Opinion ID: 720706
Heading Depth: 2
Heading Rank: 4

Heading: Applying 11 U.S.C. 523(a)(2)(A) to Credit Card Kiting

Text: 42 In the present case, the bankruptcy court applied the twelve factor approach set out in Dougherty. On appeal, the crux of the debtor's argument is that the Dougherty factors are not the proper standard for determining nondischargeability under 11 U.S.C. § 523(a)(2)(A) because the Dougherty factors do not address the creditor's reliance. 43 We incorporate the twelve factors of Dougherty into an approach which gives consideration to all of the elements of common law fraud. We adopt the twelve factors of Dougherty to establish the element of intent to deceive. However, a creditor in a credit card kiting case must also prove the other elements of common law fraud, including a false representation, justifiable reliance, and damages. 44 Our approach addresses the fraudulent nature of credit card kiting which clearly falls within the actual fraud exception to discharge. A debtor who uses cash advances on one credit card to make the minimum payments on another credit card and has no intention to pay for the money, property or services received, engages in credit card kiting.
45 In the case of credit card kiting, the debtor makes a false representation: 1) by creating the facade that all of his accounts are in good standing; and 2) by failing to disclose to the creditor his intent not to pay his credit card debt. This facade gives the debtor the appearance of an honest debtor, who is servicing his credit card debt in a timely manner by making minimum payments each month. Thus, the kiting scheme enables a dishonest debtor to hide his fraudulent intentions and engage in a spending spree which results in increasing amounts of credit card debt. Long before there were credit cards, the Supreme Court recognized that it is fraud when a party not intending to pay ... induces the owner to sell him goods on credit by fraudulently concealing his insolvency and his intent not to pay for them.... Donaldson v. Farwell, 93 U.S. 631, 633, 23 L.Ed. 993 (1876) (emphasis added). 46 The credit card kiter conceals his wrongful intent and fails to disclose to the creditor that he has no intention of paying his debt. Under common law, a false representation can be established by an omission when there is a duty to disclose. The Restatement (Second) of Torts § 551 discusses liability for nondisclosure: 6 47 (1) One who fails to disclose to another a fact that he knows may justifiably induce the other to act or refrain from acting in a business transaction is subject to the same liability to the other as though he had represented the nonexistence of the matter that he has failed to disclose, if, but only if, he is under a duty to the other to exercise reasonable care to disclose the matter in question. 48 (2) One party to a business transaction is under a duty to exercise reasonable care to disclose to the other before the transaction is consummated, ... 49 (c) subsequently acquired information that he knows will make untrue or misleading a previous representation that when made was true or believed to be so;.... 50 Restatement (Second) of Torts § 551 (1976). It follows that a credit card kiter has a duty to disclose his intention not to pay because he previously represented to the card issuer his intention to pay for charges incurred on the credit card. 51 Two Circuits have recognized in the bankruptcy context that an omission can satisfy the misrepresentation element of actual fraud. 52 Actual fraud, by definition, consists of any deceit, artifice, trick or design involving direct and active operation of the mind, used to circumvent and cheat another--something said, done or omitted with the design of perpetrating what is known to be a cheat or deception. 53 RecoverEdge L.P. v. Pentecost, 44 F.3d 1284, 1293 (5th Cir.1995) (citing 3 Collier on Bankruptcy p 523.08 (Lawrence P. King et al. eds., 14th ed. 1994)); Caspers v. Van Horne (Matter of Van Horne), 823 F.2d 1285, 1288 (8th Cir.1987), abrogated on other grounds, Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991). But see Schweig v. Hunter (In re Hunter), 780 F.2d 1577 (11th Cir.1986) (holding that debt was dischargeable because representations regarding the financial condition of the debtor must be explicit). Moreover, bankruptcy courts have conceded that a debtor's silence or omission regarding a material fact can constitute a false representation which is actionable under § 523(a)(2)(A). See Cooke v. Howarter (In re Howarter), 114 B.R. 682, 684 n. 2 (9th Cir. BAP 1990) (noting that the debtor's silence or concealment of a material fact can create a false impression which constitutes a misrepresentation actionable under § 523(a)(2)(A)); see also Trizna & Lepri v. Malcolm (In re Malcolm), 145 B.R. 259, 263 (Bankr.N.D.Ill.1992) (stating that when the circumstances imply a particular set of facts, and one party knows the facts to be otherwise, that party may have a duty to correct what would otherwise be a false impression). 54 An omission gives rise to liability for fraud only when there is a duty to disclose. In a credit card kiting case, the debtor's duty to disclose is triggered by the debtor's creation of a facade which conceals his fraudulent intentions. When a debtor, with intent to defraud the creditor, makes minimum payments with cash advances from other credit cards, the debtor has a duty to disclose to the creditor that he no longer intends to pay his credit card debt. If the debtor fails to make this disclosure, then he commits actual fraud. 55 Clearly, it is not actual fraud simply to make a minimum payment with a cash advance from another credit card. This action on the part of the debtor must also be coupled with a lack of intent to repay the debt. The admonition of the Bankruptcy Appellate Panel in Karelin v. Bank of America Nat'l Trust & Sav. Ass'n (In re Karelin), 109 B.R. 943 (9th Cir. BAP 1990), is instructive: 56 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, on pain of nondischargeability. Such a rule would unduly expand the actual fraud discharge exception by attenuating the intent requirement. A substantial number of bankruptcy debtors incur debts with hopes of repaying them that could be considered unrealistic in hindsight. This by itself does not constitute fraudulent conduct warranting nondischarge. 57 Id. 947-48. In hard financial times, people may engage in the practice of using cash advances to solve their short-term cash flow problems or to deal with sporadic and seasonal income. See Citibank (N.Y.State) v. Davis (In re Davis), 176 B.R. 118 (Bankr.W.D.N.Y.1994). Moreover, we recognize the fragility of human nature. [H]uman experience tells us debtors can be unreasonably optimistic despite their financial circumstances. In re Cox, 182 B.R. 626, 635 (Bankr.D.Mass.1995). Nonetheless, a credit card kiter is easily distinguishable from a bad luck debtor. A credit card kiter manipulates the credit card system to gain money, property, and services with no intention of ever paying for them.
