Fahey Bank v. Benton

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF OHIO
EASTERN DIVISION
In re: 	Case No. 04-55949
Jeffrey Allen Benton 	Chapter 7
Judge Preston
Debtor(s)
Fahey Bank
Plaintiff(s)
v. 	Adv. Pro. No. 04-02674
Jeffrey Allen Benton
Defendant(s)
FINDINGS OF FACT, CONCLUSIONS OF LAW
AND MEMORANDUM OPINION
This cause came on for trial on December 20, 2005, in the above-
captioned 	adversary 	proceeding. 	Present 	at 	the 	hearing 	were 	attorney
Robert Morje representing Jeffrey Allen Benton (“Debtor”), and attorney
Michael 	Schaeffer 	representing 	Fahey 	Bank 	(the 	“Bank”). 	Plaintiff’s
This document has been electronically entered in the records of the United
States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
Dated: September 06, 2006
____________________________________________________________
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Complaint seeks a judgment of nondischargeability of debt pursuant to 11
U.S.C. § 523(a)(2)(B).
The Court has jurisdiction over this matter pursuant to 28 U.S.C.
§ 1334 and the General Order of Reference entered in this District. 	This
is a core matter pursuant to 28 U.S.C. § 157(b)(2)(I).
I. 	Findings of Fact
The 	Court 	having 	considered 	the 	evidence 	presented, 	finds 	and
concludes as follows:
On March 15, 1996, the Debtor, age 25 at the time, and Jay Fisher
entered 	into 	an 	agreement 	forming 	a 	partnership 	to 	be 	known 	as 	Iberia
Woodworking. 	The purpose of the partnership was to manufacture and sell
wood 	cabinets, 	furniture 	and 	other 	wood 	products. 	The 	agreement
contemplated 	that 	the 	Debtor 	would 	devote 	his 	time, 	skill, 	labor 	and
experience full time to advance the interests of the business. 	On August
1, 1997, the parties dissolved their partnership.
Shortly thereafter, on September 11, 1997, Mr. Fisher agreed to and
did 	lease 	certain 	property 	located 	at 	3454 	State 	Route 	309, 	in 	Morrow
County, 	Ohio, 	to 	the 	Debtor 	for 	the 	purpose 	of 	operating 	a 	new
woodworking business known as Iberia Cabinet Manufacturing Company. 	The
written 	Lease 	also 	granted 	to 	the 	Debtor 	an 	option 	to 	purchase 	the
property at the end of 20 years at a fair market value to be determined
by appraisals. 	The Lease provided for payment of rent by the Debtor to
Mr. Fisher of $2000 per month, adjustable annually. 	At that time, Mr.
Fisher was the sole owner of the property, having acquired the property
by warranty deed in June 1996.
Although unclear exactly when, during the term of the Lease, Mr.
Fisher 	worked 	with 	the 	Debtor 	in 	attempts 	to 	purchase 	the 	building,
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talking with a number of financial institutions. 	However, the purchase
by Debtor never came to fruition and the Debtor continued to pay rent to
Mr. Fisher.
In 1997, the Debtor approached Fahey Bank for a loan. 	Pursuant to
Fahey Bank’s loan application process, the Debtor presented a personal
financial 	statement 	dated 	January 	1, 	1998, 	which 	reflected 	that 	the
Debtor 	had 	a 	net 	worth 	of 	$318,000. 	Among 	other 	things 	typical 	of 	a
personal financial statement, the Debtor reflected that he owned business
real estate located at 3454 State Route 309, having a value of $350,000.
The 	Debtor 	signed 	the 	personal 	financial 	statement 	in 	February 	1998.
Carl 	Hughes, 	CEO 	and 	President 	of 	the 	Bank, 	personally 	discussed 	the
financial 	statement 	with 	the 	Debtor, 	reviewing 	each 	item 	thereon 	and
specifically 	discussing 	the 	real 	estate, 	which 	comprised 	the 	bulk 	of
Debtor’s net worth. 	Mr. Hughes also contacted personal references who
provided Mr. Hughes with the highest recommendations he had ever heard.
