The Journal of The DuPage County Bar Association

Back Issues > Vol. 10 (1997-98)

Advising Clients About Credit Card Debt
By Robert V. Schaller

Throw your drowning clients a life preserver! Discuss the benefits of discharging 100% of each client’s credit card debt by filing a Chapter 7 bankruptcy case. Your clients need to know that most cases result in clients retaining all their assets while their credit card debts are discharged — with no payments being made to creditors.

Chapter 7 of the US Bankruptcy Code (the "Code") provides the basic procedure designed to give individuals or "debtors" a fresh start in life by jettisoning the accumulated burden of oppressive and often unmanageable credit card debt loads. See 11 USC Section 701 et seq. Debtors will be discharged from unpaid credit card balances. Thereafter, debtors have no further obligation to pay credit card debts and credit card creditors are forever enjoined from enforcing claims.

Judge Ginsberg of the US Bankruptcy Court for the Northern District of Illinois stated in a scholarly treatise: "A discharge voids any judgment, whenever obtained, that determines the personal liability of the debtor on any discharged debt; enjoins any judicial or non-judicial action to collect, recover or offset any discharged debt as a personal liability of the debtor; and enjoins the collection of certain claims against the debtor’s community property". Ginsberg & Martin on Bankruptcy, Fourth Edition, Section 11.01(B).

This article focuses on the "dischargeability" of an individual debtor’s credit card debts by analyzing attacks made by credit card issuers attempting to subvert the discharge provisions applying to credit card debts.

The beginning point is a simple declaration that all credit card debts are dischargeable unless challenged by adversary proceeding. Moreover, there is simply no statutory authority expressing stating that credit card debts are non-dischargeable. Consequently, credit card debt is not per se non-dischargeable.

The scope of a debtor’s discharge is not boundless however. The Code does provide statutory authority for denying the discharge of certain debts. For example, Code Section 523 identifies exceptions to the fresh-start, discharge rule and deems these exceptions as "non-dischargeable" debt, which a debtor must pay. See 11 USC Section 523.

Therefore, credit card creditors objecting to a discharge typically utilize Section 523 as a sword in an attempt to render some or all credit card purchases non-dischargeable. Section 523(a)(2)(A) is the sharpest sword because of its broad statutory language regarding "false pretenses, a false representation, or actual fraud". This Code subsection states that an individual debtor is not discharged from any particular debt for money, property, services or an extension, renewal, or refinancing or credit, to the extent obtained by false pretenses, a false representation, or actual fraud.

Therefore, the central issue is whether a debtor’s use of a consumer credit card constitutes false pretenses, a false representation, or actual fraud.

While the statutory language appears clear, the interpretation and application of the law has been cloudy. The judges in the Northern District of Illinois have addressed this issue on a case-by-case basis with rulings being made on the basis of the facts and circumstances of each case.

Standards for Attacking Dischargeability

The policies underlying the Bankruptcy Code encourage a "fresh start" for debtors and require that exceptions to discharge be strictly construed against creditors and in favor of a fresh start for debtors. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 728 (Bankr. N.D. IL 1996)(Ginsberg, J.); FCC National Bank v. Phillips, 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.). The party seeking to establish an exception to the discharge of debt bears the burden of proof—that burden is a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991); In re Robert Sheridan, 57 F.3d 627, 633 (7th Cir. 1995). The "discharge" feature is essential to the notion of a fresh start. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 728 (Bankr. N.D. IL 1996)(Ginsberg, J.).

Section 523(a)(2)(A) provides that a Chapter 7 discharge will not discharge a debtor from any debt "for money, property, services, or any extension, renewal, or refinancing of credit, 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." 11 USC Section 523(a)(2)(A).

Courts have held that a single test for dischargeability must be applied even though Section 523(a)(2)(A) lists three separate grounds for dischargeability: actual fraud, false pretenses, and false representation—and the elements of each are different under common law. First National Bank of Red Bud v. Kimzey, 761 F.2d 421, 423-24 (7th Cir. 1985); AT&T Universal Card Services v. Alvi, 191 B.R. 724, 728-729 (Bankr. N.D. IL 1996)(Ginsberg, J.). The Seventh Circuit readdressed the single-test issue in 1994, but declined to invalidate the test as a whole or to establish three separate tests for actions brought under one or more of the three types of fraudulent acts specified in Section 523(a)(2)(A). See Mayer v. Spanel International Ltd., 51 F.3d 670 (7th Cir. 1994).

