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This Proposal Will Be Voted On By Mail Ballot

Consumer Bankruptcy

Proposal #7: 11 U.S.C. § 523 Exceptions to Discharge - Credit Card Debt, Including Debts Incurred to Pay Nondischargeable Federal Tax Obligations

Bankruptcy affords a broad discharge and a fresh start to "honest but unfortunate debtors." [ FN: Local Loan Co. v. Hunt, 292 U.S. 695 (1934); Goldberg Securities Inc. v. Scarlata, 979 F.2d 521 (7th Cir. 1992). Creditors therefore are expected to prove each element of an exception to discharge by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991).] Section 523 of the Bankruptcy Code specifically enumerates exceptions, which are to be construed narrowly, [ FN: See, e.g., Schweig v. Hunter, 780 F.2d 1577, 1579 (11th Cir. 1986); Manufacturer ’s Hanover Trust Company v. Ward , 857 F.2d 1082, 1083 (6th Cir. 1988).] for debts that should not be discharged in bankruptcy for public policy reasons, presumably because they involve "moral turpitude" or intentional wrongdoing. [ FN: See Thul v. Ophaug, 827 F.2d 340 (8th Cir. 1987).] Section 523(a)(2)(A), much like its predecessor under the Bankruptcy Act of 1898, excepts from discharge a debt for money, property, or an extension of credit to the extent it was obtained by false pretenses, a false representation, or actual fraud. [ FN: This provision excludes statements of debtors ’ financial condition, addressed in section 523(a)(2)(B).] Few would object to the notion that a debtor who has engaged in fraudulent activity should not be rewarded with a discharge of a debt that was obtained through that fraud.

The Commission has received numerous comments indicating that the current version of section 523(a)(2)(A) is ill-suited to assess the nondischargeability of credit card debt. Although they reach widely divergent conclusions on the substance of the provision, the courts seem to concur on one point: application of this exception to credit card debt "has been fraught with doctrinal difficulty." [ FN: See, e.g., AT&T Universal Card Services Corp. v. Feld, 203 B.R. 360 (Bankr. E.D. Pa. 1996); AT&T Universal Card Serv. Corp. v. Akdogan, 204 B.R. 90 (Bankr. E.D.N.Y. 1997) ( "Misrepresentation and reliance in the fraud context are anchored on a direct nexus or relationship between a debtor and a creditor. Here, as in so many other nondischargeability actions, there was little, if anything, in the nature of direct, purposeful contact between the credit card issuer and the credit card holder either at the inception or over the course of the relationship between the parties "). See also Citibank (South Dakota), N.A. v. Eashai, 87 F.3d 1082 (9th Cir. 1996) (credit card debts different than those arising from traditional two-party credit transactions).] Even direction from the circuit courts is not a panacea for the confusion; within the last year, the Court of Appeals for the 9th Circuit has issued four opinions analyzing section 523(a)(2)(A), three of which involve credit card debt and employ somewhat different methods of interpretation. [ FN: See American Express Travel Related Services Company Inc. v. Hashemi, 104 F.3d 1122 (9th Cir. 1996), cert. denied , 117 S.Ct. 1824 (1997) ; Anastas v. American Savings Bank, 94 F.3d 1280 (9th Cir. 1996); Eashai, 87 F.3d 1082.] The lack of clear guidance becomes especially crucial when one considers the continuing growth in the availability and use of credit cards and the increasingnumber of consumer bankruptcy filings.

Credit card debts incurred to pay nondischargeable taxes pose special problems. Since the Bankruptcy Reform Act of 1994, the Code has excepted from discharge debts incurred to pay federal taxes. [ FN: 11 U.S.C. §523(a)(14)(excepting from discharge "debts incurred to pay a tax to the United States that would be nondischargeable pursuant to paragraph (1) ").] Congress recently enacted a bill that would permit the Internal Revenue Service to accept credit cards and other commercially acceptable means. [ FN: P.L. 105-34 (105 th Cong. August 5, 1997).]

The Recommendation

Credit Card Debt Generally

Except for credit card debts that are excepted from discharge under section 523(a)(2)(B) (for materially false written statements respecting the debtor’s financial condition) and section 523(a)(14), (debts incurred to pay nondischargeable taxes to the United States), debts incurred on a credit card issued to the debtor that did not exceed the debtor’s credit limit should be dischargeable unless they were incurred within 30 days before the order for relief under title 11.

Credit Card Debts Incurred to Pay Nondischargeable Taxes to the United States

Section 523(a)(14) should remain unchanged to except from discharge debts incurred for federal taxes that would be nondischargeable under section 523(a)(1).

Background on Credit Card Debt Generally

The Code provisions dealing with fraud in an application for a credit card, which is addressed in section 523(a)(2)(B), cause little confusion. This proposal addresses the problem created by nondischargeability actions based on a debtor’s use of a credit card. A creditor that brings a nondischargeability action under section 523(a)(2)(A) currently has the burden to show:

  • the debtor knowingly made misrepresentations;
  • the debtor intended to deceive the creditor when making these misrepresentations; and
  • the creditor justifiably relied on the representation, which proximately caused the creditors’ damages. [ FN: See, e.g., Hashemi, 104 F.3d at 1125.]

