Just What Is Justifiable Reliance

Journal Issue:

May 1998

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In 1995, in Field v. Mans,¹ the U.S. Supreme Court held that the standard for creditor reliance in fraud cases under §523(a)(2)(A) is justifiable reliance. Although not a credit card case, the Court shed light on what type of investigation was necessary before a creditor could meet its burden of showing reliance on a debtor’s misrepresentations.

According to the Restatement, there is no initial duty to investigate in order to show justifiable reliance.² As noted by one commentator, "There is little to prevent creditors from performing only a cursory examination and nothing to require creditors to perform ongoing investigations to protect their debt. Must credit card companies run a credit check after each and every purchase to determine whether a fraudulent misrep-resentation was made? Under the justifiable reliance standard, the answer is "no."³

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." The point is otherwise made in a later section, which notes that contributory negligence is no bar to recovery because fraudulent mis-representation is an intentional tort. Here, a contrast between a justifiable and reasonable reliance is clear: "Although the plaintiff’s reliance on the mis-representation must be justifiable...this does not mean that his conduct must conform to the standard of the reasonable man. 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."⁴

Justifiability is not without some limits, however. A person is:

...required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation. It is only where, under the circum-stances, the facts should be apparent to one of his knowledge and intelligence from a cursory glance, or he has discovered something which should serve as a warning that he is being deceived, that he is required to make an investigation of his own.⁵

Courts have differing views on the meaning of justifiable reliance in a credit card dischargeability context. Some courts require a creditor to conduct a level of investigation that other courts would find unreasonable under the standard set forth in Field. For example, some would have creditors conduct a very thorough and complete investigation of their potential customer’s credit history, employment history and status, assets and liabilities, and then continue to investigate at the time of each charge made on the account. Other courts, taking note of the reality of credit card transactions, find an initial investigation to be sufficient unless and until the creditor learns of a "red flag," at which time further investigation would be warranted. Still other courts find reliance not necessarily applicable to dis-chargeability proceedings, the rationale being that no debtor should profit from his fraudulent conduct. Finally, to some courts, credit card issuers assume the risk of non-payment by issuing pre-approved cards after little or no investigation. These courts reject the theory that use of the card carries with it an implied representation that the debtor has the intent and ability to repay the debt, consequently rejecting a claim of reliance on such representations.

No Red Flags

A predominant view requires the creditor, at minimum, to perform a credit check prior to issuing a card in order to satisfy the "cursory exam" requirement. Thereafter, as long as the creditor is not aware of any "red flags," its reliance continues until it learns of information that would require it to investigate further. In re Feld⁶ gives a thorough discussion of this view. Hon. Diane Sigmund, relying on the principles set forth in Field, observed that the Supreme Court would accept lending as justifiable when an initial investigation raised no red flags.

Reliance in a credit card context, as in any other context, is justifiable if the falsity of the representation is not apparent to "one of his knowledge and intelligence from a cursory glance."…[I]f a cardholder’s use is consistent with past use, and the cardholder is paying the minimum charge and staying within credit limits, reliance on the cardholder’s implied representation of intent to repay will generally be justifiable.⁷

While generally recognizing a require-ment to perform a minimal investigation, the Feld court did not rule out the possibility of a ruling of non-dischargeability based on credit card use quite contrary to the expectations of a lender who performs no credit analysis. However, when a credit card company does engage in a credit analysis, but allows use of the card contrary to its findings, it does not justifiably rely. This was the situation in In re Cacciatore,⁸ where the lender’s initial diligence was put to the test. Prior to extending the debtor an invitation to apply, the creditor performed a minimal investigation, determining that the debtor had no prior financial difficulties and hadn’t been caught in any fraudulent or irresponsible behavior. No further assess-ments were made, even though the debtor had listed himself as a "student" on the application. After using the card and filing bankruptcy, the creditor filed a complaint to determine dischargeability. The court held that the minimal credit investigation performed by the creditor was inadequate to show justifiable reliance because the debtor indicated on his application that he was a student. This should have prompted the plaintiff to make a cursory investigation of debtor’s employment status, and failing to do so, the plaintiff ignored an obvious risk.

The Ninth Circuit has followed this line of analysis:

[T]he credit card issuer justifiably relies on a representation of intent to repay 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.⁹

In a similar vein, justifiable reliance is found where a debtor has a history of repaying the creditor. In re Eashai¹⁰ found in favor of the creditor when the debtor engaged in credit card kiting in order to maintain minimum payments on the objecting creditor’s account.

