Fifth Circuit Sets Its Standard for Credit Card Non-dischargeability

Fifth Circuit Sets Its Standard for Credit Card Non-dischargeability

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Earlier this year, the Fifth Circuit Court of Appeals took the unusual step of granting a rehearing en banc to determine the standard for non-dischargeability of credit card debt in In re Mercer, 246 F.3d 391 (Miss. 2001). The rehearing followed a circuit court opinion that was not exactly unanimous. Of the three circuit judges hearing the initial appeal, one wrote for the majority, one wrote a concurring opinion and one dissented.

The facts of the case are not at all unique. Mercer opened a credit card account with AT&T in November 1995 as a result of receiving a pre-approved solicitation in late September. The account had a credit limit of $3,000. Within 31 days of the opening of the account, Mercer had exhausted her credit limit. In January, Mercer made a payment of $25, the only payment AT&T ever received. At the time the payment was made, the minimum amount due was $253.82. She filed chapter 7 in April.

Mercer had been a paralegal for 20 years, earning approximately $24,000 a year. She also had a gambling problem, having already lost $25,000 that year. She had lost considerably more in the prior two years. In total, she had more than $31,000 in credit card debt at the time she filed.

The opinions of the bankruptcy court, the three-judge panel of the Fifth Circuit and the full Fifth Circuit1 are as much reflections of their views on the credit card industry as they are a scholarly review of the elements of non-dischargeability under §523(a)(2) (A). As is typical in bankruptcy law, there is usually a case to support every point of view. Here, the majority opinion could have easily gone another way before a different court.

The Bankruptcy Court: Focus on Reliance

The bankruptcy court, finding the debt dischargeable,2 based much of its decision not on Mercer's actions, but on those of AT&T. Although there are typically five elements that a creditor must prove to have a debt declared non-dischargeable,3 the bankruptcy judge disregarded the majority of those elements, throwing the case out on just one: reliance. Specifically, the court ruled that Mercer made no representations on which AT&T relied at the time the account was opened because of AT&T's pre-approval process. Although the debtor was required to fill out an "application," the information requested by AT&T was so sparse, in the court's opinion, that it could not constitute a "representation." Even AT&T's representative testified that the information requested on the credit form was merely a reinforcement of the information they had obtained through their screening process. Rather, AT&T's decision to extend credit to Mercer was based on credit screenings made prior to the offer.

The bankruptcy court was extremely critical of AT&T (and presumably any other similarly situated creditors) because:

In their eagerness to capture market share, banks spend little time gathering financial information about their potential credit card customers... In instances where pre-approved cards are issued...card issuers apparently desire to avoid the considerable expense of determining credit-worthiness prior to issuance of the card, and spew the cards out basically upon getting the party's name, address and some scant information about employment (if any is obtained at all). Issuers have obviously made a business decision regarding credit inquiries at the inception of the relationship... [T]he court believes issuers will continue to issue pre-approved cards without any inquiry into the cardholder's ability to repay the charges to be incurred by use of the card... In other words, a creditor cannot justifiably rely on any representation...made by a cardholder if the card was pre-approved... [T]o hold otherwise only encourages creditors to continue to act irresponsibly.4

As a result of the pre-approval process, the court ruled that there was no actual reliance on any representation made by the debtor, mainly because the debtor made no representations at all. The court also noted that even if there were actual reliance, it would not have been considered justifiable because of the sparse financial information AT&T obtained. The court suggested that AT&T could have asked the debtor where she worked, her financial condition, how many children she had or whether she was married.5 At trial, the bankruptcy judge apparently further suggested that issuers could ask questions prior to issuing cards such as whether the debtor had any problem with gambling, owed any gambling debts, or had any gambling losses or winnings over the past several years.6

In short, the bankruptcy court found that the element of reliance attaches when the decision to offer credit is made and therefore could not be proven in a case where a card was pre-approved. This is because, in completing the solicitation form, the debtor does not make any representations of intent to repay upon which the creditor relies in extending credit.7

