U.S. law for centuries has distinguished between a “fraudulent debtor” and an “honest but unfortunate” one, and refused to allow debts accumulated through fraud to be wiped out in bankruptcy.
But what happens when that fraud involves a single asset claim that isn’t in writing? How much weight in relation to a debtor’s finances should that get in bankruptcy, and can that debt still be discharged?
These questions have split the circuit courts, and the U.S. Supreme Court will hear arguments April 17 to try and sort things out. It’s difficult to predict how the high court will rule between now and June in its third bankruptcy case of the 2017 term.
But the case has “widespread importance” for potentially millions of Chapter 7 debtors because of its potential to deny them a discharge and change the law in many jurisdictions, according to a “friend of the court” brief filed on behalf of retired bankruptcy Judge Eugene Wedoff and a group of law professors.
The bankruptcy discharge “goes to the very heart of bankruptcy law,” and is an essential aspect of one’s financial and personal ‘liberty,’” Wedoff and the law professors said.
On the other hand, creditors need to know for certain if debtors can escape the fraud exception to discharge if the debtor’s fraudulent misrepresentation isn’t in writing. The dischargeability of fraudulently incurred debts will affect creditors who rely on a debtor’s fraudulent conduct or deception.
A Promise Not Kept
An unwritten and unfulfilled promise by a businessman to pay his legal fees is at the heart of the case.
R. Scott Appling owed Lamar, Archer & Cofrin more than $60,000 for representing him in litigation against his former business partners. He verbally promised to pay the bill with a tax refund, but instead used the money for his business, according to a court summary.
Lamar later won a $104,000 state-court judgment against him that included interest, but Appling tried to wipe out the debt in Chapter 7.
The bankruptcy court held that the debt wasn’t dischargeable because a statement pertaining to a single asset, the tax refund, didn’t “respect,” or represent, his overall financial condition. The district court agreed.
But the U.S. Appeals Court for the Eleventh Circuit went the other way. It concluded that Appling’s debt could be wiped out because his statements weren’t in writing.
“A distaste for dishonest debtors does not empower judges to disregard the text of the statute,” the Eleventh Circuit said.
Requiring some statements to be made in writing promotes “accuracy and predictability in bankruptcy disputes that took place years after the facts arose,” the appellate court said.
It also gives creditors an incentive to create writings before the fact, which provides the bankruptcy court with reliable evidence to make a decision, the court said.
Lamar appealed, and the Supreme Court agreed to take it up.
The tension is how to balance a debtor’s “fresh start” in bankruptcy with the intent of Congress to prevent or limit the discharge due to fraud. In some circumstances, the interests of creditors recovering full payment outweighs a debtor’s interest for a new financial start.
The Eleventh Circuit “seems to go long on statutory interpretation and a little bit short on policy,” Juliet M. Moringiello, a business law professor at Widener University Commonwealth Law School in Harrisburg, Pa., told Bloomberg Law.
The Fourth Circuit has sided with the Eleventh Circuit. But the Fifth, Eighth, and Tenth Circuits have ruled that a statement about a single asset doesn’t respect a debtor’s financial condition because it says nothing about the overall financial condition of the person making the representation or the ability to repay the debt.
Although “uniformity in bankruptcy law is desirable here,” there are arguments on both sides of the split that “make some good points,” Moringiello said.
Not In Writing
As long as a false statement isn’t in writing, debtors can discharge a debt incurred by a false statement “respecting,” or reflecting, their financial condition, according to Bankruptcy Code Section 523(a)(2).
Charles J. Tabb, of counsel with Foley & Lardner LLP, told Bloomberg Law that the justices could rely on a “plain meaning reading of ‘respecting’ and conclude that even a statement about less than the debtor’s overall financial condition still is ‘respecting’ that condition.”
The fact that the U.S. government, the largest creditor in the case, came out affirming the decision is “telling,” said Tabb, who is also the Mildred Voorhis Jones Chair in Law at the University of Illinois in Champaign, Ill.
But the court in recent years has shown a “strong disinclination to interpret the Bankruptcy Code in a way that could favor dishonest debtors,” and Appling is “most definitely not a sympathetic ‘honest but unfortunate’ debtor,” Tabb said.
Affirming the Eleventh Circuit would upend bankruptcy law around fraud by allowing debtors to lie to creditors about their finances and still obtain relief from the court, Lamar argued. It said the appeals ruling is too broad and should be reversed.
“Financial condition” refers to “one’s overall financial status,” and not to any particular asset on its own, according to Lamar, which petitioned the Supreme Court to take the case.
Appling argued in his brief that the language of the statute is unambiguous and a plain language reading is correct. This reading is true to the text, and captures the particular practice for which Section 523(a)(2)(B) was designed, he said.
In recognition of widespread creditor misconduct, Congress adopted certain safeguards for debtors requiring the statement to be in writing and the creditor proving reasonable reliance to balance the scales more fairly in favor of debtors, Appling said.
The question here is whether Section 523(a)(2)(B) applies if the debtor describes some of his assets or liabilities, and Appling argues that it does.
The U.S. solicitor general’s office said in its own amicus brief supporting Appling that a statement about a single asset can be a “statement respecting … financial condition” under a natural reading of the statute, and especially if it is offered as evidence of the debtor’s ability to pay.
Economic Value to Discharge
Lamar’s view of debtors opportunistically “gaming the system” when given the chance is inaccurate, according to the brief filed on behalf of Wedoff and the law professors who favor affirming the Eleventh Circuit.
The large body of economic data on the bankruptcy system reflects the true need for discharge protection and the “macroeconomic value that relieving debt has on the general economy,” they said.
An amicus brief filed by other law professors and represented by the Institute for Bankruptcy Policy said Lamar’s proposed statutory construction would lead to “absurd results.”
They offered the court an alternative reason to uphold the Eleventh Circuit. Even if Lamar were correct, Appling’s statements were about his overall financial condition because they “amounted to a claim that he was solvent” and “able to pay his debts.”
Latham & Watkins LLP, Washington, represents Lamar. Mayer Brown LLP, Washington, represents Appling.
The case is Lamar, Archer & Cofrin, LLP v. Appling, 16-1215, cert. granted 1/12/18.
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