Lead Opinion
The claim at bar arises from the Chapter 7 bankruptcy proceeding of the defendant-appellee Terry Patrick Ward (Ward). Plaintiff-Appellant Manufacturers Hanover Trust Company (MHT) seeks to except from discharge indebtedness incurred by Ward as a result of his use of a Mastercard which it purportedly issued as a result of false representations made by Ward in his application for the credit card. The bankruptcy court concluded and the district court agreed that MHT’s debt was dis-chargeable. MHT timely appealed.
Ward received the credit card in question upon completion of an application circulated by MHT as part of a nationwide direct mail solicitation sponsored by MHT to enroll new members in its retail consumer credit business. Ward received his credit card from MHT in May of 1985 with a preapproved credit limit of $2,000. During a 23-day period beginning on May 13,1985, and ending on June 5, 1985, he charged $2,200 to this account. The charges included two cash advances of $900 each. MHT admitted that it requested no financial statement from Ward, nor did it conduct a credit check of his financial responsibility, which would have disclosed indebtedness on at least twelve other credit accounts together with an embezzlement conviction ordering a restitution of $250,000. MHT’s
After Ward filed his Chapter 7 petition, MHT instituted this proceeding seeking to declare his indebtedness to it as non-dis-chargeable under Bankruptcy Code Section 523(a)(2)(A) because the money was obtained by “false representation or actual fraud”.
To except a debt from discharge under § 523(a)(2)(A), a creditor must prove the following elements set forth in In re Phillips,
[T]he creditor must prove that the debtor obtained money through a material misrepresentation that at the time the debt- or knew was false or made with gross recklessness as to its truth. The creditor must also prove the debtor’s intent to deceive. Moreover, the creditor must prove that it reasonably relied on the false representation and that its reliance was the proximate cause of loss. In re Kimzey,761 F.2d 421 , 423 (7th Cir.1985); In re Hagedorn,25 B.R. 666 , 668 (Bankr. S.D.Ohio 1982); 3 Collier on Bankruptcy ¶ 523.08[4] (15th ed. 1985).
In the instant case, it was undisputed that Ward at least impliedly misrepresented his financial capability upon the application circulated by MHT and that he did so intending to deceive MHT. The lower court concluded, however, that the creditor did not “reasonably” rely on Ward’s'false representations because it failed to verify Ward’s credit or to investigate the veracity of his representations. MHT, as the party seeking an exception from discharge in bankruptcy, had the burden to prove reliance by clear and convincing evidence. Phillips,
The bankruptcy court decided in pertinent part that:
The fact is that this company, Manufacturers Hanover, one of the largest banks in the United States, issued two thousand dollars in preapproved credit to a person who was not only hopelessly insolvent, but who had recently been convicted of an embezzlement offense.
While the testimony of the bank officer, the assistant manager in charge of retail credit cards indicated that a credit check must have been made, indeed, the contrary must be true. A credit check could never have been made, because if it*1084 had been made credit would not have been issued. If, in fact, the credit check was made, someone didn’t heed it. ... So as far as I’m concerned, there could not have been [a] credit check.
In disposing of the controversy before it, the court apparently assigned Cordeira’s testimony little, if any, credibility in light of her vague and inconclusive recollections concerning MHT's efforts to obtain a credit bureau report or otherwise investigate Ward’s financial responsibility. In short, MHT failed to meet its burden of introducing clear and convincing evidence that it conducted even the most superficial credit investigation. Accordingly, the trial court’s factual determinations were not clearly erroneous.
Given the correctness of the district court’s factual findings, MHT’s reliance on Ward’s misrepresentation was unreasonable as a matter of law. “Congress was [when passing § 523] ... concerned that creditors use, when feasible, ‘other sources of information, such as credit bureau reports, to verify the accuracy of the [debt- or’s] list of debts.’ ” In re Martin,
This requirement that a credit check be performed best advances the policy of the Bankruptcy Act. As one commentator explained:
[F]rom the perspective of the bankruptcy proceeding, it is inequitable to reward a possibly imprudent creditor who failed to detect the debtor’s misrepresentation by excepting her debt from discharge, while the debtor’s other more prudent creditors have their claims evaluated collectively. As a matter of fairness among creditors, it is inappropriate to allow a creditor who is likely to have been imprudent to participate in the liquidation of the debtor’s assets.
Far from generating additional credit card fraud, as the dissent has suggested, this court’s decision will encourage banks to more prudently investigate the creditworthiness of high-risk borrowers and will deter potential debtors from engaging in credit card fraud. As one commentator correctly observed, disallowing a bank’s non-dischargeability claim when the bank fails to investigate would best comport with the intent of Congress and would discourage fraudulent credit transactions. Filipow, Creditor Acquiescence as a Defense to an Exception to Discharge in Bankruptcy, 58 Ind. L.J. 319, 331-34 (1983).
