SCOTUS Allows Bankruptcy Protections for Dishonest Debtors

June 11, 2018 by Alexa P. Stephenson, Esq.

The Supreme Court of the United States issued a decision on June 4, 2018 that may pose sweeping changes for how creditors challenge bankruptcies in federal court. The Court confirmed enhanced protections for debtors who attempt to discharge unsecured debts in bankruptcy, even if those obligations were obtained by fraudulent statements. In siding with debtors, the Supreme Court interpreted the U.S. Bankruptcy Code to allow debtors to discharge and terminate debts through the bankruptcy process, regardless of how said debts were obtained.

In the Chapter 7 bankruptcy case of R. Scott Appling, the law firm Lamar, Archer & Cofrin, LLP filed an adversary proceeding alleging that Appling’s debt was non-dischargeable pursuant to Section 523(a)(2)(B) of the U.S. Bankruptcy Code after Appling insisted he would be using an imminent $100,000.00 tax return to pay off his past due legal fees owed to the firm and then filed bankruptcy to discharge that same debt.

Section 523(a)(2)(B) exempts a debt from discharge if the debt or services by which the debt was created were obtained “false pretenses, a false representation, or actual fraud other than a statement respecting the debtor’s … financial condition.” Here, Appling had previously stopped paying his legal bills and the law firm threatened to drop him as a client and place a lien on his work product until the debt was repaid. Only after Appling insisted that he would be receiving a $100,000 tax return which would allow him to repay his legal expenses did the firm continue to represent Appling and work on his case.  However, after applying for and receiving a tax return of only approximately $60,000.00, Appling told the firm that he had not received his return yet so that they would continue to work on his legal matters and paid the firm nothing.

Appling attempted to dismiss the adversary proceeding by claiming that his statements regarding his ability to pay off accrued legal fees with the tax return were respecting the debtor’s financial condition, were therefore governed under Section 523, and that the non-dischargeability claim should be dismissed because the statements were not in writing.

The bankruptcy court disagreed and denied Appling’s motion to dismiss, finding that Appling had made false statements to the firm. However, the Eleventh Circuit Court of Appeals held that a “statement respecting the debtor’s financial condition” may include a statement about a single asset, and ultimately denied the law firm’s claim that the debt was non-dischargeable pursuant to Section 523(a)(2)(B).

SCOTUS then affirmed the Eleventh Circuit’s decision after looking at the specific language used in Section 523(a)(2)(B), such as “statement”, “respecting,” and “financial condition.” The parties agreed, along with the Solicitor General, that the term “financial condition” referred to one’s overall status. SCOTUS found that using the term “respecting” in a legal context means that the scope of a provision covers not only its subject, but also matters relating to that subject.

The firm contended that the term “statement respecting the debtor’s financial condition” referred only to one’s overall financial status. The Court rejected the law firm’s argument and concluded that a statement is respecting the debtor’s financial condition “if it has a direct relation to or impact on the debtor’s overall financial status.” Because a statement about a single asset can have an effect on a debtor’s overall financial condition, such a statement can be considered a “statement respecting the debtor’s financial condition.” Thus, since Appling’s statements concerning his tax returns were not in writing, the firm’s claims about the statements did not meet the criteria of Section 523(a)(2)(B). In short, Appling got to discharge his debt to the firm despite the fact that he made false statements to the firm.

It is too early to know what effect this decision will have on future bankruptcy proceedings. However, the conclusion reached by the Supreme Court indicates that a statement from a debtor about a single asset can constitute a statement concerning the overall financial condition of the debtor, thereby expanding the scope of Section 523.

This decision will lead to more creditors protecting themselves by requiring that any statements about a debtor’s financial condition be made in writing in order to preserve their claims under Section 523(a)(2)(B) should bankruptcy litigation occur.

For small businesses or individuals that extend credit to persons based on verbal guarantees, this may prove troublesome to the extent that if a false statement is not made in writing by the debtor, it would preclude them from having their debt be deemed non-dischargeable through the bankruptcy court.

If you are a creditor in a bankruptcy case or have questions about this article, the attorneys at Geraci Law Firm are more than happy to help you.