June 19, 2018
Authored by: Natalie Daghbandan and James Maloney
The recent decision from the United States Supreme Court in Lamar, Archer & Cofrin, LLP v. Appling (“Lamar”), further restricts a creditor’s ability to pursue future recovery on its debt through a nondischargeability action in a debtor’s bankruptcy. On June 4, 2018, the Court ruled in Lamar that a debtor’s false statement about a single asset must be in writing before the creditor’s debt can be excepted as nondischargeable in bankruptcy.
The Supreme Court’s full opinion can be viewed here: Lamar Opinion 2018 . The Court’s decision in Lamar resolved a circuit split and provides for consistent interpretation of the Bankruptcy Code which did not previously exist. The issue before the Court was whether a false oral statement about a single asset can render a specific obligation nondischargeable, or whether such a statement must be in writing.
Nondischargeability in Bankruptcy
A brief review of the concept of “nondischargeabilty” is helpful. A public policy underlying U.S. bankruptcy law is that an honest debtor should receive a fresh start after seeking bankruptcy protection. This “fresh start” is implemented by a bankruptcy “discharge” which generally protects debtors against creditors pursuing them for recovery of their debts after the bankruptcy case.
However, there are exceptions to this discharge, and some of them arise by reason of misrepresentations by the debtor. Remember, the underlying public policy is for honest debtors to receive a discharge. A creditor can sue a debtor within the bankruptcy case (aka an adversary proceeding) to except the creditor’s specific debt from the debtor’s discharge because of misrepresentations made by the debtor. If the creditor prevails, that particular creditor’s debt is “nondischargeable”. (Note this is different from objecting to the debtor’s discharge entirely—see the Bankruptcy Cave’s prior blog post discussing this distinction: BCLP singular-cases-nondischarge-and-dischargeability). If a creditor’s debt is determined to be “nondischargeable” then the individual debtor remains responsible for repayment of that debt despite filing for bankruptcy protection and receiving a discharge.
A creditor can seek to except its debt from a debtor’s discharge if the creditor extended credit to the debtor and that credit was obtained by a false representation. See 11 U.S.C. § 523(a)(2)(A). However, there is a limitation. If the false representation is a statement “respecting” the debtor’s financial condition, the statement must be in writing for the debt to be nondischargeable. See 11 U.S.C. § 523(a)(2)(B).
Facts in Lamar
Bankruptcy debtor R. Scott Appling (“Appling”) was a former client of the law firm Lamar, Archer & Cofrin, LLP (the “Law Firm”). The Law Firm represented Appling in litigation. When Appling was unable to pay his legal bills Appling told the Law Firm that he was expecting a substantial tax refund which would cover his outstanding legal bills and be enough to pay future legal fees incurred in ongoing litigation. In reliance on this statement, the Law Firm continued to represent Appling and did not take action to immediately collect on Appling’s overdue legal bills.
However, Appling’s statement to the Law Firm attorneys was false. He only received a modest tax refund and he spent that money on his business instead of paying the Law Firm. The Law Firm eventually sued Appling and obtained a judgment for the unpaid legal fees. Appling subsequently filed for bankruptcy protection.
Lower Courts’ Interpretation of 11 U.S.C. § 523 and Corresponding Circuit Split
The bankruptcy court, as the original trial court, ruled in favor of the Law Firm finding its debt to be nondischargeable in Appling’s bankruptcy case. The district court, on appeal, affirmed the bankruptcy court’s ruling. However, on further appeal at the Eleventh Circuit, the court overturned the lower courts’ decisions finding that a debtor’s fraudulent statement regarding a single asset may constitute a statement “respecting” the debtor’s financial condition and, thus, must be in writing to be considered a nondischargeable debt.
The Eleventh Circuit’s ruling was consistent with the Fourth Circuit’s interpretation of 11 U.S.C. § 523(a)(2). However, the Fifth, Eighth and Tenth Circuits have held that a statement about a single asset is not “respecting” a debtor’s financial condition and thus need not be in writing for the debt to be dischargeable.
Issue on Appeal
The central issue on appeal was whether Appling’s oral statement regarding his tax refund, a single asset, was “respecting” his financial condition and thus dischargeable under 11 U.S.C. § 523(a)(2)(A) or whether Appling’s statement regarding his tax refund needed to be in writing to be dischargeable under 11 U.S.C. § 523(a)(2)(B).
Supreme Court’s Decision
The Court’s decision turned on the meaning of the word “respecting” in the application of § 523(a)(2)(A). The Court determined that because the Bankruptcy Code does not define the term “respecting”, the Court looks to the plain meaning of the word. The Court consulted multiple dictionaries and interpreted the term’s plain meaning expansively. Accordingly, the Court held that an individual debtor’s statement about a single asset was a statement respecting the debtor’s financial condition and had to be in writing to be nondischargeable.
As a general matter the Bankruptcy Code prohibits individual debtors from canceling their debts that were incurred from dishonest or fraudulent conduct of the individual debtor. However, the exception to this general rule can be found in 11 U.S.C. § 523(a)(2)(B) where statements respecting the debtor’s financial condition must be in writing to be nondischargeable. Congress enacted this statute to protect individual debtors from abusive creditors in the consumer credit industry who would historically induce debtors to sign incomplete or inaccurate financial statements to render the debts nondischargeable in bankruptcy. In this decision, the Court has reemphasized the underlying public policy dedicated to an individual’s fresh start after emerging from bankruptcy.
This decision will likely be of particular import to small businesses that routinely rely on oral agreements from customers. Law360 –Small Businesses ClientsFace Off On Debt Discharge and Law360 Justices Remind Creditors To Get Debt Agreements In Writing.
As a result of the Court’s ruling a creditor’s reliance on statements made by a debtor need to be in writing now more than ever before and will result in more reliable evidence for the underlying trial court. Ultimately, the Court’s broad interpretation of this statute will likely result in more uniform application of the Bankruptcy Code nationwide.