Lee Dunham—Senior Attorney, National Legal Research Group
It can be frustrating for creditors when a debtor files for bankruptcy, especially when the creditor has put time and expense into successfully litigating a claim in court and obtaining a judgment. Nonetheless, with limited exceptions, even judgment debts are dischargeable in bankruptcy. Among these exceptions to discharge are exceptions that apply to certain fraudulently incurred debts. To claim the benefit of these exceptions, the creditor must bring a timely filed “adversary proceeding” (a suit filed in the Bankruptcy Court, under a separate case number but under the umbrella of the larger bankruptcy case) and plead and prove that a particular debt is nondischargeable under 11 U.S.C. § 523(a)(2)(A) or (B).
In nondischargeability actions brought pursuant to § 523(a)(2)(A), the plaintiff bears the burden of proving the elements of the claim by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 291 (1991); In re Ricker, 475 B.R. 445, 455 (Bankr. E.D. Pa. 2012); In re Witmer, 541 B.R. 769, 777 (Bankr. M.D. Pa. 2015).
A claim is nondischargeable under § 523(a)(2)(A) where the creditor proves each of the following: (1) the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or was made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiably relied on the false representation; and (4) its reliance was the proximate cause of loss. In re Rembert, 141 F.3d 277, 280-81 (6th Cir. 1998). Section 523(a)(2)(A) applies only to statements other than statements “respecting the debtor’s or an insider’s financial condition,” which fall under the narrower exception defined under § 523(a)(2)(B).
Justifiable reliance under § 523(a)(2)(A) is a subjective standard, and while a creditor must show that he or she actually relied upon a debtor's misrepresentation, the reliance need not be reasonable. Field v. Mans, 516 U.S. 59, 73 (1995). Moreover, the creditor is not required to show that he or she conducted an independent investigation into the truth or falsity of every representation. Id. However, the creditor is “required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation.” Id. at 71.
Most courts to consider the issue, including the First, Third, Sixth, Tenth, and Eleventh Circuits, have found that the intent to deceive can be inferred from the totality of the circumstances, including the debtor's reckless disregard for the truth. In re Cohn, 54 F.3d 1108, 1118-19 (3d Cir. 1995); Palmacci v. Umpierrez, 121 F.3d 781, 790 (1st Cir. 1997).
While a broken promise to repay a debt, without more, will not sustain a cause of action under § 523(a)(2)(A), such a promise made with scienter, or the lack of a present intent to repay the debt at the time the promise was made, is sufficient. See Field, 516 U.S. at 70-72.
A similar, but narrower, standard for an exception to discharge under § 523(a)(2)(B) applies to statements “respecting the debtor's or an insider's financial condition,” which can include, for example, representations that a particular asset will be used to pay the creditor. First, the statement must be “in writing.” The writing need not be particularly formal: an email can satisfy the requirement. See In re Owens, 549 B.R. 337, 351 (Bankr. D. Md. 2016); In re Hambley, 329 B.R. 382, 399 (Bankr. E.D.N.Y. 2005); In re May, 579 B.R. 568, 589 & n.79 (Bankr. D. Utah 2017). Second, the reasonableness of a creditor's reliance under § 523(a)(2)(B) is judged by an objective standard—the creditor must have exercised that degree of care that would be exercised by a reasonably cautious person in the same business transaction under similar circumstances. See Cohn, 54 F.3d at 1117-18.
These exceptions, while narrow, can be useful to protect a frustrated creditor who has not merely made a bad loan but who truly has been victimized by fraud.
It can be frustrating for creditors when a debtor files for bankruptcy, especially when the creditor has put time and expense into successfully litigating a claim in court and obtaining a judgment. Nonetheless, with limited exceptions, even judgment debts are dischargeable in bankruptcy. Among these exceptions to discharge are exceptions that apply to certain fraudulently incurred debts. To claim the benefit of these exceptions, the creditor must bring a timely filed “adversary proceeding” (a suit filed in the Bankruptcy Court, under a separate case number but under the umbrella of the larger bankruptcy case) and plead and prove that a particular debt is nondischargeable under 11 U.S.C. § 523(a)(2)(A) or (B).
In nondischargeability actions brought pursuant to § 523(a)(2)(A), the plaintiff bears the burden of proving the elements of the claim by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 291 (1991); In re Ricker, 475 B.R. 445, 455 (Bankr. E.D. Pa. 2012); In re Witmer, 541 B.R. 769, 777 (Bankr. M.D. Pa. 2015).
A claim is nondischargeable under § 523(a)(2)(A) where the creditor proves each of the following: (1) the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or was made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiably relied on the false representation; and (4) its reliance was the proximate cause of loss. In re Rembert, 141 F.3d 277, 280-81 (6th Cir. 1998). Section 523(a)(2)(A) applies only to statements other than statements “respecting the debtor’s or an insider’s financial condition,” which fall under the narrower exception defined under § 523(a)(2)(B).
Justifiable reliance under § 523(a)(2)(A) is a subjective standard, and while a creditor must show that he or she actually relied upon a debtor's misrepresentation, the reliance need not be reasonable. Field v. Mans, 516 U.S. 59, 73 (1995). Moreover, the creditor is not required to show that he or she conducted an independent investigation into the truth or falsity of every representation. Id. However, the creditor is “required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation.” Id. at 71.
Most courts to consider the issue, including the First, Third, Sixth, Tenth, and Eleventh Circuits, have found that the intent to deceive can be inferred from the totality of the circumstances, including the debtor's reckless disregard for the truth. In re Cohn, 54 F.3d 1108, 1118-19 (3d Cir. 1995); Palmacci v. Umpierrez, 121 F.3d 781, 790 (1st Cir. 1997).
While a broken promise to repay a debt, without more, will not sustain a cause of action under § 523(a)(2)(A), such a promise made with scienter, or the lack of a present intent to repay the debt at the time the promise was made, is sufficient. See Field, 516 U.S. at 70-72.
A similar, but narrower, standard for an exception to discharge under § 523(a)(2)(B) applies to statements “respecting the debtor's or an insider's financial condition,” which can include, for example, representations that a particular asset will be used to pay the creditor. First, the statement must be “in writing.” The writing need not be particularly formal: an email can satisfy the requirement. See In re Owens, 549 B.R. 337, 351 (Bankr. D. Md. 2016); In re Hambley, 329 B.R. 382, 399 (Bankr. E.D.N.Y. 2005); In re May, 579 B.R. 568, 589 & n.79 (Bankr. D. Utah 2017). Second, the reasonableness of a creditor's reliance under § 523(a)(2)(B) is judged by an objective standard—the creditor must have exercised that degree of care that would be exercised by a reasonably cautious person in the same business transaction under similar circumstances. See Cohn, 54 F.3d at 1117-18.
These exceptions, while narrow, can be useful to protect a frustrated creditor who has not merely made a bad loan but who truly has been victimized by fraud.