MHT and the dissent have also charged that, assuming arguendo an unreasonable initial issuance of credit, such action was nevertheless irrelevant because the bank reasonably relied upon Ward’s implied assurances that he would discharge each indebtedness incurred against MHT’s line of credit which resulted from the use of the MHT Mastercard. Indeed, decisions such as In re Doggett,
However, even if each credit card charge constituted a “representation” of ability to pay, the case law and legislative history make it clear that a credit check must be conducted at some point; otherwise an exception to discharge is unavailable. A contrary rule would “place credit card companies in a special category of creditors and makes their [credit card] debts too easily nondischargeable.” In re Carpenter,
MHT’s negligent reliance upon Ward’s application for credit and on Ward’s unsupported “implied representation” constituted an assumption of the risk that Ward would fail to pay his subsequent credit card bills. “[W]hen a credit card company issues a credit card with no credit check of the applicant it has made a calculated business decision to assume the risk of nonpayment. Such a company cannot now turn to this Court and ask for special consideration because the debt owed is being discharged in bankruptcy.” Carpenter,
It was unreasonable for MHT to rely upon Ward’s mere signature, his supposed “good faith,” and his “implied promise of repayment.” As the court explained in Hunter,
Accordingly, the judgment of the district court is AFFIRMED.
Notes
. 11 U.S.C. § 523(a)(2)(A) provides:
(a) A discharge under Section 727, 1141, or 1328(b) of this title 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, other than a statement respecting the debtor’s or an insider’s financial condition; [or]
(B) use of a statement in writing—
(i) that is materially false;
(ii) respecting the debtor’s or an insider’s financial condition,
(iii) or which the creditor to whom the debtor is liable for obtaining such money, property, services, or credit reasonably relied; and
(iv) that the debtor caused to be made or published with intent to deceive.
. Numerous bankruptcy court cases stand for the proposition that a bank must conduct a reasonable investigation as to the accuracy of the debtor’s representations. See e.g. In re Mitchell,
. At any rate, criminal law, rather than bankruptcy law, should be the primary deterrent to credit card fraud. The vast majority of consumer-debtors are unaware of the specific provisions of bankruptcy law and cannot be deterred by changes in dischargeability requirements. See 1 J. Fonseca & P. Teachout, Handling Consumer Credit Cases, 428 (2d ed.1980); Ziegler, 38 Stan.L.Rev. at 902 n. 49-50.
Dissenting Opinion
dissenting.
The essence of the decision here, as well as the decision in First National Bank of Mobile v. Roddenberry,
The Court made its first mistake in its first paragraph by assuming that the cardholder, Ward, made representations or promises on which the bank relied when he applied for the card in the fall of 1984. It assumes incorrectly that a contract was formed based on these representations when the bank issued the card. The Court states — contrary to the facts of the case— that the card was “issued as a result of false representations made by Ward in his application for the credit cards” and that “it was undisputed that Ward ... misrepresented his financial capability upon the application ... intending to deceive.” Opin. 1083. The application contained only a few pieces of information, as follows:
Terry P. Ward
821 Exmoor Drive HANOVER TRUST MasterCard card
Cincinnati, OH 45240 immediately!
Approved
$2000.00 Credit Line
Offer Expires: November 2, 1984
App. 80. The credit cardholder misrepresented nothing at this point. The credit cardholder made no representations, and no contract was made when the bank “issued” the card later. When the card was issued, it was accompanied by a form containing stipulations concerning the use of the card, the calculation of finance charges and the fact that the bank may terminate the credit arrangement at will. App. 74-75.
The Court, like the Eleventh Circuit in Roddenberry, supra, reasons that the negligent bank’s “unreasonable reliance” on the holder’s conduct and intent takes place at the time it approves the application and issues the credit card, rather than at the time the credit card is used and the bank is required to pay the third party supplier. Since the bank assumed the risk of nonpayment by the holder, the bank’s payment of the holder’s purchases does not constitute reliance.
This characterization is based on an incorrect analysis of the contractual relationship. When an issuer of a credit card, like MasterCard, Visa or American Express, sends to the holder the card and the form describing the terms for its use, it makes “an offer [for] ... the formation of a number of contracts by successive acceptances from time to time,” as the card is used. Restatement (Second) of Contracts § 31 (1981). “A standard example of a divisible offer is the continuing guaranty, the promise to guarantee performance of obligations of a specified type as a third party may
The several state courts which have analyzed the contractual relationship with care have adopted this line of reasoning. They hold that a contract is not formed when a credit card is issued but rather unilateral contracts are formed each time the card is used. Garber v. Harris,
No bilateral contract is formed when the card is issued, as the Court appears to suggest. Thus the questions of fraud and reliance turn on the honesty of the cardholder’s intent and of the holder’s representations made at the time the card is used, not when it is issued. Most bankruptcy courts which have considered this issue have adopted this same reasoning and have held that the cardholder makes an implied representation at the time he uses the card that he has the ability and intent to pay the issuing bank for his purchases. See In re Dougherty,
In the instant case, the Bankruptcy Court found that the cardholder had a dishonest intent not to pay and acted in bad faith when he used the card. App. 69. Obviously, the issuing bank “relied” on the holder’s good faith use of the card because it paid the debt created when the card was used. See In re Turner,
The three party nature of the credit card arrangement may appear on the surface to affect the analysis of the issuing bank’s reliance. Three parties are involved in a credit card transaction — the issuer, holder and supplier — and each of them has separate obligations. See generally Maffly and McDonald, The Tripartite Credit Card Transaction: A Legal Infant, 48 Calif.L. Rev. 459 (1960); Wohl, Three Party Credit Card Transactions: Legal Rights and Duties, U.C. Davis L.Rev. 357 (1969). In a sense, the issuing bank may have a preexisting duty, via an agreement, to pay the supplier for the holder’s purchase regardless of the holder’s intent. But the fact that the issuing bank may have a preexisting duty does not alter the fact that the bank relied on the holder’s honesty in paying the third party. A preexisting duty to a third party creditor on a guaranty does not alter the reliance of a guarantor on the principal debtor’s promise to reimburse the guarantor. See Restatement (Second) of Contracts §§ 73, 88. There is no reason this principle of contract law respecting payments to a third party should be changed in the credit card context.