This test has been applied to actions under this provision regardless of whether the creditor alleges actual fraud, false pretenses, or false representation as the specific grounds fornondischargeability. [ FN: See Field v. Mans, 116 S.Ct. 437, 444 (1995); Mayer v. Spanel Internat'l, Ltd., 51 F.3d 670 (7th Cir.), cert. denied , 116 S. Ct. 563 (1995).] Courts and litigants routinely recite the test, but the interpretation and application of these standards has been highly variable. Specifically, courts take disparate approaches regarding what the use of a credit card "represents," how to determine an "intent to deceive," and what constitutes "justifiable reliance" by the creditor in a tripartite credit card transaction. In the voluminous case law on this topic, many courts have acknowledged that application of the Code’s fraud exception to credit card debt has been extraordinarily problematic.

Use of a Credit Card as a Representation

When a customer has used a credit card and subsequently seeks to discharge that debt in bankruptcy, some courts have determined that by making the charge, the customer misrepresented that she was able to repay the resulting debt. [ FN: See, e.g., Mercantile Bank v. Hoyle, 183 B.R. 635 (Bankr. D. Kan. 1995); Chase Manhattan Bank v. Weiss, 139 B.R. 928 (Bankr. D.S.D. 1992). American Express Travel Related Services v. Dorsey, 120 B.R. 592 (Bankr. M.D. Fla. 1990) ("[I]f it is shown that at the time the Debtor incurred the charges that he or she knew they would be unable to live up to the obligation and pay the charges, or if it appears that they had no intention to pay the charges . . . that would clearly be actual fraud").] Sometimes, using a credit card is considered to be a representation of both an intent and a present ability to pay. [ FN: "The purchase of goods on a credit card constitutes an implied representation by the purchaser that he has both the means and intent to repay for the goods purchased. " AT&T Universal Card Services v. Ramirez, 184 B.R. 859, 861 (Bankr. S.D. Fla. 1995); Household Credit Services v. Walters, 208 B.R. 651, 653 (Bankr. W.D. La. 1997) (use of card is representation that consumer has intent and present ability to make payment); see also Norwest Bank (Des Moines, N.A.) Card Services Division v. Stewart, 91 B.R. 489 (Bankr. S.D. Iowa 1988), citing Comerica Bank Midwest v. Kouloumbris, 69 B.R. 229 (N.D. Ill. 1986);In re Buford, 25 B.R. 477 (Bankr. S.D.N.Y. 1982).] Some courts believe this representation is made even if the lender had no expectation that the debtor had the present ability to repay the charges when the debts were incurred. [ FN: "Seldom do the courts concern themselves with the debtors ’ ability to make the minimum monthly payment . " The GM Card v. Cox, 182 B.R. 626, 633 (Bankr. D. Mass. 1995) (emphasis added).] Under this theory, an individual may have committed fraud by making a charge and subsequently being unable to pay. [ FN: Cf. Feld, 203 B.R. at 365 (credit card lenders, like other lenders, must establish every element of fraud with requisite level of proof).]

Other courts decline to follow the aforementioned approach. Rather than making every consumer a guarantor of her future solvency, they find that a customer’s use of a credit card constituted an express or implied representation of an intent to repay. [ FN: "To hold, as some courts have, that objective inability to pay, coupled with an implicit representation to the contrary at the time the court is used, establishes the deceit element of the nondischargeability cause of action would be to make the debtor a guarantor of his own financial condition. Such a burden is not imposed by the statute. " F.C.C. Nat ’l Bank v. Cacciatore, 209 B.R. 609, 616 (Bankr. E.D.N.Y. 1997); Anastas, 94 F.3d at 1285; American Express Travel Related Services v. Christensen, 193 B.R. 863, 866 (N.D. Ill. 1996); Feld, 203 B.R. at 366 ( "each use of the card, accompanied by the cardholder's signed acknowledgment of additional indebtedness incurred pursuant to the card agreement, is a reaffirmation of the intent to repay "); AT&T Universal Card Services Corp. v. Chinchilla, 202 B.R. 1010 (Bankr. S.D. Fla. 1996) (intent -- not ability -- to repay, is relevant inquiry); Mercantile Bank of Illinois v. Williamson, 181 B.R. 403, 406 (Bankr. W.D. Mo. 1995); Citicorp Credit Serv. v. Hinman, 120 B.R. 1018 (Bankr. D.N.D. 1990); Sears Roebuck and Co. v. Faulk, 69 B.R. 743 (Bankr. N.D. Ind. 1986); Chase Manhattan Bank v. Carpenter, 53 B.R. 724 (Bankr. N.D. Ga. 1985).] "The availability of creditduring financially difficult times is a very good reason to maintain credit. ‘The test for nondischargeability is not whether the credit was used in difficult times but whether the credit was used with the intent not to pay the debt.’" [ FN: First U.S.A. Bank v. Hunter, 1997 WL 370840, 96-02125-6J7 (Bankr. M.D. Fla. June 27, 1997), citing Barnett Bank of Pinellas County v. Tinney, 188 B.R. 1015, 1020 (Bankr. M.D. Fla. 1995).] From this point, courts take divergent approaches to determine whether the customer actually intended to pay when she made the charges: they might use a series of objective factors to determine whether the debtor demonstrated an intent not to repay, they might consider whether the debtor "reasonably should have known" he would be unable to repay, or they might assess the debtor’s intent subjectively.

