For nondischargeability, the Ninth Circuit Bankruptcy Appellate Panel wrote an opinion explaining why a fraudulent omission falls into the orbit of a “false representation” under Section 523(a)(2)(A), not “a statement respecting the debtor’s . . . financial condition.”

The difference is critical. As a “false representation,” a creditor subject to a fraudulent omission has an easier path to nondischargeability.

The individual debtor was under contract with a major brewer to operate mobile bars. Under the contract, the debtor generated $5.6 million in revenue from January through May of 2016. Aside from the contract with the brewer, the debtor’s other income was negligible.

In June of 2016, the brewer terminated the contract. At the same time, the debtor was negotiating with a lender for a line of credit. The debtor gave the lender financial statements through May 2016 but did not tell the lender that the brewer had terminated the contract.

In the loan agreement, the debtor made a representation that the financial statements fairly represented the debtor’s financial condition and that “there has been no material adverse changes, financial or otherwise.”

The debtor drew $350,000 from the lender but defaulted almost immediately. The lender sued and won a default judgment in state court. When the debtor filed a chapter 7 petition, the lender filed an adversary proceeding alleging that the debt was nondischargeable under Section 523(a)(2)(A), based on the debtor’s failure to disclose the loss of the contract with the brewer.

When the bankruptcy court ruled that the debt was nondischargeable, the debtor appealed, but the BAP affirmed in a March 19 opinion by Bankruptcy Judge William J. Lafferty, III.

What’s a ‘Statement’?

The appeal turned on a few of the words in Section 523(a)(2)(A), which provides that a debt of an individual is excepted from discharge “to the extent obtained by — (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”

In large part, the debtor contended on appeal that his omission was a “statement” that’s not nondischargeable under Section 523(a)(2)(A). “Debtor’s position is not supported by the law,” Judge Lafferty said.

Judge Lafferty began by citing Husky Int’l Elecs., Inc. v. Ritz, 578 U.S. 355, 360-62 (2016), where he said that the Supreme Court explained how “§ 523(a)(2)(A) encompasses a broad range of fraudulent acts, including not only fraudulent representations and omissions, but also deceptive conduct.”

In nondischargeability cases under Section 523, Judge Lafferty said there is often overlap among the subdivisions when a debtor makes “makes both fraudulent representations and omissions.” “Where an affirmative representation is as broad and ambiguous as it is here,” he saw “no reason to foreclose plaintiffs from prosecuting a claim for a fraudulent omission under § 523(a)(2)(A) simply because the omission is related to an affirmative representation made by the debtor.”

In a case involving fraudulent omission, Judge Lafferty rejected the idea that the creditors must “prove their claims under the stricter standards related to fraudulent representations.” If that were the law, he said it “would essentially erase fraudulent omissions from the purview of § 523(a)(2)(A),” because “debtors could simply reference loosely related affirmative representations and require plaintiffs to prove their claims under the stricter standards related to fraudulent representations.”

Recipients of fraudulent omissions have an easier burden. In cases involving fraudulent omissions rather than fraudulent statements, Judge Lafferty quoted the Ninth Circuit for saying that “‘the nondisclosure of a material fact in the face of a duty to disclose has been held to establish the requisite reliance and causation for actual fraud under the Bankruptcy Code.’ Apte v. Romesh Japra, M.D., F.A.C.C., Inc. (In re Apte), 96 F.3d 1319, 1323 (9th Cir. 1996).”

If fraudulent omissions were taken as fraudulent statements, Judge Lafferty said that creditors would be faced with “an impossible feat.” They would be required “to demonstrate reliance on a fact they never knew.” That is “precisely the reason that authorities developed a different standard for fraud based on omissions.”

Having decided that the fraudulent omission was not a statement under Section 523(a)(2)(A), Judge Lafferty proceeded to an analysis of the Restatement (Second) of Torts to conclude that the bankruptcy court did not err in deciding that the omission was material and that the debtor had a duty to disclose the termination of the contract with the brewer.

BAP Sitting En Banc

Judge Lafferty ended his opinion by rejecting the debtor’s argument that the BAP should overrule its prior holding in Oregon v. Mcharo (In re Mcharo), 611 B.R. 657 (B.A.P. 9th Cir. 2020), where the BAP ruled that omissions are not statements.

Judge Lafferty said the panel was bound by the prior BAP decision unless there is a request for the BAP to sit en banc, or the prior decision was undermined by legislation or decisions by the Supreme Court or the Ninth Circuit. He said that Mcharo “has not been overruled or undermined by any intervening, binding authorities or applicable legislation,” nor did the debtor ask the BAP to sit en banc.

“As such,” Judge Lafferty said, “we are bound by the holding in Mcharo.” If the panel were not bound, “we would reach the same conclusion,” because the “Debtor’s interpretation of the word ‘statement’ as inclusive of ‘omissions’ runs contrary to the plain meaning of both terms.” He affirmed, given that “the bankruptcy court did not err in holding that Debtor’s omission did not qualify as a statement under § 523(a)(2)(A).”