Here’s a refresher on legal standards, and the application of those standards, for denying a debtor’s discharge for “actual fraud” under § 523(a)(2)(A):
- the opinion is Capital, Inc. v. Novak (In re Novak), Adv. Pro. No. 23-01005 in the Eastern Louisiana Bankruptcy Court (decided October 21, 2024; Doc. 34).
Background
Debtor files Chapter 7 bankruptcy.
In the bankruptcy, Creditor files a $1,387,048.20 proof of general unsecured claim (Claim No. 2-1). Creditor also files a Complaint seeking to deny Debtor a discharge of Creditor’s claim.
The case is tried under Creditor’s Complaint. After trial, the Court (i) rejects the request for a denial of Debtor’s discharge of Creditor’s claim, and (ii) declares that Creditor’s claim is dischargeable.
What follows is a summary of the governing legal standards in the case and how the Bankruptcy Court applies those standards.
Legal Standards
A debtor’s discharge under the Bankruptcy Code is subject to nineteen enumerated exceptions in 11 U.S.C. § 523(a).
Among those exceptions is one for “actual fraud”:
- (a) A discharge under [the Bankruptcy Code] does not discharge an individual debtor from any debt— . . . (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by— (A) false pretenses, a false representation, or actual fraud” (§ 523(a)(2)(A), emphasis added).
To deny a debtor’s discharge of a plaintiff’s claim under § 523(a), the plaintiff must show its entitlement to relief by a preponderance of the evidence:
- a fact is proven by preponderance of the evidence if the finder of fact finds it more likely than not, based on the evidence, that the fact is true.
Countervailing Principles
There are two countervailing and basic principles of bankruptcy law applicable here:
- the first is that exceptions to discharge must be strictly construed against a creditor and liberally construed in favor of a debtor so that the debtor may be afforded a fresh start; and
- the second is that bankruptcy only affords relief to the “honest but unfortunate debtor,” such that an individual debtor may not obtain a discharge of debts incurred through debtor’s own wrongful conduct.
“Actual Fraud” Standards
To prevail under the “actual fraud” exception of § 523(a)(2)(A), a plaintiff must prove that,
- Debtor is personally liable for the debt; and
- such debt falls within the universe of debts that are nondischargeable under § 523(a)(2)(A).
In this case:
- there is no dispute that Debtor is personally liable for the debt in question, because of a state court’s pre-petition entry of a default judgment against Debtor thereon; and
- so, the sole issue is whether the debt was obtained by “actual fraud” such that it is nondischargeable under § 523(a)(2)(A).
–Meaning of “Actual Fraud”
“Actual fraud” is fraud committed with wrongful intent. It has two parts: actual and fraud.
The word “actual” denotes any fraud that involves moral turpitude or intentional wrong.
“Actual fraud” stands in contrast to “implied” fraud or fraud “in law,” which describe acts of deception that may exist without the imputation of bad faith or immorality.
Thus, anything that counts as “fraud” and is done with wrongful intent is “actual fraud.”
–Meaning of “Wrongful Intent”
Wrongful intent may be inferred by examining the totality of the circumstances, because it most commonly cannot be established by direct evidence.
When examining a debtor’s intent under § 523(a)(2)(A), the Court must consider whether the circumstances in the aggregate present a picture of deceptive conduct on the part of the debtor, which betrays an intent on the part of the debtor to deceive creditors.
Evidence of “Actual Fraud”?
Plaintiff alleges that the agreement and the advances of funds thereunder were procured through “actual fraud.”
At trial, however, Plaintiff failed to meet its burden to show that the agreement was executed with wrongful intent. One witness provided evidence:
- as to a third party’s intent behind entering into the agreement to memorialize a repayment plan for a prior loan; but
- was unable to connect Debtor to that third party’s actions or to any wrongful intent.
Debtor testified at trial that he was uninvolved with the negotiation or execution of the agreement, and the Court found such testimony to be “earnest and credible.”
The Court also found and declared:
- “The record is silent” as to motives in entering into the agreement; and
- “given the dearth of direct or circumstantial evidence as to intent, this Court can only conclude that no wrongful intent can be inferred from the totality of the circumstances here.”
Accordingly, the Court orders that:
- “the relief sought by Plaintiff in the Complaint is DENIED,” and
- “the debt claimed by Plaintiff in Proof of Claim No. 2 in the amount of $1,387,048.20 is DISCHARGABLE.”
Conclusion
The In re Novak opinion summarized above provides an excellent refresher on nondischargeability litigation on grounds of “actual fraud” under § 523(a)(2)(A).
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