A few courts have declined to infer that a customer made a misrepresentation on the sole basis that she used a credit card and subsequently filed for bankruptcy. [ FN: Cox, 182 B.R. at 634; see also Comerica Bank Midwest v. Kouloumbris, 69 B.R. 229, 231 (N.D. Ill.1986) (because debtor may have intended to pay for purchases when charged, court cannot presume that use of credit card constituted misrepresentation); AT&T Universal Card Services Corp. v. Alvi, 191 B.R. 724 (Bankr. N.D. Ill. 1996).] The court in In re Cox concluded that Congress did not intend section 523(a)(2)(A) to cover "implied representations," nor do policy and jurisprudential justifications support the provision’s use in this regard; rather, most credit card fraud cases belong in the purview of section 523(a)(2)(C), under which debts incurred on the eve of bankruptcy for luxury goods are nondischargeable. [ FN: Cox, 182 B.R. at 634-36.] "The philosophy of Cox has its origins in nineteenth century cases holding that a borrower’s predictions regarding his future ability to pay his debts are not actionable as false pretenses." [ FN: AT&T Universal Card Service Corp. v. Nguyen, 208 B.R. 258, 260 (D. Mass. 1997), citing Commonwealth v. Drew, 36 Mass. 178, 185 (1837). However, the Cox analysis has been met with disfavor by the district courts in the district where this decision was issued. See AT&T Universal Card Services Corp. v. Pakdaman, 1997 WL 404045, 96- 30076 (D. Mass. July 17, 1997) (rejecting Cox analysis; while recognizing that the application of traditional elements of misrepresentation to the credit card area is tricky, this court must conclude that Cox strikes the balance too harshly against the creditor "); Nguyen, 208 B.R. at 261 (rejecting Cox approach as being fundamentally unfair to creditors and contrary to section 523(a)(2)).] Another court has suggested that the use of a credit card is not a "representation" because it is not a statement that is capable of being true or false; this conclusion was extrapolated from a Supreme Court decision that held that signing and submitting a check is not a factual assertion and is not capable of beingtrue or false. [ FN: Alvi, 191 B.R. at 732, citing Williams v. United States, 458 U.S. 279 (1982). See Goldberg Securities Inc. v. Scarlata, 979 F.2d 521 (7th Cir. 1992) (applying Williams analysis to bankruptcy nondischargeability action);In re Horwitz, 100 B.R. 395, 398 (Bankr. N.D. Ill.1989) (same); see also Bank One Columbus, N.A. v. McDaniel 202 B.R. 74, 78 (Bankr. N.D. Tex. 1996) (agreeing with conclusion in Alvi regarding representations).] These theories can make it difficult, if not impossible, for credit card lenders to bring nondischargeability actions under section 523(a)(2)(A) at all unless the circumstances of the use of the credit card were unique, e.g., there was some additional affirmative misrepresentation accompanying the use of the card. [ FN: See Alvi, 191 B.R. at 732, note 14.]

Intent to Deceive Using a Credit Card

Ill intent traditionally has been a crucial factor of fraud or false representation. [ FN: See Neal v. Clark, 95 U.S. 704, 709 (1877) (fraud means actual or positive fraud, not fraud implied in law);In re Welch, 208 B.R. 107 (S.D.N.Y. 1997) (regardless of what method courts apply to determine nondischargeability of credit card debt, creditor must establish that debtor intended to deceive creditor at time charges were incurred).] Although it was not central to the holding of the case, the Supreme Court noted in Field v. Mans that Congress could have barred discharge on the basis of unintentional misrepresentations if it had wished, "but it would, however, take a very clear provision to convince anyone of anything so odd." [ FN: Field, 116 S. Ct. at 442.] Scienter is a difficult element to prove, thus quite a few courts use objective factors to "infer" an intent to deceive the credit card issuer. [ FN: See, e.g., Hashemi, 104 F.3d at 1126, note 2; see also Eashai, 87 F.3d at 1087, where the court adopted the twelve factor test set forth in Citibank South Dakota v. Dougherty, 84 B.R. 653, 657 (9th Cir. BAP 1988).] The most widely-utilized set of factors includes the following:

  • the length of time between making the charges and the bankruptcy filing;
  • whether the debtor consulted an attorney about bankruptcy before making the charges;
  • the number and amount of charges;
  • whether the charges exceeded the debtor's credit limit;
  • whether the debtor made multiple charges on the same day;
  • whether the debtor was employed when making the charges;
  • whether the debtor had prospects for employment;
  • whether the debtor suddenly changed her buying habits;
  • whether the debtor was financially sophisticated;
  • whether the debtor purchased luxury items or necessary items; and
  • the debtor's financial condition at the time the charges were made. [ FN: See Dougherty , 84 B.R. at 657. ]

