Which Financial Representations Will Justify a Discharge Objection after Lamar, Archer?

Since the passage of the Bankruptcy Act of 1898, and particularly since 1926, United States bankruptcy laws have contained a provision that would penalize debtors who use false pretenses or false financial documents to obtain credit. The Supreme Court's decision in Lamar, Archer & Cofrin, LLP v. Appling, 138 S. Ct. 1752, 201 L. Ed. 2d 102 (2018) (Lamar, Archer) has significantly constricted the range and nature of statements that will support a successful objection by a creditor to the discharge of a debt that was obtained by the statements in question. This constriction could have a very real impact on how entities that loan money or provide services on credit review and collect information regarding a borrower's creditworthiness.

The Underlying Statutory Basis for Objecting to the Discharge of a Debt

11 U.S.C. 523(a)(2) currently provides that a debtor cannot obtain a discharge from a debt for money, property, services or an extension or renewal of credit if that debt was incurred or 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) on 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.

The statute carves out two types of representations by a borrower that will justify the denial of the borrower's discharge. The first is false pretenses or actual fraud that induce an entity to advance money or provide services on credit other than fraudulent statements about a borrower's financial condition. This exception encompasses false or fraudulent representations from a borrower regarding certain aspects of a pending business transaction, or the substance of that transaction, that induce a lender or service provider to extend credit.

One example would be a borrower's materially false or fraudulent representations regarding the value or potential future use of a piece of real estate owned by a third-party that will be the subject of a proposed loan (and thus collateral for the lender).

The second exception pertains to statements respecting the debtor's financial condition. In order to justify an objection to discharge, a borrower's statement about his or her financial condition must be in writing.

The Facts

Appling was a client of Lamar, Archer and Cofrin (the Firm), which was representing Appling in ongoing litigation. Appling fell behind on his legal fees, and the Firm informed Appling that it would withdraw from his representation if they could not reach an agreement on how the fees would be paid. Appling represented to the Firm that he was due to receive a substantial income tax refund (the Tax Refund) that would cover the Firm's accrued fees and fees going forward. Subsequent to making this representation, Appling received the Tax Refund, but expended it on business expenses instead of paying the Firm.

After receiving and spending the Tax Refund, Appling made a second representation to the Firm that the Tax Refund would be forthcoming and that he would use the refund to pay the Firm. Based on this representation, the Firm continued to provide legal services to Appling in connection with the litigation.

After the litigation concluded, Appling was unable to repay the Firm. The Firm sued Appling to recover the fees and obtained a judgment against him. Appling eventually filed a Chapter 7 liquidation action, and the Firm filed an Adversary Complaint under 11 U.S.C. 523(a)(2)(A) objecting to the discharge of Appling's judgment debt to the Firm.

The Primary Issue

The issue in the adversary proceeding before the bankruptcy court was whether Appling's statements regarding the Tax Refund, which was a single asset that impacted Appling's overall financial condition, constituted “… false statements, a false representation or actual fraud ….”, such that they did not have to be in writing for the Firm to prevent Appling from discharging his debt, or whether they were instead statements respecting Appling's overall financial condition, which had to be in writing to support the Firm's objection.

The Firm argued that the phrase “statements respecting financial condition” in the statute was limited to statements regarding Appling's overall financial condition, statements reciting the nature of all of his assets and liabilities, or simply statements regarding his solvency, such as “Don't worry, I am above water.”

Appling, with the support of an amicus curiae brief from the United States, argued that any statement that he had made regarding the Tax Refund was, in fact, a statement regarding his financial condition, such that it had to have been in writing before the Firm could use it to support its objection to Appling's discharge.

The Supreme Court's decision in Lamar, Archer resolves at least some questions regarding what constitutes a “… statement respecting the debtor's … financial condition ….”

The Court's opinion first considered the meaning of the word “respecting” and held that “respecting” encompasses anything that might “relate to,” concern or consider the debtor's financial condition. As such, “respecting” should be read to be broad and inclusive, encompassing more than just printed complete financial statements.