58 The most important element in establishing a kiting scheme is intent to deceive. Although a creditor must establish all of the elements of actual fraud, proof of intent to deceive should be the focal point of the analysis in a credit card kiting case. We adopt the twelve Dougherty factors to establish intent to deceive. See In re Dougherty, 84 B.R. 653, 657 (9th Cir. BAP 1988). Since a debtor will rarely admit to his fraudulent intentions, the creditor must rely on the twelve factors of Dougherty to establish the subjective intent of the debtor through circumstantial evidence.
59 The Supreme Court recently held that a creditor's reliance on a debtor's misrepresentation need be only justifiable, not reasonable, to except a debt from discharge under § 523(a)(2)(A) of the Bankruptcy Code. Field v. Mans, --- U.S. ----, ----, 116 S.Ct. 437, 439, 133 L.Ed.2d 351 (1995). The Court explained that the general understanding of fraud, as expressed in the Restatement (Second) of Torts and by legal scholars, favors a justifiable reliance standard, which turns on a person's knowledge under the particular circumstances. Justification is a matter of the qualities and characteristics of the particular plaintiff, and the circumstances of the particular case, rather than of the application of a community standard of conduct to all cases. Id. at ----, 116 S.Ct. at 444 (quoting Restatement (Second) of Torts § 545A cmt. b (1976)). The Restatement expounds upon justifiable reliance by explaining that a person is justified in relying on a representation of fact 'although he might have ascertained the falsity of the representation had he made an investigation.'  Id. at ----, 116 S.Ct. at 444 (quoting Restatement (Second) of Torts § 540 (1976)). 60 Prior to the Supreme Court's decision in Field v. Mans, the Ninth Circuit repeatedly held that creditors must prove justifiable reliance in exception to discharge cases. See In re Kirsh, 973 F.2d 1454, 1458-1460 (9th Cir.1992). In Romesh Japra, M.D., F.A.C.C., Inc. v. Apte (In re Apte), 180 B.R. 223 (9th Cir. BAP 1995), the Bankruptcy Appellate Panel explained the meaning of justifiable reliance: 61 The general rule is that a person may justifiably rely on a representation even if the falsity of the representation could have been ascertained upon investigation. In other words, negligence in failing to discover an intentional misrepresentation is no defense. However, a person cannot rely on a representation if he knows that it is false or its falsity is obvious to him. In sum, although a person ordinarily has no duty to investigate the truth of a representation, a person cannot purport to rely on preposterous representations or close his eyes to avoid discovery of the truth. 62 Id. at 229 (internal citations and quotations omitted). 63 The issue in this case is how a creditor establishes justifiable reliance when the debtor employs a kiting scheme. In a kiting case, the creditor continues to extend credit to the debtor in reliance on the fact that the debtor's credit card account is not in default. In some instances, the creditor may initially rely on the debtor's credit report (before issuing the credit card) which shows that the debtor has a history of servicing his credit card debt in a timely manner. The debtor, who is kiting his credit cards, creates the illusion that he intends to pay his credit card debts and honor his credit agreements. Presumably, if the creditor knew the true state of the debtor's financial affairs and intentions, the creditor would revoke the debtor's credit card or deny the debtor's request for a credit card. Thus, by kiting, the debtor induces the creditor to refrain from action in reliance on the appearance of the debtor's intent to repay. 64 If the creditor had warning that the debtor's account was in danger of default, the creditor will not be able to establish justifiable reliance. We will not allow a creditor, who has been put on notice of the debtor's intent not to repay, to extend credit and then later claim nondischargeability on the basis of fraud. Unfortunately, the true deceit of kiting is that by making minimum payments the debtor almost guarantees that his account will never raise a red flag.