Although 	the 	real 	estate 	was 	the 	sole 	significant 	asset 	on 	the
Debtor’s 	personal 	financial 	statement, 	the 	Bank 	did 	not 	confirm 	the
Debtor’s ownership of the real estate or the value of the real estate.
The 	Bank 	did 	not 	verify 	the 	accounts 	receivable, 	life 	insurance, 	or
liquid assets reflected on the personal financial statement. 	However,
the 	Debtor 	on 	several 	occasions 	specifically 	stated 	that 	he 	owned 	the
subject real estate and Mr. Hughes toured the facility prior to making
the loan. 	Upon inquiry, the Debtor stated 	that 	his business had done
well and that he had put all of his money into the real estate. 	There
is 	no 	indication 	that 	the 	Bank 	requested 	tax 	returns 	or 	other
documentation to confirm the performance of the business or the Debtor’s
net income.
On February 14, 1998, Fahey Bank granted a loan to the Debtor in the
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1Testimony of Mr. Hughes indicated that the June 1998 note was a renewal of a March 1998 loan; however, the March
1998 loan documentation was not presented to the Court.
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amount 	of 	$50,097.00, 	in 	the 	form 	of 	a 	line 	of 	credit 	under 	which
advances were available upon customer request with loan officer approval.
The loan was payable on demand. 	The Debtor also granted to the Bank a
security 	interest 	in 	all 	equipment 	and 	business 	assets 	owned 	by 	the
Debtor. 	On June 22, 1998, the Debtor executed a new note in the amount
of $58,005.67. 	The new note required 66 monthly installment payments and
had a maturity date of December 22, 2003. 1 In connection with this loan,
the 	Debtor 	granted 	a 	security 	interest 	in 	all 	business 	assets 	and
equipment, as well as a 1998 Ford F250 Pickup Truck.
On March 31, 2000, the Debtor once again borrowed funds from Fahey
Bank and executed a promissory note in the amount of $55,172.00, which
note called for full payment on July 1, 2000. 	By this time, it appears
that the Debtor had established a business entity of some kind, and the
entity known as “Iberia Cabinet Mfg Co” signed the note as a co-borrower
with the Debtor. 	Despite the appearance of a new entity on the scene,
and the passage of two years since the financial statement was submitted
to 	the 	Bank, 	Fahey 	Bank 	did 	not 	request 	an 	update 	or 	a 	new 	personal
financial statement from the Debtor at the time of extending this third
loan. 	This third loan was approved by another loan officer of the Bank
and Mr. Hughes testified that the Bank would not have made the 2000 loan
if the Debtor had not already had a relationship with the Bank.
On October 20, 2000, the Bank consolidated 	the three outstanding
loans, and the Debtor executed a single promissory note in the amount of
$145,930.69 	providing 	for 	payment 	in 	60 	monthly 	installments. 	The
indebtedness remained secured by the business assets and the Ford Pickup
Truck. 	On this occasion, the note was co-signed by a business entity by
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the 	name 	of 	“Conestoga 	Cabinet 	Company 	aka 	Iberia 	Cabinet 	Manuf. 	Co.”
Again, no update to the financial statement or new financial statement
was requested by Fahey Bank.
The 	Debtor 	was 	evidently 	unable 	to 	comply 	with 	the 	terms 	of 	the
October 	2000 	note, 	and 	in 	April 	2001, 	Fahey 	Bank 	obtained 	a 	Judgment
Entry 	against 	the 	Debtor 	and 	the 	business 	entity 	in 	the 	amount 	of
$141,487.04 consisting of principal balance of $l38,672.39 plus interest
of $2,814.65. 	As of the time of trial in this matter, the Bank was owed
in excess of $l87,000.
II. 	Conclusions of Law
11 U.S.C. §523(a)(2)(B) provides in pertinent part as follows:
(a) 	A 	discharge 	under 	section 	727...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 –
(B) use of a statement in writing -
(i) that is materially false;
(ii)respecting the debtor’s or an insider’s financial
condition;
(iii) on which the creditor to whom the debtor is
liable for such money, property, services, or credit
reasonably relied; and
(iv) that the debtor caused to be made or published
with intent to deceive....
Each of the five elements listed in § 523(a)(2)(B) must be satisfied for
the Court to make a finding of nondischargeability of debt.
