuit affirmed.

3. Inventory.  Shainman v. Shear’s of Affton, Inc., 387 F.2d 33 (8th Cir. 1967).

A wholesale toy distributor corporation entered into a financing agreement, under which a creditor would make loans to the corporation secured by inventory. Jerome Shainman negotiated the agreement as the corporation’s officer and personally guaranteed the loans.

The corporation, via Shainman, furnished monthly inventory reports to the creditor. The January 31, 1964 report, for example, identified an inventory value of $800,559, but a physical inspection established actual value at only $172,276.

Then, both the corporation and Shainman ended up in bankruptcy.

The creditor, Shear’s of Affton, objected to Shainman’s discharge. The Referee found for the objector and denied Shanman’s discharge. The District Court affirmed.

The Eighth Circuit also affirmed and made this finding:

“A written statement purporting to set forth the true value of a major asset of a corporation, its inventory, is a statement respecting the financial condition of that corporation.”

4. Accounts Receivable.  Albinak v. Kuhn, 149 F.2d 108 (6th Cir. 1945).

Albinak filed bankruptcy but was denied a discharge.

Before bankruptcy Albinak manufactured jigs and tools and received large orders for war products, and he obtained loans secured by accounts receivables.

Sec. 32 of the Bankruptcy Act provides for a discharge unless the bankrupt obtained credit by “a materially false statement in writing respecting his financial condition.”

The Sixth Circuit said:

“The question before us is whether the several assignments of accounts . . . constitute materially false statements in writing respecting the bankrupt’s financial condition”; and

“No cases have been cited to us, and none has been found by careful examination, which confines a statement respecting one’s financial condition as limited to a detailed statement of assets and liabilities.”

5. Promissory Note Claim.  In re Weiner, 103 F.2d 421 (2nd Cir. 1939).

Weiner was indebted to a creditor and obtained an extension of a due date thereon by:

(i) representing that he had a valid promissory note claim against another person for the sum of $2,500 that would become due in the near future; and

(ii) assigning such claim to the creditor as partial security for the extended indebtedness.

It turns out, however, that the representation about a valid claim was entirely fabricated and known by Weiner to be false.

The Second Circuit denied Weiner’s discharge, declaring that the listing and assigning of the promissory note claim as security involved “a palpably false representation” and “a materially false statement by the bankrupt ‘in writing respecting his financial condition.’”

–Statements NOT Respecting Financial Condition

In and around footnotes 4 and 5, the Supreme Court identifies the following six cases illustrating “actual fraud” events that DO NOT qualify as “statements respecting financial condition” and need not be in writing for denial of discharge.

A. Fraudulent Transfer Scheme.  Husky Int’l Electronics, Inc. v. Ritz, 578 U.S. ___ (2016):

“The term ‘actual fraud’ in §523(a)(2)(A) encompasses all forms of fraud, like fraudulent conveyance schemes.”  The scheme itself is the actual fraud, even when no misrepresentation is involved.

B. Social Security Information.  In re Tucker, 539 B.R. 861 (Bkrtcy. Ct. Idaho 2015).

“a debt arising from the overpayment of social security disability benefits to an individual who failed to report changes to his employment despite a legal duty to do so” is nondischargeable under §523(a)(2)(A).  The failure to report is the event of “actual fraud.”

C. Social Security Information.  In re Drummond, 530 B.R. 707 (Bkrtcy. Ct. ED Ark. 2015).

Under facts similar to In re Tucker, a failure to comply with “the requirement of the debtor to notify the Social Security Administration if she returns to work is not a statement that respects the debtor’s financial condition” but is a basis for nondischargeability under §523(a)(2)(A).

D. Investment Information.  In re Bocchino, 794 F.3d 376 (3rd Cir. 2015).

Steven S. Bocchino, as stockbroker, solicited investments in fraudulent ventures by oral misrepresentations and high pressure tactics, earning thousands of dollars in commissions.  The Bankruptcy Court described his actions as “egregious” and “grossly reckless” in pursuit of “his own greedy purpose.”  His liabilities for such oral misrepresentations are nondischargeable under §523(a)(2)(A).

E. Rent Amount Requirements.  In re Cohen, 106 F.3d 52 (3rd Cir. 1997).

Edward S. Cohen purchased an 18-unit residential apartment building subject to a comprehensive rent control ordinance that limited the amount of rents he could charge.  Cohen charged residents “approximately double” the authorized amounts and was ordered to refund the over-charges.  He filed bankruptcy, instead.  The Bankruptcy Court held that his misrepresentations to tenants “about the rent that legally could be charged” constituted nondischargeable fraud under §523(a)(2)(A).

F. Mortgage Downpayment Amounts.  United States v. Spicer, 57 F. 3d 1152 (DC Cir. 1995).

John R. Spicer, as real estate broker, admitted to intentionally overstating down payment amounts in 81 applications to help home buyers qualify for FHA-insured mortgages.  He was convicted of a Federal crime for such actions, sentenced to incarceration for four months, and ordered to pay restitution of $340,000 for profits he earned.  The DC Circuit found such misrepresentations to constitute “actual fraud” for denying discharge under §523(a)(2)(A).

Conclusion

Yesterday, the U.S. Supreme Court provided a clear answer to the meaning of § 523(a)(2)(A) with this pronouncement in its Appling opinion:

“a statement about a single asset can be a ‘statement respecting the debtor’s financial condition’ under §523(a)(2) of the Bankruptcy Code.”

The Supreme Court also clarified future issues about distinctions between statements that are “respecting financial condition” and those that are not by citing thirteen cases as illustrations.

This Appling opinion is helpful!  It creates a clear path.

–It might minimize the number of nondischargeability cases that are mediated because it clarifies uncertainties.

But it is helpful, nonetheless.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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