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... 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.¹¹

Going even further, the Ninth Circuit bankruptcy appellate panel (BAP) has held that the creditor’s initial inves-tigation satisfied reliance for both the initial extension of credit as well as a future increase in the debtor’s credit limit.

Requiring a card issuer to investigate each time it increases a credit limit would inappropriately provide debtors with an escape device to their own improper actions... When there is an ongoing satisfactory credit relationship between the debtor and the creditor, unless there are facts which are known to the creditor and which should have created a suspicion in the mind of that particular creditor, the creditor may increase the credit limit without conducting an investigation of the debtor’s financial circumstances.¹²

In contrast, the court in In re Wong¹³ ruled in favor of the creditor for amounts incurred by the debtor only up to the credit limit on the account. Without evidence showing what investigation was performed in extending credit over and above the account’s prior limits, however, the court found those additional amounts dischargeable.

Focus on the Debtor

Although many courts would find that a minimum amount of investigation is required in initially extending credit, and that creditors are required to present evidence of their investigation as part of their case,¹⁴ some courts held that the focus of the court’s inquiry should be the acts of the debtor in deceiving the creditor, rather than the creditor’s diligence in uncovering a fraud. One court, noting differing positions, wrote: "One of the threshold questions that has induced different judicial responses is whether a party proceeding under §523(a)(2)(A) must establish the five elements of fraud…or whether ‘fraud’ is merely one of the three independent bases for discharge pursuant to §523(a)(2)(A), and thus has a meaning broader than its traditional definition, and

does not include ‘reliance’ or ‘representation’."¹⁵

The court in In re Leventhal held: "...some fraudulent acts—some tricks, deceptive devices or artifices—do not involve ‘reliance’ upon a ‘representation.’ ...Slavish adherence to the ‘five elements of fraud’...was not required at common law, for it was long recognized that fraud was far broader in concept."¹⁶

While there is some analytic appeal to the conclusion that the card issuer has assumed the risk that the card would be used in this manner [footnote omitted] this court cannot agree that actual fraud is something of which one assumes the risk. The issuer of a credit card or credit line perhaps assumes the risk of the user’s ignorance, mistake, naiveté, gullibility, misfortune, accident or other innocent failing or adversity, but the court declines to apply assumption of risk theory to the user’s knowing and intentional use of the card to obtain goods without any realistic prospect of having the wherewithal to pay.¹⁷

Ongoing Reliance

When utilizing the implied rep-resentation theory that with each use of the card the cardholder impliedly represents his intent (and in some courts, his ability) to repay, a few courts require the creditor to show reliance upon this representation each time the card was used. The court in In re Willis¹⁸ rejected the creditor’s theory that its initial reliance in issuing the card in 1992 extended through the debtor’s future use. The creditor admitted it periodically obtained credit reports on its customers. The court found that no creditor would have been justified extending credit to the debtor had it known of her financial situation, and because this creditor could not show what facts it relied on in 1995, prior to the card’s run-up, it did not show justifiable reliance.

Very recently, another court ruled that, under the theory of implied mis-representation, "the justifiable reliance must relate to the period during which the charges (implied misrepresentations) were being incurred."¹⁹ Here again, the creditor was relying on its initial investigation and continuing reliance in the absence of "red flags." The court held the argument to be insufficient, and further ruled that in order to prevail, the creditor also would have been required to disclose the exact basis upon which it relied in granting credit to the debtor before finding that justifiable reliance existed.

Assumption of the Risk

Finally, courts can be very critical of some issuers who they perceive to be promiscuous in their lending practices. They do not reach the question of reliance because rather than focusing on the acts of the debtor in deceiving the creditor they apply "assumption of the risk" of the conduct of the debtors. This is especially true when courts perceive credit to be granted on a "pre-approved" basis, with no credit check or application whatsoever. These courts find that, in the context of pre-approved cards, the debtors make no representations on which the creditor relies. Therefore, the creditor assumes the risk of non-payment by extending credit without an initial investigation, and presumably, factors that risk into its interest rates.²⁰

The Supreme Court’s adoption of the justifiable reliance concept, while intending to settle the debate over the creditor’s burden in dischargeability litigation, has, in practice, left much room for interpretation.²¹ As credit card use continues to become the preferred method of payment for everything from catalog shopping to groceries, more litigation can be expected on this issue as courts continue to interpret just what constitutes justifiable reliance.