Therefore, the following test must be applied to Chapter 7 credit card dischargeability cases:

False Representation: the complaining creditor must prove that the debtor made a false representation through which debtor obtained money;

Knowledge: the complaining creditor must prove that the debtor either knew the representations were false or made with such reckless disregard for the truth as to constitute willful misrepresentations;

Scienter: the complaining creditor must prove that the debtor possessed scienter (i.e. intent to deceive); and

Justifiable Reliance: the complaining creditor must show that it actually relied on the debtor’s false representations and that creditor’s reliance was justifiable.

The remainder of this article analyzes separately the frequently disputed elements of the test. Cases from the Northern District of Illinois are presented only.

a. False Representation

Judge Ginsberg addressed the credit card "representation" issue in the must read Alvi case. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 731-732 (Bankr. N.D. IL 1996)(Ginsberg, J.). The Alvi Court addressed the issue of whether a debtor makes an actual "representation" by incurring a credit card charge. In Alvi, a credit card issuer brought an adversary proceeding to except from discharge the debtor’s obligation for cash advances obtained for gambling at a local casino. Judge Ginsberg declared that the use of a credit card to incur debt in a typical credit card transaction involves no representation at all, express or implied. The Alvi Court further stated that the use of a credit card to incur debt by itself is incapable of being true or false. Judge Ginsberg analyzed and rejected other courts’ holdings that the use of credit cards constitutes an "implied representation," noting that the majority of courts that accept the implied representation theory have failed to consider the NSF check cases and the US Supreme Court’s decision in Williams v. United States, 458 US 279 (1982).

However, other courts have ruled contrary to Judge Ginsberg. For example, Judge Squires held that the use of a credit card is an implied representation to the card issuer that the user has the means and the intent to repay the debt being incurred. FCC National Bank v. Phillips. 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.); See also FCC National Bank v. Berz, 173 B.R. 159, 162 (Bankr. N.D.IL 1994)(Schmetterer, J)(use of a credit card implies a representation of intent and ability to pay).

But Judge Barliant expressly disagreed with the implied representation cases that hold that the use of a credit card is also an implied representation of the means to pay. Chase Manhattan Bank v. Murphy, 190 B.R. 327, 332 (Bank. N.D.IL 1995)(Barliant, J.). Judge Barliant believed that one of the principal reasons people pay by credit card is a present lack of ability to pay. Consequently, Judge Barliant believed the credit card use represents debtor’s intent to pay only. Judge Conlon’s issued a consistent ruling in First National Bank of Lincolnshire v. Cloud, 107 B.R. 156, 159 (N.D.IL 1989)(Conlon, J.).

Scienter/Intent

The "scienter" (or intent to deceive) element appears to be the most frequently litigated element.

Judge Ginsberg addressed the "scienter" element asking "did the debtor intend to deceive" the credit card issuer in AT&T Universal Card Services v. Alvi, 191 B.R. 724, 732-733 (Bankr. N.D. IL 1996)(Ginsberg, J.). The Alvi Court noted that a debtor’s opportunity to obtain a fresh financial start would be negatively impacted if debtors would be denied discharge because of unintentional or wholly immaterial misrepresentations having no effect on a creditor’s decision to extend credit. Congress clearly did not intend to have debtors emerge from bankruptcy saddled with a mountain of nondischargeable credit card debt incurred by debtors with absolutely no intent to defraud their respective credit card lender.

Judge Ginsberg therefore adopted a subjective test regarding a debtor’s intent to repay credit card debts. A subjective test requires an inquiry into the debtor’s state of mind at the time of the representation. The Court expressly rejected an objective test that equates (i) the inability of a debtor’s to repay the debt at the time of the transaction with (ii) the lack of intent to pay. Judge Ginsberg stated he would allow a discharge to debtors who honestly, but mistakenly, believed that they would have the ability to repay their debts. The Court noted that care must be taken to stop short of a rule that would make every desperate, financially strapped debtor a guarantor of his ability to repay.