Thus the issuing bank relied on the holder’s dishonest representation of his intent to pay when the MasterCard was used. All the elements of dishonesty and fraud under this Circuit’s recent interpretation of § 523(a)(2)(A) of the Bankruptcy Code in In re Phillips,
The Court’s additional point that the bank factors into its interest rate and finance charges the risk of loss from dishonesty and nonpayment does not alter the analysis. Lenders normally factor into their finance charges the risk of loss along with the nominal rate of interest applicable to the duration of the particular loan in question. This is true whether the loan is to the government, a blue-chip corporation or a consumer. The Court does not deal with this fact.
The Court’s observation that the bank “assumed the risk” of dishonesty and therefore could not rely on the cardholder’s implied promise of repayment (Opin. 1085) improperly imports a tort concept into contract theory. Contract theory puts the question in terms of “actual reliance” and “justifiable reliance.” Here there was actual reliance on the cardholder’s good faith just as in other contract arrangements. There is no evidence or information presented in the record that would lead to the view that issuers of credit cards may not rely on the good faith of the promisor in extending credit. The idea that lenders may not rely on a definite promise of repayment in the absence of particular credit information has no precedent in contract theory and should not be adopted. The Court’s interpretation of the Bankruptcy Code is completely contrary to the historical development of contract law.
The Court’s last point, that a contrary rule on discharge in bankruptcy prefers credit card issuers to other creditors (Opin. 1085), is also mistaken. Any other creditor whose extension of credit was induced by fraud will receive the same treatment accorded the credit card issuer. Section 523(a)(2)(A) on discharge distinguishes between transactions based on fraud and other transactions. All credit induced by fraud receives the same treatment. The Court does not try to deal with this obvious inconsistency in its argument.
Finally, it should be pointed out that the Court's analysis would lead logically to the unsound conclusion that there was no consideration “bargained for” between the issuing bank and a particular MasterCard holder, and therefore no obligation or contract was formed when the holder used the card to secure a benefit in a transaction with a third party supplier or in a transaction directly with the issuing bank. If the issuing bank may not rely on a particular holder’s implied promise to pay when the MasterCard is issued, there is no valid consideration for the contract and hence no enforceable obligation.
It is elementary that in order for there to be a contract there must be an “exchange of consideration”: “To constitute consideration, a performance or a return promise must be bargained for.” Restatement (Second) Contracts § 71. If there is no reliance or expectation that a particular promise or performance by a contracting party will take place, the consideration — in the language of the Restatement of Contracts — is not “bargained for” because
the consideration and the promise bear a reciprocal relation of motive or inducement: the consideration induces the making of the promise and the promise induces the furnishing of the consideration.... [A] mere pretense of bargain does not suffice, as where there is a false recital of consideration or where the purported consideration is merely nominal. In such cases there is no consideration and the promise is enforced, if at all, as a promise binding without consideration. ...
Id. at Comment b.
Unless there is some consideration other than the cardholder’s promised intent to pay when the card is used, consideration is missing, and the contract is voidable. Here there was no other consideration in the form of an application fee or other payment made when the card was issued. The only consideration was the consumer’s promise to pay which the Court holds may not be relied on as part of the bargained for exchange.
Thus the ingredient of “reliance” on a representation which supports one of the
Many holders of the 250,000,000 American Express, MasterCard and VISA cards in the United States, see New York Times, Sunday, June 26, 1988, p. 23F, will be happy to know that all they have to do to avoid paying their just credit card debts to the issuing bank in the future is to develop a present intent not to pay any of the debts incurred by using their cards. The logical result of the Court’s reasoning that issuing banks do not rely on the honesty of the debtor in the absence of a credit check is that consideration is missing; and the contract is, therefore, voidable. Such a result would undermine credit cards as a medium of exchange and call into serious question billions of dollars of consumer and other indebtedness.
For the reasons set out above, the Court’s reasoning and analysis should be rejected.