In re Carter

• Decision Date: 30 June 1981
• Docket Number: Bankruptcy No. 379-02339,Adv. No. 380-0149.
• Citation: 11 BR 992
• Parties: In re Braxton Lamont CARTER, Debtor. FIRST AMERICAN NATIONAL BANK, Plaintiff, v. Braxton Lamont CARTER, Defendant.
• Court: U.S. Bankruptcy Court — Middle District of Tennessee

11 B.R. 992 (1981)

In re Braxton Lamont CARTER, Debtor.

FIRST AMERICAN NATIONAL BANK, Plaintiff, v. Braxton Lamont CARTER, Defendant.

Bankruptcy No. 379-02339, Adv. No. 380-0149.

United States Bankruptcy Court, M.D. of Tennessee.

June 30, 1981.

L. Wearen Hughes, Nashville, Tenn., for plaintiff.

John R. Reynolds, Nashville, Tenn., for defendant.

MEMORANDUM

RUSSELL H. HIPPE, Jr., Bankruptcy Judge.

This is the second of two opinions by the court dealing with the measure of relief available to a creditor under the fraud exception to the discharge of § 523(a)(2) of the Bankruptcy Reform Act of 1978 which provides as follows:

(a) A discharge under section 727, 1141, or 1328(b) of this title does not discharge an individual debtor from any debt —

. . . .

(2) for obtaining money, property, services, or an extension, renewal, or refinance of credit, by —

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor\'s or an insider\'s financial condition; or

(B) use of a statement in writing —

(i) that is materially false;

(ii) respecting the debtor\'s or an insider\'s financial condition;

(iii) on which the creditor to whom the debtor is liable for obtaining such money, property, services, or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive;. . . .

11 U.S.C. § 523(a)(2) (1979).

In the other opinion the court considered the measure of relief available under subsection (A) and concluded that the creditor was entitled to recover compensatory damages proximately caused by the fraud measured by the benefit-of-the-bargain rule. Castner Knott Co. v. Wilson, 12 B.R. 363 (Bkrtcy. M.D. Tenn., 1981). In this proceeding the court must determine the measure of relief available under subsection (B).

At the conclusion of the hearing the court announced its decision that each of the four elements set out in subsection (B) had been established by the proof with respect to a note executed by the debtor on July 5, 1979.¹ The principal amount of $7,172.13 represented the balance owed to the plaintiff bank on a past-due note which the debtor requested that he be permitted to renew. At the time, his liabilities exceeded his assets. At the request of the bank, he prepared a financial statement on which he indicated a positive net worth by omitting a debt to another bank in excess of $20,000. Bank officers testified that they relied on this statement in permitting the debtor to renew this obligation by execution of the July 5, 1979, note, which they would not have done if they had known the truth. The size of the omitted debt in relation to the debtor's assets ($28,000) convinced the court that it was omitted from the financial statement with the requisite intent to deceive.

No additional funds or "fresh cash" were advanced to the debtor in reliance upon the false financial statement. The bank has not suggested that any damages were caused by this fraudulent conduct. The debtor testified that if this obligation had not been renewed in July 1979 he simply would have filed his bankruptcy petition then instead of in December of that year. There is no indication in the record nor has there been any insistence on the part of the bank that its prospects of having this obligation paid would have been enhanced if it had not been renewed. Not having been damaged by the debtor's fraudulent conduct, the bank is not entitled to compensatory relief. As this court recently concluded in Wilson, compensatory relief is available to defrauded creditors under subsection (A). Is a different measure of relief — one which is punitive rather than compensatory—applicable under subsection (B)?

Pertinent to the resolution of this issue is the history of the false-financial-statement provisions of the Bankruptcy Act of 1898, as amended, the decisions construing those provisions, as well as the language of § 523(a)(2)(B) of the Reform Act and its legislative history. The court is unaware of any reported decisions addressing this issue under the new Reform Act.