This "subjective" test has been also adopted by other bankruptcy courts in the Northern District of Illinois. See Chase Manhattan Bank v. Murphy, 190 B.R. 327, 332-333 (Bankr. N.D.IL 1995)(Barliant, J.) (inquired into the debtor’s state of mind at the time of the representation and determined that chronic gambler and speculator had intended to repay debt and believed, however unreasonably, that debtor would have the means to do so from gambling winnings and other speculative investments).

However, other courts have held that an "objective" standard should be applied to determine a debtor’s intent to deceive. See FCC National Bank v. Phillips, 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.); Comerica Bank-Midwest v. Kouloumbris, 69 B.R. 229 (N.D.IL 1986)(Holderman, J.); and FCC National Bank v. Berz, 173 B.R. 159, 162 (Bankr. N.D.IL 1994)(Schmetterer, J).

Judge Squires applied the objective standard to the "scienter" or intent issue in FCC National Bank v. Phillips, 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.). In Phillips, debtor incurred credit card debt that the card issuer sought to except from discharge because debtor allegedly incurred the debt knowing that debtor was falsely representing the intent and ability to repay the debt. The issuer further alleged that debtor incurred the debt while debtor knew debtor was insolvent and would be unable to repay the debt.

The Phillips court ruled that proof of fraudulent intent may be implied from the totality of the circumstances. Circumstantial evidence could support a finding that a debtor had no intent to repay the indebtedness even when the debtor testifies that the debtor fully intended to pay the debt when incurred. Judge Squires then analyzed the circumstantial evidence presented in Phillips and granted debtor’s motion for summary judgment. The Court held that the credit card issuer had failed to meet its burden of proof because it failed to produce any evidence to establish any fraudulent intent on the part of the debtor.

The Phillips court and several courts have set forth a list of factors to be reviewed. See FCC National Bank v. Phillips, 1994 WL 168279 (Bankr. N.D. IL 1994)(Squires, J.); FCC National Bank v. Berz, 173 B.R. 159, 162 (Bankr. N.D.IL 1994)(Schmetterer, J); Mercantile Trust Company v. Pozucek, 73 B.R. 110 (Bankr. N.D.IL 1987)(Hertz, J.). Some of these factors are set forth below:

Debtor’s financial sophistication;

did debtor exceed the credit card limit; did debtor exceed the limit in a series of small transactions that are below the amount requiring prior clearance; length of time between charges and bankruptcy filing; whether an attorney was consulted concerning the filing of bankruptcy before the charges were made; the number, nature and amount of the charges(including whether debtor made multiple charges on the same day, to show evidence of a spending spree); debtor’s employment status; whether there was a sudden change in the debtor’s buying habits; the financial condition of the debtor at the time the charges were made; whether the debtor made payments on the charges; past use of the card; whether the charges were made for luxuries or necessities; and the credit limit on the account.

District Judge Holderman also addressed the "scienter" or intent issue in Comerica Bank-Midwest v. Kouloumbris, 69 B.R. 229 (N.D.IL 1986)(Holderman, J.). In Comerica, credit card creditor sent debtor a pre-approved application for a credit line. Debtor took a cash advance against the established credit line and Debtor’s wife made additional purchases that in the aggregate exceeded the credit line. Thereafter, the credit card creditor sent repeated monthly statements requesting payment of the overcharges. However, the credit card creditor did not terminate its credit relationship. Judge Holderman rejected the credit card issuer’s fraud claim because the facts suggested that when debtor charged purchases, debtor may have intended to pay for them. The Comerica court buttressed its decision by citing the following facts: debtor did not know the amount of charges charged by debtor’s spouse; debtor worked throughout the months during which the debt was incurred; debtor had a steady stream of income to pay credit card bills; and most importantly, debtor stopped charging purchases when debtor later lost employment. Consequently, Judge Holderman affirmed the bankruptcy court’s holding that the credit card debt was dischargeable.

