In our example of the adversary proceeding about whether a debt gets discharged, here is the bankruptcy court’s ruling on the matter.
This is the last of six blog posts in a series showing how a dischargeability dispute gets resolved in bankruptcy court. Check out the last five posts about all the steps in the “adversary proceeding” so far, including the trial itself. In the last one, lawyers for the creditor and the debtor gave their closing arguments. Today the judge announces and explains her ruling.
The Judge’s Opening Remarks
At issue in this adversary proceeding is whether the debtor, Marshall, can discharge his debt to the creditor, Heather. The loan was made five years ago for $35,000; its current balance is about $21,000. The purpose of the loan was for Marshall to start a car repair business. Heather is Marshall’s aunt. At Heather’s request, Marshall completed a loan application and signed a promissory note. As she instructed, after completing and signing these documents Marshall delivered them to Heather’s lawyer. The loan was not secured by any collateral.
For four years Marshall paid the monthly payments on time. But about a year ago there was a fire in the building where his shop was located. He had to shut down his business for a month and replace some of the shop’s equipment. This deeply hurt his business. He stopped the monthly payments to Heather and was eventually forced to close down his shop.
A few weeks ago Marshall filed a Chapter 7 case. Heather responded by filing a complaint asking this court to declare that her debt not be discharged.
Her complaint was based on the allegation that Marshall obtained the loan through fraud. Specifically, she alleged that Marshall lied on his loan application by not listing a $7,500 debt that he owed at the time to another aunt. She argued that under Section 523(a)(2)(B) of the Bankruptcy Code this omission constituted 1) the “use of a statement in writing” 2) that was “materially false” 3) about his “financial condition” 4) on which Heather had “reasonably relied,” and 5) which Marshall had prepared “with intent to deceive” her.
Marshall admitted allegations #1 and #3. He disputed allegations #2, 4, and 5. Heather had the burden of presenting evidence establishing that that all of these three disputed allegations were more likely true than not true in order for her to prevail.
After carefully listening to and reviewing all of the evidence admitted at trial, I have determined s follows.
First, Marshall prepared the loan application “with intent to deceive” her.
Second, Marshall’s omission of the prior $7,500 debt from Heather’s loan application was clearly false but, under the evidence presented, was not “materially false.”
And third, Heather did not “reasonably rely” on the loan application in deciding whether to make the loan.
The Rationale for “Intent to Deceive”
Marshall rationalized his omission of the outstanding $7,500 debt two ways:
- He wanted to avoid Heather potentially deciding not to make the loan to him for what he saw as an irrelevant and irrational reason. He knew Heather could be erratic and unreasonable. He’d heard she was having a personal dispute with his other aunt who had made the earlier loan to him. He understandably didn’t want what he considered totally unrelated to the loan clouding her judgment.
- Marshall guessed that Heather’s decision about making the loan was based on factors not connected to the loan application. It turns out that he guessed correctly. But at the time he completed the application this was nothing but wishful thinking on his part.
These rationales may have been understandable and seemingly justifiable. But they do not change the clear fact that Marshall omitted the $7,500 loan with the intent to deceive Heather. And, importantly, his specific intent was to deceive her into making the loan.
The nuance that he was trying to prevent her from being irrational does not matter. The nuance that he hoped she wasn’t actually going to rely on the loan application also does not matter. His entire purpose in making the omission was deceit, deceit calculated to induce her into giving him the money.
So, this court finds that Heather has met her burden of proof as to Marshall’s “intent to deceive” her.
The Rationale for “Material Falsity”
Marshall’s omission on the loan application was clearly false.
The question is whether the omission was materially false. Given that the prior loan was a family loan just like the one Heather was considering may make omitting it more relevant. Given that the $7,500 loan balance was not an insignificant amount also makes its omission appear to be a material one.
However, what determines materiality in this statutory context is a specific objective standard. What is crucial under the law is whether Heather would have still made the loan to Marshall had he listed the prior loan in Heather’s loan application. Whether a falsity is material turns on whether it affected the creditor’s loan-making decision.
Based the evidence (as discussed in more detail in the next section), Heather would clearly have still made the loan if the prior debt had been accurately listed in the application. Since Marshall’s omission would not have made a difference in Heather’s decision, that omission was not materially false.
So, this court finds that Heather has not met her burden of proof as to the “material falsity” of Marshall’s omission.
The Rationale for “Reasonably Rely”
Heather admitted she never looked at the loan application after Marshall completed it. She asked him to deliver it and the signed promissory note to her lawyer without her looking at them beforehand. She did not instruct the lawyer to review the application, inquire into Marshall’s credit record, or do anything else to determine his financial condition. She did not discuss the content of the loan application with her lawyer. She did not rely on the loan application whatsoever. So she could not have reasonably relied on it either.
Heather also affirmatively testified that she based her loan decision on matters of family connection and loyalty. She clearly did not rely, reasonably or not, on the completed loan application.
So, this court finds that Heather has not met her burden of proof as to her “reasonable reliance” on Marshall’s application and the omission contained in it.
Therefore, since Heather has not met her burden of proof as to these last two allegations as required under Section 523(a)(2)(B) of the Bankruptcy Code, Marshall’s debt to her will be discharged in his Chapter 7 case.