Bankruptcy Court Predicts Fifth Circuit Will Adopt Broad View of Statement of Financial Condition

Section 523(a)(2) is a Code section which is very familiar to most experienced practitioners, but still can be tricky. In particular, the distinction between statements regarding financial condition and all other fraudulent statements has prompted disagreement among the courts. A new opinion from Judge Craig Gargotta predicts that the Fifth Circuit would join the minority position on this issue. Material Products International, Ltd. v. Ortiz, No. 09-1062 (Bankr. W.D. Tex. 8/27/10). You can find the opinion here.

There are three types of fraudulent statements under 11 U.S.C. Sec. 523(a)(2):

1. Statements which are not made "respecting the debtor's or an insider's financial condition" which are actionable under Sec. 523(a)(2)(A);

2. Written statements "respecting the debtor's or an insider's financial condition" which are actionable under Sec. 523(a)(2)(B) and have a higher reliance standard; and

3. Verbal statements "respecting the debtor's or an insider's financial condition" which cannot form the basis for a non-dischargeability complaint based on fraud.

Because the distinction between statements about the debtor or an insider's financial condition and all other statements is significant, it is important to know what a "statement respecting the debtor's or an insider's financial condition" means.

The majority opinion, as represented by the Tenth Circuit's opinion in In re Joelson, 427 F.3d 700 (10th Cir. 2005), holds that only statements which concern a debtor's overall financial condition, that is, are the equivalent of a financial statement, will be subject to the restriction. The minority position holds that "financial condition" is broader than simply a financial statement and that statements regarding an individual asset may qualify.

In the Ortiz case, the creditor alleged that the Debtor had lied about whether equipment at a restaurant was free of liens. (The restaurant was located in my neighborhood and I ate there once. There was nothing about the food which indicated that it was or was not subject to prior liens). The creditor's complaint alleged the elements of Section 523(a)(2)(A) and quoted the statute. The complaint did not reference Section 523(a)(2)(B). The debtor filed a motion for judgment on the pleadings under Rule 12(c).

The court ruled that whether the equipment was subject to prior liens was a statement regarding financial condition. Thus, it could not be brought under Sec. 523(a)(2)(A). Although the Fifth Circuit has not ruled on this issue, the Court found the Fifth Circuit's opinion in In re Mercer, 246 F.3d 391 (5th Cir. 2001) to be instructive. Judge Gargotta wrote:

The parties readily agree that the Fifth Circuit has not addressed this issue. That said, the Court agrees with the Defendants that the Fifth Circuit’s opinion in AT&T Universal Card Svcs. v. Mercer (In re Mercer), 246 F.3d 391, 405 (5th Cir. 2001) is suggestive of how the Fifth Circuit might rule.

The Court agrees with the Defendants’ assertion that while it has not expressly addressed the scope of a “statement respecting a debtor’s or insider’s financial condition,” the Fifth Circuit Court of Appeals’s decision regarding the applicability of § 523(a)(2) to credit card use is consistent with the broad interpretation of that phrase. Under that approach, courts have included statements that reflect on the debtor’s ability to pay as statements respecting a debtor’s financial condition. See Mercer, 246 F.3d at 405 (5th Cir. 2001) (noting that “if [credit] card-use could be understood as a representation not only of intent, but also ability, to pay, the latter is not actionable under § 523(a)(2)(A); as noted, it excludes from its scope ‘a statement respecting the debtor’s . . . financial condition.’”) (emphasis and footnote omitted); (additional citations omitted).

Therefore, as a matter of law, taking all Plaintiff’s allegations in the Complaint as true, Plaintiff cannot show that the claim is non-dischargeable under § 523(a)(2)(A) as it alleges, and the Defendants are entitled to judgment on the pleadings denying the Plaintiff’s cause of action requesting that the claim be declared non-dischargeable.

Ortiz, slip op. at 15-16.

This opinion is significant because Judge Gargotta adopted the minority position. By taking a broad view of what constitutes a statement of financial condition, the Court has given creditors a higher burden of both pleading and proof. When in doubt about whether a representation is a statement of financial condition, it is better to plead both subsections (A) and (B) in the alternative.