Accordingly, a debtor's statement about the status, value or ownership of a material single asset can be a “… statement respecting the debtor's financial condition …” just as much as a full printed financial statement. Under this holding, any statement that the borrower makes regarding the value or status of a single asset upon which the creditor relied in advancing funds or services must be in writing in order before a lender or service provider can use that representation to justify an objection to the discharge of a borrower's debt obligation. It is not enough for a creditor to simply rely on a debtor's oral representation that a piece of property, a patent right or an account receivable has a certain value. Instead, the lender must have some written confirmation of the debtor's representation in order to use that representation as the basis for a successful objection to the discharge of the borrower's debt to that creditor.

The Immediate Impact

Clearly, in the wake of Lamar, Archer, lenders and those that provide services on credit are going to have to insist that the information they rely upon to underwrite the credit must be in writing.

For example, if a lender is considering providing a loan that will be secured by a piece of commercial property that the borrower owns, any representations that the borrower makes regarding the value of that property must be in writing. If the borrower provides a fraudulent appraisal document or broker's opinion of value, this is clearly the type of evidence that the lender will submit to justify an objection under 11 U.S.C. 523(a)(2)(B).

Similarly, to the extent that a seller of raw materials is considering delivering goods to a borrower based on the value of the borrower's inventory of finished goods, the seller needs to ensure that any representation as to the value of the inventory is in writing.

Finally, and in a more difficult gray area, if a service provider is considering providing services on credit, the provider should make certain that any representations about the strength and likely revenue from a given customer relationship are made in writing.

Credit underwriting typically involves reviewing a number of facets of a borrower's financial condition, including a review of a debtor's financial statements and the documentation the supports the line items therein. Any misrepresentations in these statements or documentation could well support an objection to discharge under 11 U.S.C. 523(a)(2)(B). However, these same credit decisions are often based on the strength of one or two assets that could be liquidated to repay the debt in the event of a default.

When the underwriting process focuses on these types of assets or classes of assets, lenders now need to make certain that their files contain significant written documentation and evidence as to what the borrower has represented with regard to the value of those key collateral assets.

The Thorny Issues That Remain

Lamar, Archer leaves some issues open for further review. For example, what is a “writing” that would be sufficient to justify an exception to discharge?

Clearly, if a borrower tenders to the lender a written “marketing proposal” regarding a piece of the borrower's property that contains material misrepresentations as to the value of the property, that should be sufficient to meet the “writing” requirement (provided it is reasonable for the creditor to rely on this type of information).

But what would be the result if a loan officer or credit manager receives an oral representation from the borrower regarding the value, status or strength of a given asset, and then engages in a series of confirmatory emails with the borrower wherein the borrower, in an email “writing,” confirms the understanding of the lending officer or credit manager regarding that asset's value? Will such a confirmatory email be sufficient to constitute a “writing”?

Similarly, Lamar, Archer appears limited to representations regarding a single asset of the borrower. What is the likely outcome when a borrower makes oral representations regarding the value or strength of a class of assets such as commercial leases in which the borrower is the lessor? Does the lender need to have written estoppel certificates for each lease or some other verification as to the term and rent due for each lease, or is it sufficient for the lender to obtain the borrower's email confirming the understanding of the lending officer or credit manager with regard to the value of the leases going forward?

Conclusion

Until bankruptcy courts and the various United States courts of appeal have an opportunity to apply and refine the holding in Lamar, Archer, lenders and service providers should train their lending officers and credit managers to go to extraordinary lengths to make sure that any representations made by a particular borrower or recipient of services are thoroughly documented through some type of writing that has been prepared by or at least confirmed in writing by the prospective borrower or service recipient.

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John A. Thomson, Jr. is an attorney with Adams and Reese (Atlanta) and a member of the Banking and Financial Services Practice Team. John has been a commercial litigator and bankruptcy attorney for more than three decades. He represents a variety of clients in matters related to debtor and creditor issues, commercial bankruptcies and commercial finance.