Representation of Financial Condition: Does the Sum Equal Its Parts?

Wednesday, February 21st, 2018 at 11:04 am by Sungha Park

On December 19, 2017, the Court of Appeals for the Fifth Circuit held that the debt of a bankrupt Texas businessman would be forgiven, even though he provided misleading oral statement about his company’s financial health.[1] Under §523(a)(2)(A), debt that was obtained through false pretense or fraud cannot be discharged through a bankruptcy proceeding, except if the representation had been an oral “statement respecting the debtor or an insider’s financial information.”[2] This decision revisited the disagreement between Court of Appeals on whether statements regarding a single asset class can qualify as statements respecting financial conditions under §523(a)(2)( )

In In re Haler, the Fifth Circuit reversed the decision from the lower court, ruling that the oral statement made by the debtor in the case can be an oral “statement regarding… financial condition” that falls outside the scope of §523(a)(2)( ).[3] In this case, the statement at issue was that the defendant’s company was in “very fine legally [sic] financial shape” and that it had “plenty of cash to operate [the] business”.[4] The Fifth Circuit reasoned that this was the type of statement that “purport[s] to present a picture of the debtor’s overall financial health,” which the statute had intended to protect.[5]

While dictum, the court mentions an interesting circuit split regarding whether a representation about a certain asset can qualify as the exception statement under §523(a)(2)(A).[6] The court does not continue with this discussion, as it did not need to in order to decide on the case. However, this split brings up a new question: at what point does a conversation become statement respecting overall financial condition?

The Tenth and the Eighth Circuits have held that representations regarding a specific asset class do not qualify as statements regarding overall financial condition. In In re Joelson, the Tenth Circuit held that courts should give debtors less leeway to discharge their debt, as representations regarding specific asset class are less likely to bear inadvertent errors.[7] The court viewed that the exception built into §523(a)(2)( ) was intended to protect debtors who made mistakes in the representation of their financial condition. The Eighth Circuit takes a similar view, saying that the failure to disclose sale of a particular asset cannot qualify as the exception under §523(a)(2)( ).[8]

However, other Chave come to a different conclusion. The Eleventh Circuit clarified in In re Appling that a “debtor’s assertion that he owns certain property free and clear of other liens is a statement respecting his financial condition.”[9]  Further, it added that the Bankruptcy Code calls for a plain interpretation of the word “respecting”, which in turn should be defined broadly to include a statement about a single asset that relates to or impacts the debtor’s overall financial condition.[10] Similarly, the Fourth Circuit also agreed with this view, by holding that the Congress did not speak in terms of financial statements.[11] The court reasoned that the lack of reference to a financial-statement-like representation must mean that the Congress must have intended this exception to be applied broadly: to include representation regarding single class of assets.[12]

The disagreement between these two school of thoughts can be summarized as a question of line drawing. At what point does a representation become statement respecting overall financial condition? The courts seem to agree that broad statements representing the financial condition should be given leeway, but disagree about whether smaller components of such statement should also be given exceptional treatment.

The Tenth and the Eighth Circuit hint that this exception exists to protect debtors making innocent mistakes, and such mistakes should not be forgiven when more accuracy can be attained by talking about specific asset classes. This policy-oriented view places heightened burden on each debtor, to incentivize debtors to accurately represent each of its asset class. This, however, creates a contradicting situation; debtors are encouraged to be accurate in its statements regarding each asset class, but making an overall misstatement may be forgiven. In other words, instead of inquiring into the overall financial health of debtors, creditors will be incentivized to make specific inquiries into each of the relevant and material assets and liabilities. This in turn fosters a don’t ask, don’t tell approach for debtors.

On the other hand, the broad approach that the Eleventh and the Fourth Circuit take also has its shortcomings. Interpreting statements regarding a specific asset places this exception clause on a slippery slope. At what point is a statement NOT respecting the financial condition of the debtor? Following the logic that the term “respecting” should be interpreted as “relates to” or “impacts”, one may argue that almost any statement regarding the debtors’ business falls under this exception. Without a firm limitation on the scope of this type of communication, the statutory exception will be applied too broadly and its significance will be diminished.

As for the time being, the best way to ensure protection against this confusion is to limit such representation to written statements. §523(a)(2)( ) is interpreted as applicable to only non-written statements, whereas §523(a)(2)(B ) provides guidance on similar written communication, disallowing such “financial condition” exception.

[1] Haler v. Boyington Capital Grp., LLC (In re Haler), No. 17-40229, 2017 BL 466302 (5th Cir. Dec. 29, 2017).

[2] Id. at 2, quoting 11 U.S.C. § 523(a)(2)(A).

[3] Id. at 3

[4] Id.

[5] Id.

[6] Id. at 4, n2

[7] Cadwell v. Joelson (In re Joelson), 427 F.3d 700, at 707 (10th Cir. 2005).

[8] See Rose v. Lauer (In re Lauer), 371 F.3d 406 (8th Cir. 2004).

[9] Appling v. Lamar, Archer & Cofrin, LLP ( In re Appling), 848 F.3d 953, at 957 (11th Cir.2017), quoting Engler v. Van Steinburg, 744 F.2d 1060, 1061 (4th Cir. 1984).

[10] Id. at 958

[11] Engler v. Van Steinburg (In re Van Steinburg), 744 F.2d 1060 (4th Cir. 1984)

[12] Id. at 1060-1061.