Two recent cases analyzed the misrepresentations of a debtor regarding a single asset and held a written misrepresented value of a single scheduled estate asset would result in nondischargeability under Section 727, and that a verbal misrepresentation of a pre-petition asset to a creditor did not result in an exception to discharge under Section 523.
In Worley v. Robinson,/ the Fourth Circuit affirmed nondischarge where a financially sophisticated debtor’s Schedules substantially undervalued his estate’s only substantial asset. In Appling v. Lamar, Archer Cofrin LLP,/ the Eleventh Circuit reversed a district decision and held that a false oral statements to a creditor regarding one pre-petition asset would not render the associated debt nondishargeable because they were statements of “financial condition” that must be in writing to support denial of discharge of a debt.
Litigation seeking nondischarge under Section 727 or the dischargeability of a debt under the exceptions of Section 523 is a broad topic. In general terms:
- Section 727 provides a broad scope of discharge for the debtor, but sets out certain misconduct that will result in nondischarge, which denies the remedy of discharge of any of the debtor’s obligations. The scope of such misconduct is generally some manner of fraudulent representation or activity in the context of the bankruptcy case, though it can involve pre-petition conduct. The issue of nondischarge is raised procedurally by an objection to discharge filed by a creditor, the Trustee, or the U.S. Trustee.
- Section 523, on the other hand, provides for exceptions to the general discharge of the debtor. These exceptions can render a specific obligation nondischargeable. Many of the exceptions are based on legal policies surrounding the character of the indebtedness, like certain taxes, child support obligations, and student loans. But the commonly litigated exceptions generally involve some manner of pre-petition fraud upon a specific creditor. The offended creditor typically initiates an adversary proceeding to obtain such an exception to discharge.
The Worley and Appling cases offer illustrations of nondischarge and dischargeability from the most singular perspective where the debtor’s misrepresentation pertains to only one asset. The very limited facts regarding the assets actually help to identify the very important governing principals and policies of these different Bankruptcy Code treatments of alleged debtor misconduct.
In Worley, the debtor suffered nondischarge where he used a capitalization of income method to value an investment at $2,500, but the Court found it to be worth at least $13,200 under different considerations. While just those facts may make it seem the Court was slicing it pretty thin against this debtor, other facts leveraged the adverse holding. The debtor was an MBA with 10 years of brokerage experience who assumedly knew that the valuation method he used would undervalue the basically non-income producing asset, and that the “no asset” appearance of his bankruptcy Schedules would tend to chill further investigation by creditors or the trustee or even lead to abandonment of the property. The Court found no clear error in the bankruptcy court’s denial of discharge under Section 727(a)(4), for the making a false oath or account.
Appling also involved very simple facts: the debtor lied to his lawyers to obtain pre-petition legal services on credit, first saying that he expected a big tax refund that would enable him to pay his legal bills, then after getting the refund, using it in his business and telling his lawyers he didn’t get the refund. But again, the simple facts regarding this asset assist the clarity of the legal issues involved. Section 523(a)(2)(A) and (B) both provide for exceptions from a discharge a debt obtained by misrepresentations. However, (B) governs any misrepresentation “respecting the debtor’s … financial condition”, and requires that the misrepresentation be in writing. Misrepresentations regarding other topics are governed by (A), and may be oral statements. So, the question in Appling turned to whether debtor’s oral statements about this one asset were statements “respecting the debtor’s … financial condition.” If they were, then Section 523(a)(2)(B) controls, and if the creditor does not have a written statement, the creditor loses. Here, the existence vel non of a tax refund did relate to financial condition, and lacking any writing by the debtor about it, the debt was dischargeable./ (We at The Bankruptcy Cave found this confusing – what oral statements do not relate to financial condition, and thus could lead to nondiscahrgeability? The opinion answers it – “false [oral] representations about job qualifications and lies about the purpose and recipient of a payment,” for example, are the stuff that can lead to nondischargeability. But if the creditor is complaining about a falsehood regarding financial condition, it should have gotten it in writing, the Eleventh Circuit held.)
Together the Worley and Appling cases show the varied levels of legal scrutiny of debtor intent and creditor reliance, and variable levels of materiality in the landscapes of nondischarge and dischargeability. (My colleague Mark Duedall from BC Atlanta also wrote recently on this, in the context of a lender’s failure to perform any real diligence on a debtor’s statements, rendering the lender’s reliance unreasonable and foiling another effort to deny a discharge, here.) It is intuitively useful to first remember that discharge and a “fresh start” are basically the whole point of the Code, and that variance of that result would be relatively rare. (See a nice collection of Supreme Court statements on this point here.)
In the context of Section 523 dischargeability and misrepresentations, there is, in practical effect, a relatively lower expectation of debtor intent and a higher scrutiny of creditor reliance. For example, the Appling case arguably weighs “fresh start” against a legally sophisticated creditor’s unsecured lending to a financially distressed guy based on his oral statement that he was going to get a tax refund. Is that really the creditor due diligence or underwriting standard that the Courts are endeavoring to protect in the scheme of Code policy goals? Is that the creditor we should break “fresh start” for? Is it too much to ask for unsecured creditors to obtain written statements of the borrower’s financial condition? Were the oral statements really material to any reliance upon which credit was extended? The result in Appling would indicate a negative answer to each of those rhetorical questions.
However, in the context of Section 727 nondischarge and misrepresentations, there is, in practical effect, a relatively higher expectation of debtor intent and a lower scrutiny of creditor reliance. For example, the Worley case arguably weighs the debtor’s “fresh start” against his own financially sophisticated methods of asset valuation without any consideration of whether reasonably diligent creditors or trustees would have, in fact, been fooled. Section 727 is itself the “fresh start”, and so the expectations of debtor conduct in the proceeding are high. Does a debtor have to be scrupulously honest in characterizing his financial condition? Can a Court scrutinize errors in a debtor’s Court statements down to the level of a single asset and the debtor’s subjective experience and expertise? In the right circumstances, can a single asset be so material as to support nondischarge? The result in Worley would yield positive answers to all those questions.
While the Worley and Appling cases involve unusual matters in their analysis of single asset factual disputes, the cases do illustrate that disputes involving nondischarge and dischargeability do not tend to provide safe harbors, and rather always involve a facts-and-circumstances analysis and a result that will largely depend on issues of intent, reliance, and materiality.