Courts disagree on the extent to which objective factors such as these should be used to impute intent. Some courts carefully examine most or all of the aforementioned elements to determine whether or not the debtor demonstrated that he intended to repay. [ FN: See Williamson, 181 B.R. at 406 (finding that debt was dischargeable); General Electric Capital Corp. v. Janecek, 183 B.R. 571, 575 (Bankr. D. Neb. 1995) (insolvency can be considered, but is not determinative in assessing debtor ’s intent to deceive).] Thus, if these factors illustrate that the debtor was "loading up" on luxury goods, this may lead a court to conclude that the debtor did not intend to repay and was acting deceitfully. [ FN: See, e.g., Hashemi, 104 F.3d at 1126 (using factors to determine that $60,000 worth of credit card charges on six week European vacation on eve of bankruptcy was not dischargeable).]

However, other courts believe that the consideration of one or two objective factors may suffice to produce an inference that the debtor intended to deceive the creditor when making a credit card purchase. [ FN: See, e.g., FCC Nat'l Bank v. Berz, 173 B.R. 159 (Bankr. N.D. Ill. 1994).] Using this approach, the fact that a reasonable person would not have believed that she would be able to repay may result in a finding of fraud and nondischargeability: "If the cardholder uses the card to purchase goods or to obtain cash advances while knowing that the charges cannot be paid, or if evidence indicated that the cardholder should have known that the charges cannot be paid, the creditor has established a claim of nondischargeability." [ FN: Ramirez, 184 B.R. at 861; Southtrust Bank of Alabama v. Moody, 203 B.R. 771 (Bankr. M.D. Fla. 1996) ("It should not take a rocket scientist to figure out that even if [debtor] lived 1000 years she would still not be able to repay the charges she ran up on her credit cards"), citing Dorsey, 120 B.R. at 594; Mercantile Bank v. Hoyle, 183 B.R. 635, 638 (Bankr. D. Kan. 1995); Household Card Services/VISA v. Vermillion, 136 B.R. 225, 226 (Bankr. W.D. Mo. 1992). Cf. Stewart, 91 B.R. at 495 (insolvency alone does not establish intent to deceive); Chinchilla, 202 B.R. at 1016 (lack of ability to pay is insufficient basis on which to infer intent to deceive).] This approach enables a credit card lender plaintiff to "prove" fraud merely by indicating the pattern of credit card charges, the proximity of the charges to the bankruptcy filing, and the debtor's inability to repay the debts. [ FN: A closely related approach is to use objective factors to find "constructive fraud. " See Strawbridge & Clothier v. Caivarelli, 16 B.R. 369 (Bankr. E.D. Pa. 1982); Mercantile Trust Co. Nat'l Assoc. v. Pozucek, 73 B.R. 110 (Bankr. N.D. Ill. 1987).]

Some courts reject the notion that a debtor’s inability to repay amounts to fraudulent intent, and instead try to determine whether the debtor subjectively intended to deceive a creditor. [ FN: See, e.g., Sears, Roebuck and Co. v. Taylor, 1997 WL 418035, 96-06051 (Bankr. M.D. Fla. July 25, 1997) (although court can review litany of factors, ultimate determination turns on subjective intent); Feld, 203 B.R. at 367 (dischargeability will not turn on reasonableness of debtor ’s expectations of ability to repay); AT&T Universal Services v. Totina, 198 B.R. 673, 679 (Bankr. E.D. La. 1996); Chase Manhattan Bank v. Murphy, 190 B.R. 327, 333 (Bankr. N.D. Ill. 1995).] These courts have reasoned that the "hopeless state" of the debtor's financial affairs isno substitute for an actual finding of bad faith. "[A]lthough the reasonableness of the debtors' belief as to the truth of their representations may be circumstantial evidence of their intent, ultimately the issue is their actual intent and not the objective reasonableness of it." [ FN: Chevy Chase Bank, FSB v. Briese, 196 B.R. 440, 451 (Bankr. D. Wis. 1996).] The 9th Circuit stated in Anastas that "the focus should not be on whether the debtor was hopelessly insolvent at the time he made the credit card charges . . . if ability to repay were the focus of the fraud inquiry, too often would there be an unfounded judgment of nondischargeability of credit card debt." [ FN: See Anastas, 94 F.3d at 1285, citing 124 Cong. Rec. H11089 (Sept. 28, 1978) (Statement of Rep. Edwards) ("subparagraph (A) is intended to codify current case law . . . which interprets 'fraud' to mean actual rather than fraud implied in law"); Alvi, 191 B.R. at 733; First Federal of Jacksonville v. Landen, 95 B.R. 826 (Bankr. M.D. Fla. 1989) (debtor's honest but questionable relief that he would be successful at gambling and be able to repay his debts defeats finding of intent to deceive).] Thus, objective factors may be relevant, but only to the extent they assist the court in determining whether the debtor actually and subjectively intended to deceive the creditor. [ FN: See Id., at 1285; Feld, 203 B.R. at 367 (factors may be helpful, but not controlling, in determining whether debtor had subjective intent to repay). See also Kouloumbris, 69 B.R. at 231.] In courts that take this approach, creditors may have to prove that the debtor incurred credit card debt in bad faith with the intention of filing for bankruptcy and avoiding the debt. [ FN: See Chinchilla, 202 B.R. at 1015.]