The Plaintiff bears the burden of proof when pursuing an exception
to discharge against the Debtor. 	Abroms v. Kern (In re Kern), 289 B.R.
633, 637 (Bankr. S.D. Ohio 2003). 	The standard of proof for establishing
an exception to discharge pursuant to 11 U.S.C. § 523(a) is “the ordinary
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preponderance-of-the-evidence standard.” 	Grogan v. Garner, 498 U.S. 279,
291 	(1991). 	Further, 	exceptions 	to 	discharge 	are 	to 	be 	strictly
construed against the party seeking the same. 	Rembert v. AT&T Universal
Card Servs. (In re Rembert), 141 F.3d 277, 281 (6th Cir. 1998) (citation
omitted).
The 	Debtor 	concedes 	that 	he 	used 	a 	written 	statement 	that 	was
materially false respecting his financial condition. 	However, the Debtor
disputes 	that 	he 	intended 	to 	deceive 	Fahey 	Bank 	and 	that 	the 	Bank
reasonably relied on the financial statement.
A. 	Intent
Few will openly admit to deceitful intent; therefore, all of the
facts, including circumstantial evidence, may be relied upon by the court
to make its findings. 	Hoffman & Kuhn, Inc. v. Branham (In re Branham),
126 	B.R. 	283, 	290 	(Bankr. 	S.D. 	Ohio 	1991), 	citing 	Devers 	v. 	Bank 	of
Sheridan, 	Montana 	(In 	re 	Devers), 	759 	F.2d 	751, 	754 	(9th 	Cir. 	1985)
(other citations omitted).
In the instant case, the Court can draw no conclusion but that the
Debtor intended to deceive the Bank. The Debtor, who did not appear to
testify 	in 	the 	trial, 	makes 	much 	of 	the 	fact 	that 	he 	has 	only 	a 	high
school education, and was 	only 	age 27 at the time, suggesting that he
lacked sophistication in business affairs. However, there is no evidence
that he was unable to read and understand documents. 	The Lease, written
in plain English, is quite simply a lease of the real estate; at no place
does 	it purport to transfer ownership of the real estate. 	Indeed, it
plainly states that the payments to be remitted by the Debtor are payable
to the 	“Lessor” and constitute rent. 	The concept of an option is often
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times confusing to lay persons; however, the option granted by the Lease
allows the Debtor to purchase the property, not then or within a short
period of time, but “at the end of twenty (20) years at fair market value
....” 	(Lease, p. 10). 	Furthermore, the Debtor met with other financial
institutions in an effort to purchase the property; thus, he knew that
he did not yet own it.
Notwithstanding 	this, 	the 	Debtor 	represented 	in 	the 	financial
statement, confirmed by express verbal statements, that he owned the real
estate, 	and 	owned 	it 	free 	and 	clear 	of 	any 	encumbrances. 	At 	the 	same
time, he represented that he had no rent or other monetary obligations
with respect to the real estate, despite the fact that he was paying rent
to 	Mr. 	Fisher. 	The 	Court 	is 	satisfied 	that 	he 	knew 	that 	the
representations were false and intended the Bank to rely on them.
B. 	Reasonable Reliance
The Bank may not necessarily have an affirmative duty to investigate
or verify ownership of assets claimed on a loan application. 	“[I]t is
reasonable 	for 	a 	creditor 	to 	assume 	that 	the 	financial 	statement
[presented 	by a potential borrower] is accurate when it is complete and
contains no apparent inconsistencies.” 	Branham, 126 B.R. at 291 	There
is 	no 	statutory 	duty 	on 	the 	part 	of 	creditors 	to 	make 	such 	an
investigation. 	The question is whether it is the creditor’s customary
practice to do so and whether there is such a custom or practice in the
industry. 	Harbor 	Federal 	Savings 	& 	Loan 	Ass’n. 	v. 	DiMarco 	(In 	re
DiMarco), 105 B.R. 128 (Bankr. S.D. Fla. 1989).
