Ch. 7 Debtor Must Pay Debt Owed to Law Firm

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By Diane Davis

April 4 — A state court judgment for unpaid legal fees can't be discharged in a debtor's Chapter 7 bankruptcy because the debtor made false misrepresentations to counsel about his financial condition and the amount of his anticipated tax refund, a district court in Georgia held March 28.

Judge C. Ashley Royal of the U.S. District Court for the Middle District of Georgia affirmed the judgment of the bankruptcy court, and concluded that the bankruptcy court correctly adopted the Fifth Circuit's strict interpretation of Bankruptcy Code Section 523(a)(2)(A)'s exception to discharge for false and misleading statements.

In Chapter 7 bankruptcy, a debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors in order to give the debtor a fresh start. Section 523(a)(2)(A) provides an exception to discharge for a debt “for money, property, services, or an extension, renewal, or refinancing of credit” to the extent that it is “obtained by false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition.” A false oral statement is enough to render a debt nondischargeable under Section 523(a)(2)(A), the court said.

Broad v. Strict View

Courts disagree, however, as to “what constitutes a ‘statement respecting financial condition,' which is an undefined term,” according to Bloomberg Law: Bankruptcy Treatise, pt. II, ch. 63 (D. Michael Lynn et al. eds., 2016). “Under the broad view, any communication that bears on the debtor's financial position, including statements addressing the status of a single asset or obligation, falls within the statutory phrase. Under the narrow or strict view, on the other hand, a statement relates to financial condition only if it addresses the debtor's overall financial position, net worth, or financial health.”

The Eleventh Circuit, which would apply in this case, hasn't addressed the issue yet. The Fourth Circuit follows the broad interpretation, but the Fifth, Eighth, and Tenth Circuits have adopted the strict interpretation.

The district court found the Fifth Circuit's reasoning in , 683 F.3d 671 (5th Cir. 2012), to be persuasive and adopted this strict approach. Under this approach, statements about the debtor's financial condition involve the debtor's worth, overall financial health, or equation of assets and liabilities. A statement pertaining to a single asset isn't a statement of financial condition, the court said.

Promised Tax Refund?

Appellant/debtor R. Scott Appling purchased a business that manufactured seating components. After he learned that he had been defrauded, he hired appellee law firm Lamar, Acher & Cofrin, LLP to represent him as counsel. The appellant/debtor also hired Walter Gordon as local counsel.

After filing suit in state court against the seller, the appellant/debtor owed $60,819 in unpaid legal fees, and owed Gordon around $18,000 in legal fees. Subsequently, at a meeting with the appellee law firm and Gordon, the appellant/debtor stated that his accountant had completed his return and he would be receiving a tax refund of $104,000, which would more than cover his unpaid legal fees.

Ultimately, the appellant/debtor received a tax refund of only $59,851, and didn't use the refund to pay his attorneys. In a second meeting with his attorneys, the appellant/debtor said he hadn't received his refund and would use it to pay his legal fees. After not receiving payment, the appellee law firm sued the appellant/debtor in state court and obtained a judgment of $104,179. A year later, the appellant/debtor filed for Chapter 7 bankruptcy. The appellee asked the bankruptcy court to declare its claim nondischargeable under Section 523(a)(2)(A).

Debtor's Intent to Deceive

The district court found that the appellant/debtor intended to deceive the appellee by his statements about the tax refund. The bankruptcy court didn't commit clear error by finding the appellant/debtor knowingly misrepresented the amount of the tax refund, the court said. The court also found that the appellee law firm justifiably relied on the appellant/debtor's false statements about the tax refund. According to the appellee, if the law firm had known the truth, it would have stopped the representation, put an attorney's lien on the appellant/debtor's file, and begun collection of unpaid legal fees.

The court noted that several courts have held that Section 523(a)(2) doesn't impose a “new money” requirement on claims arising out of secondary debt transactions. Thus, a false representation in connection with a renewal or refinancing of credit may render the entire debt nondischargeable even if the creditor didn't lend new money in reliance on the false statement, the court said.

In this case, the appellant/debtor became delinquent on payments and the appellee forbore from collecting the overdue amounts in reliance on the appellant/debtor's false statement, the court said. This forbearance was an extension of credit and the entire debt is nondischargeable, the court concluded.

Daniel Lewis Wilder, Macon, Ga., represented appellant/debtor R. Scott Appling; David W. Davenport, Atlanta, Ga., represented appellee Lamar, Archer & Cofrin, LLP.

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