Credit Card Lender’s Reliance on Borrower’s Representation by Use of a Credit Card

Even more difficult is the question of reliance, another essential component to the common law definition of fraud. In a section 523(a)(2)(A) case involving a land sale, the Supreme Court held that a creditor must prove that his reliance was justifiable; if the falsity of the representation should have been readily apparent to that particular creditor, the creditor will not prevail. [ FN: Field, 116 S.Ct. at 444; P& S X-Ray Co. Inc. v. Dawes, 189 B.R. 714 (Bankr. N.D. Ill. 1995); Irwin v. O'Bryan, 190 B.R. 290 (Bankr. E.D. Ky. 1995).] This resolved a split in the circuits over whether reliance has to be "reasonable," but did not minimize the difficulties in credit card debt nondischargeability cases. The ongoing nature of the relationship between the credit card holder and the issuer make it difficult to gauge what constitutes reliance for each individual credit card transaction. [ FN: The courts do not agree on whether each credit card transaction should be considered a separate contract or whether they are part of a continuing contract, a distinction that may have implications on the outcome of the case. Cf. Anastas, 94 F.3d at 1285 (each transaction is separate contract), with Cox, 182 B.R. at 636 (continuing contract), and Feld, 203 B.R. at 367, note 7 (same).]

Following an 11th Circuit case decided under the Bankruptcy Act of 1898, some courts hold that when a debtor exceeds her credit limit, a credit card company "assumes the risk"of nonpayment until it attempts to revoke her credit privileges. [ FN: First Nat'l Bank of Mobile v. Roddenberry, 701 F.2d 927 (11th Cir. 1983), cited in Cox, 182 B.R. at 631. Cf. Feld, 203 B.R. at 367, note 6 ( "fact that creditors anticipate loss does not mean they should be saddled with losses resulting from fraud "), citing Briese, 186 B.R. at 449.] Some courts in the 11th Circuit, although not all, have considered themselves bound by this approach, [ FN: See, e.g., Sears, Roebuck and Co. v. Taylor, 1997 WL 418035, 96-06051 (Bankr. M.D. Fla. July 25, 1997) (stating that Roddenberry remains good law); AT&T Universal Card Services Corp. v. Harris, 1997 WL 402642 96- 4739 (Bankr. M.D. Fla. July 14, 1997) (under Roddenberry, creditor can only prevail on allegations of actual fraud, not false pretenses or false representation if creditor failed to revoke privileges); First Card Services Inc. v. Herndon, 193 B.R. 595 (M.D. Fla. 1996) (upholding summary judgment to dismiss); AT&T Universal Card Services Corp. v. Stansel, 203 B.R. 339 (Bankr M.D. Fla. 1996) (under Roddenberry, court cannot hold debts nondischargeable when debtor exceeded credit limit but creditor failed to revoke credit privileges); AT&T Universal Card Services Corp. v. Berry, 197 B.R. 382, 383 (Bankr. M.D. Fla. 1996). See also Ward, 857 F.2d at 1082; Kouloumbris, 69 B.R. at 231.] which will preclude a finding of reliance in many instances absent evidence of actual fraud.

Other courts do not require a credit card issuer to prove reliance at all. They simply presume that a credit card issuer is entitled to rely on each use of a credit card as a manifestation of an intent to repay. [ FN: See, e.g., AT&T Universal Card Services Corp. v. Burdge, 198 B.R. 773 (Bankr. 9th Cir. 1996); Colonial Nat ’l Bank U.S.A. v. Levinthal, 194 B.R. 26, 28 (Bankr. S.D.N.Y. 1996).] "The credit card issuer justifiably relies on a representation of intent to repay as long as the account is not in default and any initial investigations into a credit report do not raise red flags that would make reliance unjustifiable." [ FN: Anastas, 94 F.3d at 1286, quoted in Hashemi, 104 F.3d at 1126.] The fact that many courts presume justifiable reliance may explain why it is not uncommon for credit card plaintiffs to refrain from offering any specific evidence of reliance. [ FN: See, e.g., Feld, 203 B.R. at 368-369; Christensen, 193 B.R. at 867; FCC Nat'l Bank v. Willis, 190 B.R. 866 (Bankr. W.D. Mo. 1996), aff ’d, 200 B.R. 868 (W.D. Mo. 1996).]