The bankruptcy court also found that AT&T was "fully aware" that the debtor was using the card to obtain cash at an ATM machine located in a casino and thus could not now complain about the card's usage. The court reasoned that AT&T knew this because the debtor's billing statement showed that the transactions were made at the Isle of Capri Casino. The court suggested that if AT&T did not want its card to be used for gambling, they could put such a restriction in the cardholder agreement.8

The Fifth Circuit Panel—Three Different Conclusions

The majority panel opinion of the Fifth Circuit9 also found no reliance, but its focus was on the element of Mercer's representation of intent to repay. "The information Mercer returned to AT&T with her acceptance does not amount to any false representation regarding her intent to pay."10 Also dismissed was the "implied representation" theory adopted by many courts, which finds that with each use of the account, the debtor makes an "implied" promise to pay upon which the creditor relies in extending credit. The panel declined to adopt this theory in the context of pre-approved credit cards on two bases: First, the decision to extend credit was made not when the debtor used the account, but previously when the account was issued. Second, this theory, according to the court, shifts the burden of proof to the debtor to show his failure to pay was not fraudulent, rather than leaving it with the creditor to show that there was fraud, as intended by the Code.11

Like the bankruptcy court, the panel was also critical of AT&T's business practices:

The credit card issuers' irresponsible lending practices are another part of this problem... If AT&T had merely had asked Mercer for information regarding her credit card usage, AT&T may have been more prudent in its lending practices, but AT&T did not... This holding properly places a greater responsibility on credit card issuers for their lending practices, which have become increasingly irresponsible...[and] properly favors the debtor instead of the creditor, and will hopefully encourage more responsible lending practices by credit card issuers.12

The concurrence to the panel opinion did find an implied promise to repay when a debtor uses a credit card. But where a creditor issues a card without a "reasonably adequate assessment" of the debtor's creditworthiness, the creditor cannot justifiably rely on the debtor's implied representation. The judge agreed with the majority opinion that AT&T did not make a reasonably adequate assessment of Mercer's financial condition to be able to justifiably rely on her implied promise to pay. This judge added that a creditor's reliance may become justified if, after the card is issued, the debtor establishes a good payment history with the creditor—that is, justifiable reliance can develop over time.13 Here, however, since the debtor ran the card up to its limit within a month, there was no possibility that reliance could have developed.

The dissenting judge began by stressing the importance of the analysis of the dischargeability of credit card debt:

The analysis for determining whether credit card debt is dischargeable in bankruptcy has enormous implications, not only for credit card issuers, but also for millions of credit card users. Moreover, neither the card's being pre-approved, nor its use in large part for gambling, should alter the standards for representations and justifiable reliance vel non... Accordingly, rehearing en banc is necessary and appropriate for this exceptionally important issue.14

The Fifth Circuit: Still No Consensus

The dissent formed the basis for the majority opinion of the full Fifth Circuit. In that opinion, the majority reiterates the significance of this issue:

Cards play a major role in, and promote, modern commerce... Cards are a convenient—if not necessary—substitute for cash and checks, especially where they are not a viable medium, such as telephone and Internet purchases. They help small retailers compete with larger ones... Finally, cash advances, the focus of the case at hand, are a prompt, simple and extremely convenient alternative to bank loans.15

The court also took note of the other side of that argument:

Readily available cards tempt consumers, hard-pressed by loss of work, illness or family difficulties, to attempt to tide themselves over and to postpone financial collapse or bankruptcy with little or no realistic prospect of success.16

The court recognized that the difficulty in credit card cases is for the creditor to prove the elements of misrepresentation and reliance, since the creditor does not deal face-to-face with the debtor. This court disagreed with the bankruptcy court and majority panel opinions and adopted the implied representation theory, holding that the debtor makes a promise to pay each time she uses the card. The fact that the card was pre-approved does not discount this theory because these promises to pay occur at card use, not when a card is issued. Merely by accepting the card, the debtor was not obligated to use it. But by using it, the debtor is requesting a loan, which implies a promise to repay it.