Judge Schmetterer also addressed the "intent" issue but held that the debtor’s credit card debt was non-dischargeable. FCC National Bank v. Berz, 173 B.R. 159, 162 (Bankr. N.D.IL 1994)(Schmetterer, J). In Berz, Judge Schmetterer was confronted with a debtor who admitted to being a perpetually unemployed wastrel living off the father’s largesse. That generosity terminated. Nevertheless, debtor later took two large cash advances that were the subject of the credit card creditor’s attack. Applying a totality of the circumstances approach, the Court ruled that debtor did not have a reasonable expectation that debtor would have the subsequent ability to repay the credit card debts.

Judge Hertz also addressed the "intent" issue in Mercantile Trust Company v. Pozucek, 73 B.R. 110 (Bankr. N.D.IL 1987)(Hertz, J). Judge Hertz held that the debtor’s credit card debt was non-dischargeable because debtor purchased goods with the credit card without intending to pay the debt. The Court noted that a substantial portion of the debt was incurred within three months of the bankruptcy filing and after consulting with a bankruptcy attorney. Also relevant was the fact that debtor had filed a previous bankruptcy and was knowledgeable about bankruptcy law and the benefits of bankruptcy protection.

c. Justifiable Reliance

Justifiable reliance is an element that must be proved. Field v. Mans, 116 S.Ct. 437 (1995). The Supreme Court rejected the "reasonable" reliance standard in favor of the less demanding standard of "justifiable" reliance. Id. At 439.

Judge Schmetterer has held that the use of a credit card implies a representation by debtor that debtor intends to pay, and the creditor relies on such implied representation. Chase Manhattan Bank v. Williams, 85 B.R. 494, 496 (Bankr. N.D.IL 1988)(Schmetterer, J.).

Judge Ginsberg on the other hand rejected the implied reliance theory in AT&T Universal Card Services v. Alvi, 191 B.R. 724, 731 (Bankr. N.D. IL 1996)(Ginsberg, J.). There, Judge Ginsberg held that credit card creditors must first prove that they actually relied on debtor’s representations according to Judge Ginsberg. Id. at 731. Judge Ginsberg further ruled that a credit card issuer’s act of passively extending credit do not constitute reliance on individual instances of card usage. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 729-730 (Bankr. N.D. IL 1996)(Ginsberg, J.). The Court stated that it could hardly conceive why such reliance, if it did exist, should always be justifiable. Therefore, the Alvi Court ruled that a credit card issuer cannot sit back and do nothing and still meet the standard for actual and justifiable reliance when the issuer had an opportunity to make an adequate examination or investigation. Judge Ginsberg granted the debtor’s motion for a judgment on partial findings because the credit card issuer failed to present any evidence indicating any reliance in fact on representations.

Judge Ginsberg also stated that a court cannot just assume the credit card issuer actually relied on any alleged representation by debtor in doing business with debtor. AT&T Universal Card Services v. Alvi, 191 B.R. 724, 731-732 (Bankr. N.D. IL 1996)(Ginsberg, J.). In fact, the Alvi Court noted that case law indicates that some credit card issuers don’t rely on debtor’s "representations" at all, choosing not to prevent the use and abuse of their cards. Instead, these issuers calculate the attendant risks and allow consumers relatively free reign with their cards and credit limits. Quoting a 11th Circuit case, Judge Ginsberg stated "Banks are willing to risk nonpayment of debts because that risk is factored into finance charges." Citing First National Bank of Mobile v. Roddenberry, 701 F.2d 927, 932 (11th Cir. 1983).

Conclusion

Serve those of your clients drowning in credit card debt by discussing the benefits of discharging unmanageable credit card debt loads. By helping your client jettison the accumulated burden of oppressive debt, you will probably have a grateful client who will be a "client for life".


Robert Schaller
is a sole practitioner in Oakbrook Terrace. He is also a C.P.A. His practice is concentrated in Bankruptcy Law. He received his Undergraduate Degree in 1982 from the University of Illinois-Urbana and his Law Degree in 1985 from DePaul University.


 
 
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