Still other courts are critical of a presumption of reliance, for reliance is a discrete and independent element of fraud that must be proven by a preponderance of the evidence. [ FN: See, e.g., Cacciatore, 209 B.R. at 614 (court "will not ignore the element of reliance simply because it may be difficult for credit card companies to prove "); Sears, Roebuck & Co. v. Hernandez, 208 B.R. 872, 880 (Bankr. W.D. Tex. 1997) (rejecting implied reliance); Christensen, 193 B.R. at 867; AT&T Universal Card Services v. Richards, 196 B.R. 181, 182 (Bankr. E.D. Ark. 1996). Alvi, 191 B.R. at 731; Willis, 190 B.R. at 869.] At a minimum, these courts may require a creditor to show that it did not continuously extend credit passively or blindly. [ FN: Akdogan, 204 B.R. at 98 (granting debtor's motion for summary judgment on nondischargeability complaint due to lack of proof of justifiable reliance). The court in Akdogan cited Alvi, 191 B.R. 731, Ward, 857 F.2d 1082, and First Card v. Leonard, 158 B.R. 839 (Bankr. D. Colo. 1993), in support of its decision. The Akdogan court found it noteworthy that the creditor "did not request any information relating to the Debtor's expenses, assets, nature of employment or business, health, home ownership, credit references or general financial condition," nor did the creditor require the debtor to supply the basic requested information before issuing the debtor the credit card. Id.] If a creditor conducts a financial analysis that raises a "red flag" andextends credit nonetheless, this also may defeat a finding of justifiable reliance. [ FN: Briese, 196 B.R. at 453.]

Some of these courts are especially troubled by the fact that creditors send an increasing number of unsolicited credit card applications and make minimal inquiries into the status of the consumer’s income and debt load when originally extending credit to the debtor. [ FN: See, e.g., Walters, 208 B.R. at 654 (looking first at whether lender justifiably relied on any credit information when originally issuing card; pre-approved, unsolicited cards do not indicate justifiable reliance); McDaniel, 202 B.R. at 79 (referring to credit issuer ’s practice as "commercial entrapment "), citing Mercantile Bank v. Hiemer, 184 B.R. 345 (Bankr.D.Neb.1995).] Therefore, if a creditor never conducted a meaningful initial credit check, some courts will find that the creditor could not have relied justifiably on any representation made by the subsequent use of a credit card. [ FN: See, e.g., Cacciatore, 209 B.R. at 616 (lender did not justifiably rely when it granted $5,000 line of credit to 21 year old student that listed no employer or place of business) ; Akdokan, 204 B.R. at 97.]

In addition, the element of reliance becomes even more elusive in the context of another modern credit device, the "live check." With this credit product, a creditor sends an unsolicited check to a consumer; by endorsing the check, the consumer becomes subject to the fine print in the credit agreement. At least one court has found that a creditor cannot prove reliance in this context: "Absent proof of [lender]’s clairvoyant abilities, this Court is hard pressed to find that [lender] relied upon a representation which occurred subsequent in time to Beneficial’s action of issuing the check." [ FN: Beneficial of Missouri Inc. v. Shurbier, 134 B.R. 922 (Bankr. W.D. Mo. 1991) (noting that reliance may be part and parcel to ongoing relationship between credit card issuer and user in open-ended credit relationship, but this is distinguishable from discrete loan transaction).]

Reasons for the Change

Benefits to All Parties of a Bright-Line Rule

The subject of the conflicting case law, and hence the subject of this recommendation, is the routine use of a credit card under a valid open-ended credit agreement. [ FN: The present provisions of section 523(a)(2) work fine in the context of fraud in an application for a credit card or instances of actual fraud that happen to involve a credit card, such as using some one else ’s card.] Chaotic case law interpretations presently govern the dischargeability of debt resulting from the use of a properly-obtained credit card. Especially in light of the ubiquity of credit cards and the high rate of bankruptcy filing, it becomes particularly important to provide some order to this area of the law.As one court recently noted:

Each of the . . . approaches [presently used by courts] has been criticized by courts that adhere to one of the other approaches or to one of the many other divergent views that do not fit neatly into the above categories. It seems likely that until Congress takes action to establish clear cut guidelines in credit card nondischargeability cases under Code section 523(a)(2)(A), divergent views among the courts will continue to proliferate. Unabated, the current situation will result in increased inconsistency of outcomes among cases resting on similar facts. That such lack of consistency is harmful to the system, should be obvious to all concerned. [ FN: AT&T Universal Card Services v. Wong, 207 B.R. 822, 828, note 4 (Bankr. E.D. Pa. 1997) (emphasis added).]

It should not be surprising that these circumstances do not fit smoothly into a fraud test; when a credit card lender grants a line of credit for a consumer that is not conditioned on her financial condition when she makes the charges or the types of purchases made, it is hard to articulate why the resulting debt should be nondischargeable when other unsecured debts are discharged. However, if some debts from proper use of a credit card are to be nondischargeable, the statute should provide a bright line rule to curb the proliferation of inconsistent outcomes on identical fact patterns. The present inconsistency is fundamentally unjust for debtors and creditors alike.

As with other Code provisions that establish lookback periods for activities occurring directly pre-petition, such as the 90-day preference period in section 547(b), a bright line exception to discharge for credit card debt may not be foolproof at the margins but has several advantages and may be superior to a fact-specific analysis. A case-by-case analysis under a fact-specific fraud test already has proven to be an inadequate legal sorting device for credit card debt. The various elements of fraud are handled in a disparate fashion, with some elements ignored or others conflated because they are so difficult to prove in the credit card usage context. Moral issues surrounding the proliferation and use of credit cards provide an additional overlay onto an already-contorted analysis, and conflicting moral judgments may be playing a large role in the determination of these disputes. In addition, judicial time and resources in the bankruptcy system are at a premium, and case-by-case analyses may be too costly and require other sacrifices. A "rough justice" standard that does not require litigation of the underlying principle in each case, may be the fairest and most expedient method to identify debts most eligible for exception from discharge.

