Nondischargeability for Fraud “Other Than a Statement Respecting the Debtor’s Financial Condition” in Bankruptcy [11 USC 523(a)(2)(A) & 523(a)(2)(B)]

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Bankruptcy Code Section 523(a)(2)(A) Dischargeability Cannot be Based on Oral Fraudulent Misrepresentation “Respecting the Debtor’s Financial Condition”

The Supreme Court has held that nondischargeability under Section 523(a)(2)(A) of the Bankruptcy Code for fraudulent misrepresentations “other than a statement respecting the debtor’s or an insider’s financial condition” means that creditors in bankruptcy are barred from claiming oral misrepresentations that have “a direct relation to or impact on the debtor’s overall financial status.” Lamar, Archer & Cofrin, LLP v. Appling, 138 S.Ct. 1752, 1755 (2018). This article provides the analysis of our bankruptcy attorneys in California to apply this law to various factual scenarios.

False Statements Respecting the Debtor’s Financial Condition Must be in Writing in Order for the Debt to be Nondischargeable

A discharge in bankruptcy releases a debtor from liability of certain debts. However, some debts, such as fraud, willful and malicious injury, and intentional fraudulent transfers may be exempted from discharge.

Specifically, Section 523(a)(2)(A) of the Bankruptcy Code provides nondischargeability “for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”

Indeed, if the fraud relates to a “statement respecting the debtor’s or an insider’s financial condition,” the creditor in bankruptcy must proceed under Section 523(a)(2)(B) of the Bankruptcy Code, which provides an exception to discharge for “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.”

What this means is “that a debtor may not discharge debts for money obtained by false pretenses, false representations, or fraud, except that false statements ‘respecting the debtor’s … financial condition’ must be in writing in order for the debt to be nondischargeable. 11 U.S.C. §§ 523(a)(2)(A), 523(a)(2)(B).” Engler v. Van Steinburg, 744 F.2d 1060 (4th Cir. 1984) (debtor’s oral misrepresentations that he owned the property free and unencumbered related to his financial condition).

Said another way: “It is well-established that subsections 523(a)(2)(A) and (a)(2)(B) are mutually exclusive, and that if a ‘statement respecting the debtor’s or an insider’s financial condition’ is communicated orally, the creditor’s claim will fail and the underlying debt will be discharged.” In re Ransford, 202 B.R. 1, 3 (Bankr. D. Mass. 1996).

What is “a Statement Respecting the Debtor’s or an Insider’s Financial Condition” Under Section 523(a)(2)(A) of the Bankruptcy Code?

Many times, the creditor’s allegation of fraud border on a claim of an oral misrepresentation about the debtor’s financial condition. For example, the debtor may tell a creditor that they are “rich” and will have “no problem paying back a loan.” Of course, that turned out not to be true, since the debtor is in bankruptcy seeking to discharge their debts. So, is that sufficient in bankruptcy court to allege fraud without being excluded as a statement respecting the debtor’s or an insider’s financial condition?

“Where an individual debtor is involved, the definition of ‘insider’ includes a ‘corporation of which the debtor is a director, officer, or person in control.” Blackwell v. Dabney, 702 F.2d 490, 492 (4th Cir. 1983). In Blackwell, statements by a debtor that “convinced [plaintiffs] the business ‘was growing’, that ‘he was very successful’ [and]… [insider] was a ‘top-notch company’ and that ‘they were just blooming’ … that ‘business was going great,’ that the corporation was a ‘very successful company of some young black men and they were doing very, very good.’ And that it was a ‘striving business that was doing well’” were found to be statements “concerning the financial condition of [insider]. Further, all of [debtor’s] statements were oral. [Thus] [t]he representations are therefore outside the scope of 11 U.S.C. § 523(a)(2) and can not be the basis for preventing discharge of the bankrupt.”

As the Ninth Circuit Bankruptcy Appellate Panel (BAP) explained, “the phrase ‘statement respecting the debtor’s … financial condition’” should be interpreted as analogous to those statements “that purport to present a picture of the debtor’s overall financial health.” In re Belice, 461 B.R. 564, 577–578 (B.A.P. 9th Cir. 2011). The BAP went on to provide that: Statements that present a picture of a debtor’s overall financial health include those analogous to balance sheets, income statements, statements of changes in overall financial position, or income and debt statements that present the debtor or insider’s net worth, overall financial health, or equation of assets and liabilities…. What is important is not the formality of the statement, but the information contained within it—information as to the debtor’s or insider’s overall net worth or overall income flow.”