Although the falsity of Mercer's representation of intent to pay was not decided, the opinion did discuss how intent is to be determined, considering the fact that most debtors will rarely admit that they did not intend to repay. The court found that the commonly cited "12 factors"17 are helpful in determining a debtor's intent. The court further concluded that when a debtor testifies as to her intent to repay, the bankruptcy judge must ultimately make a credibility decision after considering the testimony as well as the objective circumstances.18

When gambling is involved, this determination becomes more complicated because often, a debtor will claim that she intended to repay with winnings from gambling. The court would not find this argument persuasive however, pointing out that gamblers only hope to win. But, hoping to win is not synonymous with intending to pay. Relevant to the inquiry of intent under these circumstances is whether the debtor has other sources of income, and whether she intended to pay her debt with her winnings, or use those winnings to continue gambling. In this context, the court suggested the proper inquiry is whether the debtor has ever gambled and won, and, if so, what she did with the winnings.19

Addressing the dissent's view that a creditor must first establish reliance at the time the credit card was issued in order to establish reliance on subsequent card use, the court found this to be erroneous. Actual reliance is established by the fact that credit is extended, and whether or not that reliance is justifiable is a question of fact. Dismissing the lower court's criticism of the "minimal" information obtained on and by Mercer, the Ninth Circuit's justifiable reliance standard for credit dischargeablility was adopted: An issuer justifiably relies on a representation of intent to pay as long as the account is not in default and any initial investigations into a credit report do not raise red flags that would make reliance unjustifiable. Further, the nature and extent of the credit investigation is not determinative. In fact, an investigation is not even required. However, if undertaken, only obvious falsities would make reliance unjustifiable.20

As related to Mercer, the information obtained by AT&T prior to issuing the card, according to the court, appeared not to have raised any red flags that would have required further investigation. "For justifiable reliance, the focus should be on whether [AT&T], based on its credit screening and its relationship with Mercer during her brief card use, had reason to believe she would not carry out her representation of intent to pay."21

The court also addressed the issue of cash advances taken at a casino, which seemed to be an important factor in the bankruptcy court's decision.

Not everyone [accesses cash at a casino] to obtain gambling funds...for example, if given a choice, some might consider it safer, or more convenient, to enter a casino to obtain cash, rather than to do so at an ATM outside a bank, where there is no security and far greater potential for being robbed. Or, some might be in a casino hotel for a convention or musical entertainment and obtain a cash advance at an ATM there for non-gambling uses.22

Ultimately, the case was remanded back to the bankruptcy court for a determination of whether Mercer's representation of intent to repay was knowingly false, and if so, whether AT&T justifiably relied on that representation. However, Mercer does more than clarify the issues for credit card cases in the Fifth Circuit. It is a case study on how different views on non-bankruptcy matters affect the outcome of a case that is governed by bankruptcy law. Judges with obviously divergent views on the credit card industry came to very different conclusions on the same set of facts. While this is to some extent a necessary and healthy way to resolve disputes, it also keeps the waters muddy for practitioners. To a great degree, the legal system depends on litigants and their attorneys having an idea of what to expect in a given case. In credit card cases, until all circuits clarify the standards, debtors won't be the only ones gambling.


1 The chief judge was recused from participating. Return to article

2 220 B.R. 315 (Bankr. S.D. Miss. 1998). Return to article

3 (1) That the debtor made a representation (2) that was false, (3) made with the intent to deceive (4) that was relied on by the creditor and (5) that was the proximate cause of a loss to the creditor. Return to article

4 220 B.R. at 325-326. Return to article

5 220 B.R. at 319. The court did not discuss the legality of such questions. Return to article

6 246 F.3d at 422. Return to article

7 The district court affirmed. Return to article

8 220 B.R. at 328. Return to article

9 211 F.3d 214 (5th Cir. 2000). Return to article

10 Id. at 217. Return to article

11 Id. at 217-218. Return to article

12 Id. at 218. Return to article

13 This was also suggested by the bankruptcy court in a footnote. Return to article

14 Id. at 222-223. Return to article

15 246 F.3d 391, 401 (5th Cir. 2001). Return to article

16 Id. Return to article

17 See In re Dougherty, 84 B.R. 653, 657 (9th Cir. BAP 1988). Return to article

18 246 F.3d at 409. Return to article

19 Id. at 410. Return to article

20 Id. at 421-422. Return to article

21 Id. at 423. Return to article

22 Id. at 424. Return to article

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Journal Date: 
Monday, October 1, 2001