A bright line test would minimize unnecessary costs and burdens for credit card lenders who no longer would have to keep track of the vastly disparate approaches being employed by various courts, many within the same district. Although nondischargeability actions are brought by some lenders with great regularity, pursuing nondischargeability complaints under the currentsystem simply is not cost effective for other lenders, whether or not they have colorable claims. A bright line rule would permit all credit card lenders to look to the same intelligible test to determine whether a debt is nondischargeable and to proceed accordingly.

Clarifying the law also would have an important effect in the cases involving the poorest debtors who cannot afford to defend these actions. The current uncertainty facilitates threats of nondischargeability actions, which leads debtors to settle and agree to repay otherwise dischargeable unsecured debts. Although the Code contains a fee-shifting provision to encourage debtors to defend actions that are not substantially justified, [ FN: 11 U.S.C. §523(d).] the wide spectrum of interpretations of section 523(a)(2)(A) makes almost any credit card debt potentially nondischargeable. As a result, it is nearly impossible to show that a credit card debt nondischargeability action was wholly unjustified, a risk that few debtors and debtors’ attorneys can afford to take. One court recently noted this when rejecting a prevailing debtor’s request for attorneys’ fees and costs:

"a variety of overlapping theories have emerged in respect of the elements required of a credit card plaintiff to obtain a judgment of nondischargeability as well as the manner in which those elements may be satisfied. The papers submitted by [creditor]’s motion in opposition to [debtor]’s motion cite authority tending to support some of its arguments. In the absence of prior rulings on point by this court, or binding 2nd Circuit authority, the Court cannot conclude that [creditor]’s position lacked substantial justification within the meaning of section 523(d)." [ FN: Cacciatore, 209 B.R. at 618.]

Even putting aside the question of fee-shifting, an honest debtor cannot be certain that she will be able to defeat a finding of "implied fraud" that is constructed out of various objective factors. Courts around the country report that they are receiving increasing numbers of motions for extensions for time to file nondischargeability complaints, shortly followed by settlements and/or reaffirmations. A clearer bright-line rule for nondischargeability should abate this trend.

Justification For This Particular Bright-Line Approach

In formulating a clearer standard, the proposed approach reaches debts most likely incurred in contemplation of bankruptcy. It thus is similar in method -- but broader in scope and more definitive -- to section 523(a)(2)(C), which shifts the presumption of dischargeability for luxury goods purchased on credit on the eve of bankruptcy. [ FN: Hernandez, 208 B.R. at 880, citing S. REP. No.98 - 65, 98th Cong, 1st Sess. 58 (1985), Senate Report Accompanying section 445, Omnibus Bankruptcy Improvements Act of 1983. "[O]pinions dealing with the term "luxury" as used in this statute have "considered whether under circumstances of each particular case the purchases or transactions were 'extravagant,' 'indulgent,' or 'nonessential.'" Hernandez, 208 B.R. at 880, citing Carroll & Sain v. Vernon, 192 B.R. 165, 170 (Bankr. N.D. Ill. 1996), General Motors Acceptance Corp. v. McDonald, 129 B.R. 279 (Bankr. M.D. Fla. 1991), and Sears Roebuck & Co. v. Faulk, 69 B.R. 743 (Bankr. N.D. Ind. 1986).] Timing creates a sufficiently stronginference that certain credit card debts were incurred in contemplation of bankruptcy to render them nondischargeable and other debts incurred outside the time limit are dischargeable. However, the time period must be set with care; the justification for a time-cleavage approach breaks down as the nondischargeability period is enlarged. Every day that the nondischargeability period is extended, it becomes less probable that the debts were incurred in contemplation of bankruptcy and increasingly difficult to rationalize the preferential treatment of credit card debts over other unsecured debts.

This proposal is not intended to disrupt credit granting practices and does not condition creditors’ relief on the rigor of their initial scrutiny of borrowers, as some courts do presently when assessing creditor reliance under section 523(a)(2)(A). However, as a consequence of the proposal’s design, the bankruptcy system would not provide an additional safeguard for all improvident lending decisions that lenders might have addressed themselves by restricting or revoking credit privileges. As such, credit card lenders would not receive preferential treatment to other creditors.

Debts Incurred to Pay Federal Taxes

In 1994, Congress introduced an exception to discharge for a debt "incurred to pay a tax to the United States that would be nondischargeable pursuant to paragraph (1)." [ FN: 11 U.S.C. §523(a)(14).] According to Congress’ section-by-section analysis of the 1994 amendments, this provision was intended to facilitate individuals’ ability to use their credit cards to pay federal taxes. Currently, this provision can be used when an individual takes a cash advance on a credit card (or uses a check issued by a credit card company) and uses those funds to pay taxes. With this limited application, the published case law indicates that section 523(a)(14) seldom has been used; an on-line search reveals that this provision has been cited in only a few reported decisions and has provided the basis for nondischargeability in one case. [ FN: In re Chrusz, 196 B.R. 221 (Bankr. D.N.H. 1996). See MNBA America v. Parkhurst, 202 B.R. 816 (Bankr. N.D.N.Y. 1996), in which section 523(a)(14) provided additional grounds for nondischarge abi lity to a credit card issuer already pursuing a section 523(a)(2) claim against a pro se debtor.]

