[1]An important component of chapter 7 bankruptcy is the discharge of debts.[2] Congress excepted from this “fresh start” certain types of debts, including those involving fraud and deceit.[3] In Privitera v. Curran,[4] the First Circuit considered the discharge exception in § 523(a)(2)(B). Instead of wading into a murky circuit split involving the meaning of a “statement respecting ... financial condition,” however, the First Circuit “decide[d] the case on less controversial principles of pleading and materiality.”[5] This case offers lessons in pleading for both debtors’ and creditors’ lawyers.
An Ill-Fated Loan
Carolyn Privitera, romantically involved with Joseph Curran, agreed to loan him money.[6] During negotiations, Privitera asked Curran to provide a list of all property used in his landscaping business belonging to him “by title or by physical possession.”[7] Curran provided the list, as well as the “cost” of each item. Privitera’s counsel[8] turned the list into a “List of Collateral” and attached it to the loan agreement. The loan agreement required Curran to deliver a security agreement and financing statement covering the collateral. The list of collateral contained various landscaping items at a cost of $22,000, plus two trucks valued at $64,000, for a total listed “cost” of $86,000. Based on this value, Privitera loaned Curran $30,000.
Unbeknownst to Privitera, Curran was still making installment payments on at least one of the trucks, and title was in the lender’s name.[9] Inexplicably, the parties failed to execute a security agreement or financing statement. Curran repaid less than $5,000 of the loan, and Privitera filed a lawsuit for breach of contract. Privitera received a $137,030.78 default judgment.
Curran then filed a chapter 7 petition, and Privitera filed an adversary proceeding to except the debt from discharge under § 523(a)(2)(B) for a false statement of financial condition.[10] Curran answered the complaint, then moved to dismiss for failure to state a claim under Fed. R. Civ. P. 12(b)(6). Privitera opposed the motion and moved to amend her complaint to add a count for nondischargeability under § 523(a)(2)(A) for false pretenses, false representation or actual fraud.
History Below
The U.S. Bankruptcy Court for the District of Massachusetts dismissed the complaint.[11] It held that Privitera’s failure to perfect any security interest rendered her reliance unjustifiable. The bankruptcy court then denied the motion to amend as futile, noting a failure to allege any affirmative misrepresentations as required under § 523(a)(2)(A).
Privitera appealed to the First Circuit Bankruptcy Appellate Panel (BAP).[12] The BAP affirmed, although it treated Curran’s motion as a motion for judgment on the pleadings under Fed. R. Civ. P. 12(c) because he filed the motion after answering the complaint. After considering both sides of the split of authority on the meaning of a statement respecting financial condition, the BAP held that the list of collateral was not a statement respecting financial condition under either approach. Even if the statement qualified under either approach, Privitera failed to plausibly allege material falsity. The BAP also affirmed denial of Privitera’s motion to amend. Privitera again appealed.
No Obligation to Volunteer Information
The First Circuit highlighted the circuit split[13] on statements regarding financial condition, but declined to pick a side.[14] The court first noted that the two lower courts disagreed about the proper procedural mechanism; the bankruptcy court treated Curran’s motion as a motion to dismiss, while the BAP analyzed it as a motion for judgment on the pleadings. The goal of each, the First Circuit reasoned, is to “test the plausibility of a complaint” after accepting well-pleaded facts as true and drawing reasonable inferences in the plaintiff’s favor.[15] The First Circuit concluded that any distinction between a motion to dismiss under Fed. R. Civ. P. 12(b)(6) and a motion for judgment on the pleadings under Fed. R. Civ. P. 12(c) was immaterial to deciding the motion.
The court then examined the complaint for plausibility. Nondischargeability under § 523(a)(2)(B) requires “[1] use of a statement in writing [2] that is materially false [3] respecting the debtor’s ... financial condition [4] on which the creditor ... reasonably relied [5] that the debtor caused to be made or published with intent to deceive.” The parties and the lower courts focused their efforts on whether the list of collateral satisfied the third requirement as a statement respecting financial condition. However, the First Circuit instead examined the second requirement: material falsity. Under this requirement, a plaintiff must plausibly allege that the defendant made a statement “that would normally affect the decision to grant credit.”[16] A statement can be either (1) an affirmative misrepresentation or (2) an omission, but an omission only suffices when accompanied by an obligation to furnish the missing information.[17]
Here, Privitera asked for a list of collateral that Curran either owned or possessed, as well as the cost of such collateral; Curran gave her just that.[18] There was no alleged misrepresentation. Likewise, there was no obligation to disclose that the truck was encumbered and titled in the lender’s name, as Privitera did not ask about encumbrances. Under the loan agreement, Curran agreed not to further encumber the collateral, but he had no duty to disclose the previous encumbrances.
