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Supreme Court Provides Harsh Lesson on the Importance of a Writing

Bankruptcy is intended to allow an honest but unfortunate debtor to obtain a fresh start.  In order to keep dishonest debtors from abusing the process, Congress has defined a class of debts which cannot be discharged in a bankruptcy proceeding.   One of the common exceptions to discharge is debts incurred through fraud.   However, the Bankruptcy Code distinguishes between two types of fraudulent debts.   A fraudulent statement respecting “the debtor’s or an insider’s financial condition” must be in writing in order to be excludible from the discharge.

In its June 4, 2008, decision in Lamar, Archer & Cofrin, LLP v. Appling, the Supreme Court ruled that a statement regarding a single asset qualified as a statement “respecting the debtor’s . . . financial condition.”   In a scenario familiar to many lawyers, a client got behind on paying his legal fees.   When the firm threatened to withdraw, Appling told the law firm that he had a tax refund coming in the amount of approximately $100,000 which he would use to bring them current and cover future fees.   Unfortunately, the refund was less than $60,000 and Appling used it to pay business expenses instead of paying his lawyers.

When  Appling filed for bankruptcy protection, the law firm claimed that as a result of his false oral statement, the debt was non-dischargeable under the general fraud exception to discharge.   The debtor, on the other hand, claimed that the statement concerned his financial condition and therefore could not form the basis for a non-dischargeable debt because it was not in writing.   The Bankruptcy Court found the debt to be non-dischargeable., but the Eleventh Circuit Court of Appeals reversed, finding that the statement regarding the tax refund, was a statement regarding “the debtor’s . . . financial condition.”

Writing for a unanimous Court, Justice Sotomayor used grammarian interpretation of the statute.   She found that the term “respecting” had a broadening effect such that it referred not only to its subject but also matters related to its subject.   She also noted that cases under the Bankruptcy Act had interpreted similar language to refer to just one or several of the debtor’s assets.    Thus, while a lie about even a single asset could keep a debt from being discharged, a debtor can make a false statement regarding one or all of his assets and still receive a discharge of the resulting debt if the statement is not in writing.

The lesson is that an oral statement regarding a debtor’s financial condition is not worth the paper on which it isn’t written.   When a law firm or other creditor is negotiating with a debtor who promises to pay from a specific asset, the creditor should get the debtor to confirm in writing any promises or representations regarding the asset.   If the law firm had gotten Appling to send an email stating “I will pay you from the tax refund of approximately $100,000 I will be receiving,” the debt could have been non-dischargeable.     In a text and email world, this in not an onerous expectation.