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Fraud Claim Released in Settlement Agreement Preserved in Bankruptcy Proceedings
Suppose that a lessor has a legitimate fraud claim against its lessee. Also suppose that in an effort to save the costs of litigation, this lessor agrees to settle the matter. The lessee executes a promissory note in favor of the lessor in exchange for a release. Now assume that the lessee not only defaults on its obligation under the promissory note, but also files for bankruptcy. As counsel for the lessor you feel safe assuming that the underlying fraud claim is nondischargeable under Section 523(a)(2)(A) of the Bankruptcy Code, and therefore the lessor's position is fairly strong. Well, in the jurisdiction of the Fourth and Seventh Circuits this assumption was incorrect before a recent ruling by the U.S. Supreme Court finally resolved this issue.
In Archer v. Warner, No. 01-1418 (March 31, 2003), the Supreme Court resolved a circuit split by ruling that where a settlement agreement releases an underlying fraud claim in exchange for a promissory note, the note does not act as a novation that creates a new debt. Therefore, the underlying fraud claim may still be applied to the promissory note, thus rendering it a nondischargeable debt under '523(a)(2)(A).
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