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.
|
|
