Liberal Test Applied to Impose Fee Award for Creditors Unsuccessful Discharge Objection

By: Lauren Michalski

St. John’s Law Student

American Bankruptcy Law Review Staff

In In re Dunbar, the United States District Court for the District of Montana held that a creditor was not substantially justified in objecting to the debtor’s discharge where the creditor could not demonstrate that the debtor had acted in bad faith by incurring the debt in the first instance. Dunbar, the debtor, obtained a $9,000 cash advance against a credit card issued by FIA, which he used to pay off other credit card debt.[1] Later that year, Dunbar filed a Chapter 7 petition, and sought to discharge more than $43,000 in credit card debt, including the debt owed to FIA.[2]  FIA objected to the discharge of Dunbar’s debt pursuant to section 523(a)(2) of the Bankruptcy Code, arguing Dunbar had procured the loan under false pretenses because he never intended to repay FIA.[3] Dunbar counterclaimed for attorney’s fees and costs under section 523(d), claiming that FIA’s position was not substantially justified.[4] FIA’s complaint was dismissed and the court awarded Dunbar $5,595 in attorney’s fees and costs.[5] FIA appealed, alleging that it should not be forced to pay Dunbar’s attorney’s fees because (i) its position was substantially justified, and (ii) special circumstances existed that should bar the award. In the alternative, FIA argued that Dunbar had failed to mitigate his costs and therefore any attorney fee award should be reduced as a result.[6] The District Court disagreed with FIA and affirmed the bankruptcy court’s ruling.[7]

Pursuant to section 523(a)(2), a debtor who has obtained money from a creditor under false pretenses is not entitled to receive a discharge.[8] FIA argued that Dunbar’s perilous financial condition at the time of the cash advance was evidence that he did not intend to repay the $9,000 charge.[9] The court disagreed and found that FIA’s position was not substantially justified even though Dunbar’s financial condition may have appeared hopeless.[10] The appearance of hopelessness, the court held, is not sufficient to demonstrate that Dunbar acted in bad faith. The court also refused to reduce the award of attorney’s fees to Dunbar based on FIA’s claim that Dunbar should have dismissed his counterclaim once FIA agreed to dismiss its complaint.[11] Dunbar had no obligation to dismiss his counterclaim, and thereby reduce his legal expenses, because FIA only offered to dismiss its complaint after Dunbar had already incurred substantial legal fees.[12] The court therefore found that no special circumstances existed that would warrant barring the award of attorney’s fees.[13]

Section 523(d) was designed to deter creditors from unjustifiably objecting to a debtor’s discharge.[14] It protects consumer debtors, debtors who often cannot afford to litigate spurious challenges to their request for a discharge because they often have fewer resources than their creditors.[15] Congress feared that creditors would use their resource advantage to pressure debtors into inappropriate settlements in an effort to avoid litigation and thus placed a high burden on creditors to prove that debtors did not intend to not repay their loans.[16] This burden is so high that the Ninth Circuit has found that creditors could not prove that a debtor incurred new debt in bad faith even when the debtor was using the new loans to fund his gambling losses.[17] Despite extensive case law in this area, however, creditors still lack guidance regarding what conduct constitutes “false pretenses, a false representation, or actual fraud” and what conduct can be deemed the norm for an individual simply swimming in debt and making poor decisions out of desperation.[18] This means that creditors must be cautious in determining if their claim is substantially justified as they run the same risk as FIA in failing to recover most, if not all loan money, and also being forced to pay hefty attorney’s fees.[19]