Michael J. Custer, left, and Francis J. Lawall, right, of Pepper Hamilton.

Although broad, the Bankruptcy Code’s discharge provisions for individual debtors are not without limits. For example, as many practitioners know, Section 523 provides exceptions for debts or obligations incurred by false or fraudulent means. Arising from this Section 523 exception has been a dispute among the circuit courts involving individual debtors who make a false, but unwritten statement regarding one particular asset. In a recent decision, the U.S. Supreme Court tackled this difficult question by holding that such “a statement respecting the debtor’s financial condition,” is only excepted from discharge if, among other things, it is in writing. In so doing, the broad discharge the Bankruptcy Code provides individual debtors has been clarified and strengthened in Lamar, Archer & Cofrin v. Appling, 2018 U.S. LEXIS 3384 (U.S. June 4).

The facts in Lamar are straightforward. Prior to his bankruptcy filing, the debtor hired a law firm to represent him in business litigation. Thereafter, he fell behind on his legal bills, which soon totaled more than $60,000. As a result, the law firm threatened to withdraw from the litigation and place a lien on its work product until the bill was paid. At a subsequent meeting, the debtor told his attorneys that he was expecting a tax refund of approximately $100,000, upon which the firm relied. The debtor later filed his tax return, but requested a refund of less than $61,000 and ultimately received slightly less than $60,000. Rather than paying the law firm, the debtor spent the money on his business. At a subsequent meeting, the debtor told his attorneys he had not yet received the refund. The firm again relied on that statement and completed the litigation. Eventually the firm sent the debtor its final invoice, which went unpaid for five years. The law firm obtained a judgment in excess of $104,000, following which the debtor and his wife filed for bankruptcy.

In the bankruptcy case, the law firm argued that the debtor’s fraudulent statements concerning his tax refund rendered his debt nondischargeable pursuant to Section 523(a)(2)(A), which exempts debts from an individual’s discharge “to the extent obtained, by … false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s … financial condition.” The debtor moved to dismiss the nondischargeability complaint framing his alleged misrepresentations as a “statement … respecting his financial condition,” and therefore governed by Section 523(a)(2)(B), which requires such statements be “in writing” to be nondischargeable.

The bankruptcy court held that a statement regarding a single asset is not a “statement respecting the debtor’s financial condition,” and the law firm debt nondischargeable. The district court affirmed, but the U.S. Court of Appeals for the Eleventh Circuit reversed, finding that “statements respecting the debtor’s financial condition” could include a statement about a single asset, and because the debtor’s statements about his tax refund were not in writing, the debt was not excepted from discharge under Section 523(a)(2)(B). The Supreme Court granted certiorari to resolve a conflict among the courts of appeals as to whether a statement about a single asset can be a “statement respecting the debtor’s financial condition,” with the Fifth and Tenth circuits having found that it cannot, and the Fourth and Eleventh circuits having found that it can.

The Supreme Court began its analysis by focusing on the word “respecting” contained within the statutory phrase “statement respecting the debtor’s financial condition.” The appellant law firm argued that while the term could be used broadly, it also can have a more limited meaning, and when “respecting” was understood to have a more limited meaning, the phrase “a statement respecting the debtor’s financial condition” meant a statement that is “about” or “makes reference to” the debtor’s overall state or well-being. The law firm argued that under that formulation, a formal financial statement providing a detailed accounting of one’s assets and liabilities would qualify, as would more general statements about the individual’s overall financial status, but a statement about a single asset would not. The debtor, in response, argued that the term “respective” has an expansive meaning, such that a “statement respecting the debtor’s financial condition” is a statement “that has direct relation to, or impact on the balance of all of the debtor’s assets and liabilities or the debtor’s overall financial status.” As such, an oral statement describing an individual asset or liability would qualify.

The Supreme Court disagreed with the appellant law firm, finding there was no basis for a clear distinction between the various ordinary usage definitions of “respecting” that the firm sought to impose. Rather, the court observed that the word “respecting” in a legal context “generally has a broadening effect, ensuring that the scope of a provision covers not only its subject but also matters related to that subject.” The court agreed with the debtor, and the United States as amicus curiae, that given the ordinary meaning of “respecting,” the law firm’s statutory construction should be rejected because it effectively read the term “respecting” out of the statute. The court also agreed that a statement is “respecting” a debtor’s financial condition if it has a direct relation or impact on the debtor’s overall financial status. The court reasoned that a single asset has a direct relation to or impact on aggregate financial condition, and therefore a statement about a single asset bears on the debtor’s overall financial condition and can help indicate whether a debtor is solvent or not, able to repay a given debt or not.

The Supreme Court found further support in its conclusion by noting the “incoherent results” the law firm’s interpretation would yield, where a misrepresentation about a single asset made in the context of a formal financial statement or balance sheet would trigger Section 523(a)(2)(B)’s heightened nondischargeability requirements, but the same exact misrepresentation made on its own or in the context of a list of some but not all of the debtor’s assets would not. The court also found support for its interpretation in the statutory history of the phrase “statement respecting the debtor’s financial condition.” Between 1926, when the phrase was introduced in an amendment to the Bankruptcy Act of 1898, and 1978, when Congress enacted the Bankruptcy Code, Circuit courts had consistently construed the phrase to encompass statements addressing just one or some of a debtor’s assets or liabilities. The court reasoned that when Congress used the materially same language in Section 523(a)(2), it presumptively was aware of its longstanding judicial interpretation and intended for it to retain its established meaning.

Finally, the Supreme Court rejected the appellant law firm’s contention that the debtor’s interpretation would give Section 523(a)(2)(B) “implausibly broad reach” such that little would be covered by Section 523(a)(2)(A)’s general rule rendering debts arising from “false pretenses, a false representation or actual fraud” nondischargeable. The court countered that the provision would still retain significant function, even where the phrase “statement respecting the debtor’s financial condition” is interpreted to encompass a statement about a single asset, because Section 523(a)(2)(A) has been applied to types of debts that can be effected without a false representation, like fraudulent conveyance schemes, and debts resulting from misrepresentations about the value of goods, property or services. The court also rejected the law firm’s argument that the debtor’s interpretation was inconsistent with the overall principle that the Bankruptcy Code exists to afford relief only to the honest but unfortunate debtor. The court found the legislative history of Section 523(a)(2)(B) reflected a balance between the potential misuse of statements by debtors with the need to protect individuals from consumer finance companies’ practices that encouraged loan applicants to make incomplete disclosures in order to render resulting debts nondischargeable. The court concluded that the law firm’s interpretation of the exception would exclude precisely the type of statements Congress was concerned with when adopting Section 523(a)(2).

The Lamar court’s decision may be unsatisfying from an emotional perspective given the protection it affords debtors who verbally misrepresent their assets or liabilities to a creditor, but it is an important development as it further strengthens the Bankruptcy Code’s vital discharge provisions for such debtors. The decision should prompt creditors and their counsel to ensure that individuals with whom they are transacting business commit to writing any statements regarding their financial condition, including statements regarding any particular asset or liability, so as to increase the chance that a resulting debt will be deemed nondischargeable in bankruptcy.

Francis J. Lawall, a partner in the Philadelphia office of Pepper Hamilton, concentrates his practice on national bankruptcy matters and workouts, including the representation of major energy and health care companies in bankruptcy proceedings and general litigation throughout the United States.

Michael J. Custer is an associate in the corporate restructuring and bankruptcy practice group of the firm, resident in the Wilmington office.