Supreme Court in Lamar, Archer & Cofrin, LLP v. Appling, 138 S.Ct. 1752, 1761 (2018) found that an Oral Misrepresentation is Not Actionable Under Section 523(a)(2)(A) if it “Has a Direct Relation to or Impact on the Debtor’s Overall Financial Status”

In 2018, the United States Supreme Court weighed in on the issue in Lamar, Archer & Cofrin, LLP v. Appling, 138 S.Ct. 1752, 1761 (2018),  finding that “a statement is ‘respecting’ a debtor’s financial condition if it has a direct relation to or impact on the debtor’s overall financial status. A single asset has a direct relation to an impact on aggregate financial condition, so a statement about a single asset bears on a debtor’s overall financial condition and can help indicate whether a debtor is solvent or insolvent, able to repay a given debt or not. Naturally, then, a statement about a single asset can be a “statement respecting the debtor’s financial condition.” Lamar found that: “Had Congress intended § 523(a)(2)(B) to encompass only statements expressing the balance of a debtor’s assets and liabilities, it could have so specified—e.g., ‘statement of the debtor’s financial condition.'”

Oral Statements Respecting an Insider’s Financial Condition Are Also Barred as Fraud Under Section 523(a)(2)(A) of the Bankruptcy Code

Sometimes, the claim of fraud is that the debtor orally misrepresented the financial condition of their company, corporation, limited liability company, other business entity, or business partner. It is important to remember that, under Section 523(a)(2)(A) of the Bankruptcy Code, the exception to discharge is only for “for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”

“Where an individual debtor is involved, the definition of ‘insider’ includes a ‘corporation of which the debtor is a director, officer, or person in control.” Blackwell v. Dabney, 702 F.2d 490, 492 (4th Cir. 1983). However, the definition of insider is even more broad. Under 11 U.S.C. Section 101(31):

The term “insider” includes—
(A) if the debtor is an individual—
(i) relative of the debtor or of a general partner of the debtor;
(ii) partnership in which the debtor is a general partner;
(iii) general partner of the debtor; or
(iv) corporation of which the debtor is a director, officer, or person in control;
(B) if the debtor is a corporation—
(i) director of the debtor;
(ii) officer of the debtor;
(iii) person in control of the debtor;
(iv) partnership in which the debtor is a general partner;
(v) general partner of the debtor; or
(vi) relative of a general partner, director, officer, or person in control of the debtor;
(C) if the debtor is a partnership—
(i) general partner in the debtor;
(ii) relative of a general partner in, general partner of, or person in control of the debtor;
(iii) partnership in which the debtor is a general partner;
(iv) general partner of the debtor; or
(v) person in control of the debtor;
(D) if the debtor is a municipality, elected official of the debtor or relative of an elected official of the debtor;
(E) affiliate, or insider of an affiliate as if such affiliate were the debtor; and
(F) managing agent of the debtor.

Even if the creditor meets this hurdle, they will need to allege fraud with particularity by alleging the “who, what, when, where, and how” of the alleged misconduct. Indeed, even negligent misrepresentation can form the basis of fraud, which can become a nondischargeable judgment. Note that bankruptcy lien avoidance on exempt property is permissible even for nondischargeable debts [11 USC 522(f)(1) & 523(a)].

Contact a Bankruptcy Nondischargeability Attorney in California Serving Los Angeles, Orange County, San Diego, Riverside, Palm Springs, San Bernardino, Palo Alto, San Jose, Santa Barbara, Redding, Oakland, and Long Beach

Nondischargeability in bankruptcy is a complex and difficult area of law where skilled a knowledgeable bankruptcy attorney with experience in adversary proceedings can guide you through the bankruptcy process from start to finish. If you have a question, contact Talkov Law at (844) 4-TALKOV (825568) or contact us online.

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About Ferdeza Zekiri

Ferdeza Zekiri is an attorney at Talkov Law in San Diego. The focus of her practice is real estate law and trusts, probate & estate law in California. She can be reached at (858) 800-3300 or ferdeza@talkovlaw.com

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