Fraudulent use of a false financial statement was added to § 14(c) of the old Act as a ground for denial of discharge by a 1903 amendment. Act of Feb. 5, 1903, Pub.L. No. 62, § 4, 32 Stat. 797. The thrust of that provision was to penalize bankrupts rather than compensate creditors. Bankrupts were denied discharge from any debts regardless of the extent to which any creditors may have been damaged by the statement. Creditors benefitted who had never even seen it. Although not specifically mentioned, fraudulent use of such statements also was a ground for excepting individual debts from the discharge under the fraud exception of § 17(a)(2) of the old Act. False-financial-statement dischargeability litigation occurred in state courts until their jurisdiction to determine such issues was withdrawn by a 1970 amendment to the Act. When a prior obligation had been renewed in reliance on such a statement, the state courts were divided as to the measure of relief under § 17(a)(2). Some excepted the entire debt from the discharge, including the renewed portions as well as any "fresh cash" that may have been advanced. Others concluded in effect that the injured creditor was only entitled to recover compensatory damages caused by the fraud and limited relief to the "fresh cash" advanced to the debtor. Townsend, "Fresh Cash" — Another Element of a Bankrupt's "Fresh Start"?, 31 U. Miami L.Rev. 275 (1977).

In 1960, by the so-called Celler Amendment, the false financial statement was deleted from § 14(c) as a ground for denial of discharge except when used in connection with business transactions. At the same time Congress also amended § 17(a)(2) to include a specific reference to such statements so that there was excepted from the discharge

liabilities for obtaining money or property by false pretenses or false representations, or for obtaining money or property on credit or obtaining an extension or renewal of credit in reliance upon a materially false statement in writing respecting his financial condition made or published or caused to be made or published in any manner whatsoever with intent to deceive,. . . .

Act of July 12, 1960, Pub.L. No. 86-621, 74 Stat. 409 language added by amendment emphasized. The legislative history of this amendment contains the following statement of the reason for these changes:

The committee believes that complete denial of a discharge is too severe a penalty in the case of the individual noncommercial bankrupt. It is also a penalty which experience has shown to be subject to abuse. An unscrupulous lender armed with a false financial statement has a powerful weapon with which to intimidate a debtor into entering into an agreement in which the creditor agrees not to oppose the discharge in return for the debtor\'s agreement to pay the debt in full after discharge. The creditor may also accomplish his purpose of preserving his debt by not opposing the discharge and then suing in a State court on the ground that the debt is not dischargeable. Testimony before the Subcommittee on Bankruptcy and Reorganization by experts in bankruptcy law indicates that unscrupulous lenders have frequently condoned, or even encouraged, the issuance of statements omitting debts with the deliberate intention of obtaining a false agreement for use in the event that the borrower subsequently goes into bankruptcy.

Even where the creditor has had no part in the issuance of a false financial statement, the exercise of his right to bar the discharge completely results in a windfall for other creditors who were not even aware of such a statement. Debts which are dischargeable are not discharged solely because one of many debts was induced by a false financial statement. This result is not required to protect a creditor who has relied on a false financial statement since under section 17a(2) that particular debt is not dischargeable.

In view of the protection which section 17a(2) gives to the creditor, and in view of the abuses which have grown out of section 14c(3), the committee believes that it is desirable to eliminate the false financial statement as a ground for the complete denial of a discharge insofar as the individual noncommercial bankrupt is concerned.

The situation is somewhat different in the case of a business bankrupt. The businessman is more likely to be aware of the severe consequences to him of issuing a false financial statement. His ordinary business records enable him to produce a more accurate statement than a householder who may have a multitude of small debts and no records. Furthermore, the financial statement issued by a businessman is frequently for the purpose of establishing credit standing in the community. His creditors may never see the financial statement itself. On the other hand, the nonbusiness debtor normally issues his financial statement to a particular creditor as part of his application for credit or for a loan. That creditor already has the protection of nondischargeability under section 17.

. . . .

. . . . The purpose of this amendment is to assure that although the obtaining of money or property on credit through the issuance of a false financial statement is no longer to be a ground for denial of a discharge to a nonbusiness bankrupt, any obligation incurred as a result of such a statement is to be nondischargeable under section 17.

S.Rep. No. 1688, 86th Cong., 2d Sess. 2-3 (1960); H.R.Rep. No. 1111, 86th Cong., 1st Sess. 2-3 (1959), U.S.Code Cong. & Admin. News 1960, p. 2954, 2955.

Immediately after the passage of this amendment, at least one commentator concluded that its effect was to render the entire debt nondischargeable, including the renewed portion. Note, Effect of False Financial Statements on Debts Discharged in Bankruptcy — Section 17a(2) of the Bankruptcy Act, 21 La.L.Rev. 638 (1961). More significantly, four state courts, three of which had...