Kelly v. Merrill (In re Merrill)

Summarized by Jon Powers , White and Williams LLP
11 years 11 months ago

Citation:

BAP Case No. CC-13-1370-KuPaTa

Tag(s):

Ruling:

Affirmed a bankruptcy court's ruling that a lender's reliance on a guarantor's misrepresentations in a loan application was not reasonable. Also affirmed on an alternative ground that the lender did not "actually rely" on the guarantor's application in making the decision to issue the loan.

Procedural context:

Appeal from a bankruptcy court order denying a Section 523(a)(2)(B) nondischargeability complaint after a one day bench trial.

Facts:

Two individuals ("Lenders") formed a small mortgage brokerage firm that brokered "hard money" secured real estate loans to individual borrowers. As relevant to the appeal, the Lenders funded a $250,000 construction loan to Daniel and Sandra Levy. Mr. Merrill signed a personal guaranty. The Levys defaulted and Merrill ended up in bankruptcy. The Lenders brought a Section 523(a)(2)(B) nondischareability complaint against Merrill asserting he made material misrepresentations on the loan application. The only document Merrill apparently provided the Lenders was a form loan application containing his financial information. The application Merrill provided was unsigned and undated. It also substantially misrepresented Merrill's net worth and his monthly income. At trial, the Lenders gave conclusory testimony that they relied on the application in deciding to issue the loan to the Levys. The bankruptcy court found that both of the Lenders were sophisticated parties and the record failed to demonstrate sufficient evidence of reasonable reliance. For example, the Lenders did not insist on receiving a signed or dated copy of the guarantor's application. They also did not verify any of the information on the application, some of which (such as inflated income numbers) should have been obviously false and raised red flags. The bankruptcy court, after weighing the evidence and noting that evidence fell on both sides of the issue, ultimately found the Lenders did not reasonably rely on the information provided--thus, Section 523(a)(2)(B) was not satisfied and Merrill's guaranty obligation was dischargeable. The BAP upheld, finding the bankruptcy court's reasonable reliance finding could not be overturned on appeal under the onerous "clearly erroneous" standard. While the panel noted the Ninth Circuit has been reluctant to impose a strict duty on lenders to investigate financial information provided by a borrower and has been careful when addressing "red flag" arguments to avoid such a duty, the Panel still determined that the bankruptcy court did not clearly misapply the facts to the question of whether, under the totality of circumstances, a reasonably prudent person would have done nothing to verify the information on the loan application. While the Panel may not have agreed with every finding the bankruptcy court made, it still found the ruling supported by sufficient evidence. The Panel also affirmed on the alternative ground that the evidence demonstrated that the Lenders did not "actually rely" on the guarantor's application, especially given the Lenders did not verify a single item on the guarantor's application.

Judge(s):

Ninth Circuit BAP Panel: Kurtz, Pappas and Taylor. Bankruptcy Judge: Zive

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