However, the provision is about to take on a new-found importance; quite recently, Congress amended the laws to permit the Internal Revenue Service to accept payment of taxes by credit card. [ FN: PL 105-34, 1997 H 2014 (105th Cong. August 5, 1997).] In light of this change in circumstances, it would be premature to recommend any change to section 523(a)(14).

Putting this provision in the context of credit card dischargeability generally, section 523(a)(14) would provide an exception to the proposed general rule governing nondischargeability of credit card debt. Thus, any credit card debt incurred to pay nondischargeable federal taxes would be nondischargeable.

To except a debt from discharge under section 523(a)(14), the only element a lender must establish is that the debtor used the funds to pay a nondischargeable federal tax liability. No culpability must be proven. The lender must establish merely that the charge was incurred to pay nondischargeable federal taxes. In the context of cash advances, this presented potential, although not insurmountable, [ FN: SeeIn re Chrusz, 196 B.R. 221 (Bankr. D.N.H. 1996) (access check that was first deposited into account and then used as part of funds to pay IRS was nondischargeable debt).] tracing problems. If consumers pay the Internal Revenue Service directly with credit cards, clearly those tracing issues are not applicable, and the use of the provision may become more prevalent.

While permitting tax payments on credit cards conceivably will benefit the Internal Revenue Service, one should recognize that credit card lenders are the real beneficiaries of the exception to discharge. If a consumer paid taxes with a credit card and subsequently defaulted on her credit card, the Internal Revenue Service is not required to give the money back to the credit card company and thus the Internal Revenue would not experience losses if the credit card debt were dischargeable. The terms of credit card lending agreements are not triggered by the potential dischargeability of the purchases made or obligations paid with the credit card; rather, credit card lenders lend money fully aware that the entire line of credit might be dischargeable in bankruptcy. Given that the obligation to the taxing authority already has been satisfied, section 523(a)(14) allows a credit card lender to collect an unsecured, nonpriority debt postbankruptcy on the fortuity that its credit card was used for a particular type of debt.

Competing Considerations

Some have argued that excepting debts from discharge based on bright line tests may not identify culpably-incurred debts and thus runs counter to the policies underlying the exceptions to discharge. This argument is highlighted by a concern that the bright line test will capture the credit card debts of only innocent debtors, including pro se debtors or debtors dealing with emergency situations. There is substantial merit to this argument. Nonetheless, the proposed rule would be less prejudicial to honest debtors than many of the rules currently used to determine the dischargeability of credit card debt, and honest debtors also would be at less risk of being forced to settle nondischargeability actions of questionable merit. Even if the proposed test would encompass some debts not culpably incurred, the penalty is not severe; the last month’s worth of charges essentially would be treated as if they were made postpetition and hence could not be discharged in the bankruptcy while the debtor still would be relieved of the majority of her overwhelming debt. The proposal represents a compromise: some debts that were innocently incurred before bankruptcy will be nondischargeable, but the lookback period is clearly limited. The solution is not perfect, but no single approach will be wholly satisfactory, either in theory or in practice.

At the same time, a nondischargeability rule that does not specifically target culpably-incurred debts might be too permissive towards sophisticated debtors who carefully plan the timing of their bankruptcy filings. Again, it must be emphasized that this proposal only speaks to debts incurred within a consumer’s credit limit pursuant to a nonfraudulent credit application. How a consumer handles the credit once granted is less relevant for dischargeability purposes because credit card lenders were in the best position to expand or limit their risks by determining when it is economically beneficial to lend unsecured dischargeable debt. Some people find this response insufficient and advocate more punitive measures to except from discharge all credit card debts incurred during periods of financial distress, even if they were incurred properly within the terms of a credit card agreement and notwithstanding the fact that the debtor was able to make the minimum monthly payment. However, this approach does not explain why credit card lenders, who already determined the amount of credit they were willing to risk, should receive superior treatment to other types of unsecured debts.

With respect to tax debts, because potentially substantial credit card debts will be excepted from discharge with no regard to culpability under section 523(a)(14), some would argue that there is insufficient justification for a special strict liability exception for credit card debts for taxes, including high interest charges, when the taxing authority already has received its payment and there is no evidence that the debtor acted with malfeasance. The primary beneficiary of this provision is the credit card industry, not the taxing authority, and many would argue that the subject of the charge should not be determinative of the dischargeability of credit card debt. However, the provision is premised on the notion that it is important to reinforce the principle that citizens must bear responsibility for certain tax obligations, regardless of their methods of payment.

Others might argue that there is no basis on which to distinguish between debts incurred for federal taxes and debts incurred for state and local taxes.


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