The creditor must have actually and reasonably relied on the false
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financial 	statement 	in 	making 	its 	credit 	decision. 	However, 	the 	bank
does not have to demonstrate that the financial statement was the only
factor 	influencing 	its 	credit 	decision. 	Partial 	reliance 	on 	the
financial statement is sufficient. 	Northern Trust Co. v. Garman (In re
Garman), 643 F.2d 1252, 1253 n.1 (7th Cir. 1980), citing Cunningham v.
Elco Distributors, 189 F.2d 87 (6th Cir. 1951); First Commercial Bank v.
Robinson 	(In 	re 	Robinson), 	192 	B.R. 	569, 	576 	(Bankr. 	N.D. 	Ala. 	1996),
citing Central National Bank & Trust Co. v. Liming (In re Liming), 797
F.2d 895, 898 (10th Cir. 1986) (other citations omitted).
On the other hand, reliance must be reasonable. 	Several factors
need 	to 	be 	ascertained 	to 	evaluate 	whether 	a 	creditor's 	reliance 	was
reasonable. 	As stated by the Sixth Circuit Court of Appeals:
Whether 	a 	creditor’s 	reliance 	was 	reasonable 	is 	a
factual determination to be made in light of the totality of
the circumstances. 	Among the circumstances that might affect
the reasonableness of a creditor’s reliance are: (1) whether
the creditor had a close personal relationship or friendship
with the debtor; (2) whether there had been previous business
dealings with the debtor that gave rise to a relationship of
trust; 	(3) 	whether 	the 	debt 	was 	incurred 	for 	personal 	or
commercial 	reasons; 	(4) 	whether 	there 	were 	any 	“red 	flags”
that would have alerted an ordinarily prudent lender to the
possibility 	that 	the 	representations 	relied 	upon 	were 	not
accurate; 	and 	(5) 	whether 	even 	minimal 	investigation 	would
have revealed the inaccuracy of the debtor’s representations.
BancBoston Mortgage Corp. v. Ledford (In re Ledford), 970 F.2d 1556, 1560
(6th Cir. 1992). 	The Sixth Circuit emphasized that the reliance test is
not 	particularly 	rigorous; 	however, 	that 	Court 	also 	cautioned 	that
dischargeability 	cannot 	be 	denied 	where 	the 	creditor’s 	reliance 	is 	so
unreasonable 	as 	to 	negate 	any 	actual 	reliance. 	Id. 	Also 	relevant 	are
other 	circumstances 	at 	the 	time 	of 	the 	transaction, 	the 	creditor’s
standard 	business 	practices, 	and 	the 	standards 	and 	customs 	of 	the
industry. 	In re Robinson), 192 B.R. at 577.
The 	Court 	has 	no 	doubt 	that 	the 	Bank 	relied 	on 	the 	financial
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statement to some extent, in light of the effort to review the financial
statement 	with 	the 	Debtor 	in 	detail 	and 	the 	visit 	to 	the 	premises.
Although the Bank did not verify from other sources any of the content
of 	the 	financial 	statement, 	according 	to 	the 	testimony 	of 	Mr. 	Hughes,
this was consistent with the Bank’s normal practice when considering a
loan 	request. 	However, 	the 	Court 	cannot 	say 	that 	the 	reliance 	was
reasonable. 	At the time of the first loan, neither the loan officer nor
the Bank had had a close personal or previous business relationship with
the Debtor. 	At the time of the second loan, the relationship was only
six 	months 	old. 	Therefore, 	no 	relationship 	of 	trust 	could 	have 	yet
developed. 	The 	loans 	were 	acquired 	for 	commercial 	purposes 	but 	the
Debtor is by all accounts, unsophisticated in business dealings.
Moreover, 	there were “red flags” 	in the financial statement that
should have indicated that additional investigation was warranted: the
Debtor 	was 	a 	27 	year 	old 	cabinet 	maker 	who 	had 	been 	in 	business 	for
himself only seven or eight years, yet he purportedly owned improved real
estate 	of 	significant 	value 	($320,000), 	free 	and 	clear 	of 	any
encumbrances. Even Mr. Hughes testified that he was quite impressed that
such 	a 	young 	man 	could 	own 	such 	an 	asset. 	Second, 	the 	financial
statement 	reflected 	federal 	and 	state 	income 	tax 	liabilities 	of 	over
$12,000 but the list of annual expenses reflected income taxes of only
$3800. 	Additionally, 	the 	Debtor 	failed 	to 	list 	on 	the 	financial
statement the very assets in which he gave the Bank a security interest.
