In Bandi, the debtors made false statements regarding their ownership of particular real estate. The Fifth Circuit upheld a finding that debts incurred in reliance on those false statements were non‑dischargeable in bankruptcy. The statements were characterized as false statements, but not as statements “respecting the debtor’s or an insider’s financial condition” which are only non-dischargeable if they meet more stringent standard.
Although a general goal of bankruptcy is to provide a “fresh start” for the debtor, there are limits. Section 523 of the Bankruptcy Code contains a number of exceptions from the discharge of an individual debtor including:
(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by
(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;
(B) use of a statement in writing –
(i) that is materially false;
(ii) respecting the debtor’s or an insider’s financial condition;
(iii) and 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.
Charles and Stephen Bandi (both Chapter 7 debtors) were guarantors of a commercial loan made to an affiliated company. The brothers had falsely represented to the lender (Becnel) that they owned a commercial building, a condominium that they were developing, and a residence. The bankruptcy court found (at least implicitly) that the intent was to “convey the impression that the two brothers owned valuable real property and that their personal guaranties of a loan to RSB [the affiliate company] would be backed by some measure of wealth.”
The key issue in this case was whether these misrepresentations were “a statement respecting the debtor’s or an insider’s financial condition” so that the more stringent test of subsection 503(2)(B) applied. Although it may seem strange to have a more stringent test for some lies than for others, as explained by the US Supreme Court in a case quoted in the Fifth Circuit opinion:
The House report on the [Bankruptcy Code] suggests that Congress wanted to moderate the burden on individuals who submitted false financial statements, not because lies about financial condition are less blameworthy than others, but because the relative equities might be affected by practices of consumer finance companies, which sometimes have encouraged such falsity by their borrowers for the very purpose of insulating their own claims from discharge.
After the lender obtained judgments on their personal guarantees, both brothers filed for bankruptcy protection under Chapter 7. The lender contended that their guarantee obligations should be non-dischargeable under both Sections 503(2)(A) and 503(2)(B). The bankruptcy court found that the loan was acquired through “false pretenses, false representations, or actual fraud regarding property ownership” under Section 503(2)(A). It also concluded that these were not statements regarding “financial condition” as contemplated by Section 503(2) since they were not statements about the “overall financial condition” of the debtor or an insider.
The district court affirmed, and upon appeal the Fifth Circuit agreed that “financial condition” means the “general overall condition of an entity or individual, that is, the overall value of property and income as compared to debt and liabilities.” It then held that a representation about ownership of particular properties does not say anything about overall financial condition since, among other things, the properties could be encumbered or undisclosed liabilities of the person could be far more than the value of the property.
The court acknowledged that there is a split among courts on the interpretation of a statement about financial condition. It noted that the Tenth Circuit and Eighth Circuit cases are generally consistent with the Bandi decision, while the Fourth Circuit has held that a representation about certain property being unencumbered is a statement regarding financial condition, and thus a loan made in reliance on the statement is dischargeable (unless the more stringent conditions of Section 503(2)(B) are met). So, the outcome in a particular case will depend in part on which jurisdiction is involved.
This case illustrates that if an individual debtor has made any misrepresentations in connection with obtaining credit (including for an affiliate), bankruptcy may not provide the magic bullet that allows the individual to escape liability.