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NH Legal Perspective: How fraud can impact the bankruptcy process

Of Sheehan Phinney

December 03. 2017 2:51AM

A fundamental policy behind bankruptcy law is to provide a debtor with a "fresh start" by allowing him or her to discharge his or her debts.

However, this policy is not all encompassing and does not override the competing policy that a dishonest debtor should not benefit from bad acts.

Accordingly, bankruptcy law provides that certain debts incurred through fraud or misrepresentation are not dischargeable as part of one's bankruptcy case. Therefore, creditors should not assume that all is lost if a debtor files bankruptcy.

Section 523(a) of the bankruptcy code lists debts that are excepted from a debtor's discharge. Generally, the exceptions to discharge under section 523(a) express congressional intent that certain debts should be excluded from discharge because of overriding public policy relating to the type of debt, the manner in which liability for the debt was incurred, and the underlying social responsibility that the debt represents.

Dischargeability exceptions reflect the decision by Congress to allow certain competing public interests to override the "fresh start" purpose of bankruptcy. The debts that are excepted from discharge in section 523(a) may be classified, generally, as government liabilities, liabilities incurred through fault and family support obligations, among others.

Focusing on those discharge exceptions related to liabilities incurred through fault, and more specifically, through fraud, the bankruptcy code states that a debt for "services" or an "extension, renewal or refinancing of credit" is not dischargeable to the extent that the debt is obtained by "false pretenses, a false representation, or actual fraud."

In order for the bankruptcy court to determine that a creditor's claim is not discharged because of fraud under section 523(a), the creditor must prove the following elements: 1) the debtor made a knowingly false representation or made a representation in reckless disregard of the truth; 2) the debtor did so with fraudulent intent; 3) the debtor intended to induce the creditor to rely on the false statement; 4) the creditor actually relied upon the false statement; 5) the creditor's reliance was justifiable; and, 6) the creditor's reliance upon the false statement caused damage.

The first two elements describe the conduct and intent required to show the debtor's fraudulent conduct generally. The last four elements embody the requirement that the creditor's claim arise as a direct result of the debtor's fraud.

The intent requirement may be met in one of several ways,such as, if the debtor a) knows or believes that the matter is not as he/she represents, b) does not have the confidence and the accuracy of the representation that he/she states or implies; or (c) knows that he/she does not have the basis for the representation that he/she states or implies. Intent may also be inferred from the totality of the circumstances surrounding the transaction, including inferences from circumstantial facts. However, fraudulent intent cannot be presumed.

For example, potentially misrepresentative statements may include statements relating to one's: a) purpose for a loan, b) use of loan proceeds; c) assets, d) liabilities, e) expertise or licensing, or f) financial support.

Written misrepresentations, such as those made in a loan application, may also provide grounds for a creditor's claim to be excepted from a debtor's discharge. A textbook example is when a debtor overstates his/her assets in a loan application intending that the lender rely upon those misrepresentations and the lender lends based upon the debtor's misrepresentations.

Not all misrepresentations however lead to a non-dischargeable debt. A misrepresentation which is of little or no importance to a creditor's decision to enter into a contract with the debtor or lend money to the debtor is not material and does not go to the essence of the contractual agreement.

For example, the reliance placed upon a misrepresentation of marital status in entering into a lease was so negligible that the creditors failed to prove that their damages under the lease for unpaid rent were caused by the misrepresentation.

In conclusion, a creditor who has transacted business with a less than honest debtor should not simply assume that it has no recourse once the debtor has filed bankruptcy.

Instead, the creditor should undergo a careful review of its transaction with the debtor to determine if there is a basis to except its claim from discharge, or, at the very least, to begin a conversation about whether its claim should be discharged.

NH Legal Perspective is a biweekly column sponsored by Sheehan Phinney Bass & Green PA. This column does not provide legal advice. We recommend that you consult an attorney for specific guidance on legal questions.

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