Lastly, the court rejected the argument that Curran should have implicitly understood the need to disclose encumbrances, reasoning that Curran could have believed there was sufficient equity in the collateral to fully secure the $30,000 loan despite the encumbrances. Concluding that Privitera’s allegations of material falsity did not “cross the line from possible to plausible”[19] and availing itself of the right to affirm dismissal “on any ground made manifest by the record,”[20] the court affirmed dismissal and moved to amend.
Amendment Futile
The court likewise affirmed the order denying Privitera’s motion to amend.[21] Section 523(a)(2)(A) requires Privitera to show that Curran obtained credit by “false pretenses, a false representation, or actual fraud.” Subject to certain exceptions, amendments require leave of court.[22] Courts should freely grant leave to amend, but futility is one ground for denying leave to amend.[23] An amended complaint is futile when it fails to state a plausible claim for relief.[24]
Privitera’s strongest claim under § 523(a)(2)(A) was arguably for false pretenses. However, false pretenses only exist when circumstances imply one set of facts and the defendant knows the facts to be otherwise, yet fails to correct the false impression.[25] Here, Curran had no part in creating false circumstances. Privitera never asked about encumbrances, just about potential collateral, and the list “was exactly what it purported to be: a description of items that the debtor used in the course of his business and their cost when he purchased them.”[26]
Conclusion
Failing to disclose encumbrances without an accompanying duty to do so under the loan documents will not render a debt nondischargeable under § 523(a)(2)(B); in negotiating a loan, lender’s counsel should impose upon the debtor a duty to make explicit representations about all material aspects of the collateral, including encumbrances, basis for the value, equity, etc. This case also illustrates, post-Twombly and Iqbal, that even if a party wants a court to choose one side of a circuit split, a plaintiff must first plausibly allege all elements of a cause of action before getting to the circuit split.[27]
[1] My thanks to Chief Judge Cynthia Norton, Western District of Missouri, and Clay Nordsiek, my fellow law clerk, for their contributions. Any views expressed in this article are my own and not those of the court or my current employer.
[2] See generally 11 U.S.C. § 727. All further statutory references are to the Bankruptcy Code, 11 U.S.C. § 101, et seq.
[3] See generally § 523(a).
[4] In re Curran, 855 F.3d 19 (1st Cir. 2017).
[5] Id. at 22.
[6] Id. at 23.
[7] Id.
[8] Curran was unrepresented in the loan negotiations.
[9] 855 F.3d at 23.
[10] Id.
[11] Id. at 24.
[12] 554 B.R. 272 (B.A.P. 1st Cir. 2016).
[13] The Fifth and Tenth Circuits follow the “narrow approach,” holding that a statement respecting financial condition must speak to the debtor’s overall financial condition. By contrast, the Fourth and Eleventh Circuits have held that even a statement referencing a single asset or liability may qualify as a statement respecting financial condition (the “broad approach”). See 855 F.3d at 22.
[14] 855 F.3d at 22.
[15] Id. at 24-25 (citation and internal quotations omitted).
[16] Id. at 25 (citation omitted).
[17] Id. at 25-26.
[18] Id. at 26.
[19] Id. at 27.
[20] Id. at 25, n.1.
[21] Id. at 29.
[22] Fed. R. Civ. P. 15(a)(2), as incorporated by Fed. R. Bankr. P. 7015.
[23] 855 F.3d at 27-28.
[24] Id. at 28.
[25] Id.
[26] Id. at 28-29.
[27] Here, Rule 2004 testimony showed Curran actually understood he was supposed to provide a list of unencumbered property. 554 B.R. at 283 n.11. However, by failing to include such allegation in her complaint or attempt to treat the motion as one for summary judgment under Fed. R. Civ. P. 12(d), Privitera failed to plausibly allege material falsity.