Finally, without the real estate, the Debtor had a negative net worth.
Mr. Hughes testified that the real estate constituted a very important
factor in the Bank’s evaluation, and that the Bank wouldn’t have made a
loan to a borrower with a negative net worth.
These combined factors signal that the financial statement lacked
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2 Note that the Court is not suggesting that, as a matter of course, a lending institution should verify ownership of
assets listed on a financial statement. Further investigation (over and above the lenders customary procedures, and industry
standards) is only required when “red flags” indicate that such is warranted prior to making a credit decision, and verification of
ownership is but one option in such circumstances.
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accuracy, 	or 	at 	least 	that 	there 	existed 	anomalies 	in 	the 	Debtor’s
financial 	condition 	that 	warranted 	explanation. 	In 	short, 	the 	flags
should have evoked additional minimal investigation by the Bank. 	Such
a minimal investigation could have taken various forms, three of which
readily spring to mind and would require little effort: (1) verifying the
ownership of the real estate, (2) obtaining copies of recent financial
statements 	or 	other 	financial 	information 	for 	the 	business 	(since 	no
significant 	financial 	information 	for 	the 	business, 	a 	sole
proprietorship, 	was 	included 	in 	the 	personal 	financial 	statement
submitted 	to the Bank by the Debtor), 	or (3) perhaps more telling and
perhaps more customary in the industry, obtaining copies of the Debtor’s
recent 	income 	tax 	returns, 	which 	would 	have 	verified 	(or 	not) 	the
Debtor’s 	wherewithal 	to 	have 	acquired 	the 	real 	estate, 	as 	well 	as 	the
ownership of the real estate and the Debtor’s net income. 2 Even though
excellent references can lend credibility to the financial statement and
the Debtor’s creditworthiness, they cannot overcome anomalies or unusual
entries on the financial statement that should signal to the creditor to
stop 	and 	proceed 	only 	after 	more 	due 	diligence. 	See, 	e.g., 	Leadership
Bank, N.A. v. Watson (In re Watson), 958 F.2d 977 (10th Cir. 1992).
At the time of the third loan, in addition to the factors discussed
above, the financial statement was two years old, obviously stale. 	The
court 	in 	Robinson 	faced 	a 	similar 	situation: 	in 	Robinson, 	the 	lender
allegedly relied on a financial statement that was 20 months old. 	The
Robinson court held that the debtor's verbal reaffirmation to the lender
that 	his 	financial 	condition 	had 	not 	changed 	since 	the 	date 	of 	the
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earlier financial statement brought the aged financial statement current,
curing 	any 	staleness, 	and 	therefore, 	the 	lender’s 	reliance 	was
reasonable. 	Robinson, 	192 	B.R. 	at 	577, 	citing 	Martin 	v. 	Bank 	of
Germantown (In re Martin), 761 F.2d 1163 (6th Cir. 1985). 	In the instant
case, the record is devoid of any evidence that the Bank obtained any
confirmation, 	written 	or 	verbal, 	of 	the 	continued 	accuracy 	of 	the
financial statement. 	It is patently unreasonable for the Bank to have
relied on a two year old financial statement without some verification
of the Debtor’s current financial condition.
Under the totality of the circumstances 	in the instant case, the
Court cannot find that the Bank’s reliance on the financial statement was
reasonable.
III. 	Conclusion
The 	Plaintiff 	having 	failed 	to 	satisfy 	all 	of 	the 	elements 	of 	a
cause of action under Section 523(a)(2)(B), the Court must enter judgment
in favor of the Debtor and dismiss the Plaintiff’s Complaint. A separate
final judgment shall be entered in accordance with the foregoing.
Copies to:
Erica A. Probst, Attorney for Plaintiff(s)(Electronic Service)
Michael Schaeffer, Attorney for Plaintiff(s) (Electronic Service)
Robert J. Morje, Attorney for Defendant(s)(Electronic Service)
Office of U. S. Trustee (Electronic Service)
# # #
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