In re Barrett

• Decision Date: 23 January 1980
• Docket Number: Bankruptcy No. 78-828 to 78-830.
• Citation: 2 BR 296
• Parties: In re Paul L. BARRETT and Catherine A. Barrett, Individually and Jointly, Bankrupts. BENEFICIAL CONSUMER DISCOUNT COMPANY OF LANCASTER, PENNSYLVANIA, Plaintiff, v. Paul L. BARRETT and Catherine A. Barrett, Individually and Jointly, Defendants.
• Court: U.S. Bankruptcy Court — Eastern District of Pennsylvania

2 B.R. 296 (1980)

In re Paul L. BARRETT and Catherine A. Barrett, Individually and Jointly, Bankrupts.

BENEFICIAL CONSUMER DISCOUNT COMPANY OF LANCASTER, PENNSYLVANIA, Plaintiff, v. Paul L. BARRETT and Catherine A. Barrett, Individually and Jointly, Defendants.

Bankruptcy Nos. 78-828 to 78-830.

United States Bankruptcy Court, E.D. Pennsylvania.

January 23, 1980.

H. Joseph Flynn, Lancaster, Pa., for bankrupts.

J. Richard Gray, Lancaster, Pa., for Beneficial Consumer.

Michael J. Rostolsky, Lancaster, Pa., trustee.

Jacques H. Geisenberger, Jr., Lancaster, Pa., for trustee.

OPINION

THOMAS M. TWARDOWSKI, Bankruptcy Judge.

The proceedings before this Court concern the dischargeability of a certain debt based upon a loan allegedly made in reliance upon a false financial statement.¹

In June, 1976, defendant-bankrupts borrowed $3,500 from plaintiff, Beneficial Consumer Discount Company ("Beneficial"). On April 25, 1977, the bankrupts applied to Beneficial for a loan of an additional $1,000. Consequently, the original loan was refinanced, thereby incorporating the amount of the new loan as well.

Defendants initially communicated some preliminary credit information to plaintiff via telephone. Notes of Testimony hereinafter cited as N.T. at 19-20, 26, 37. As part of the loan application procedure, defendants were asked to list all of their debts in a credit statement, which statement Paul Barrett completed and both he and his wife signed (Exhibit D-2). The outstanding debts listed on the statement correlated with those which the bankrupts had telephoned to James Foley, Beneficial's branch manager, who handled the Barrett loans.

Defendants represented that they had a net monthly income of $1,260 and fixed monthly expenses of $628. Mr. Foley calculated that defendants thus had $632 available monthly for variable living expenses, and that the ratio of fixed monthly expenses to monthly net income ("debt ratio") equalled 49.84 percent, a marginally acceptable figure. N.T. at 9-10.

On April 26, 1977, the original loan to defendants was refinanced and they received an additional $1,100 in "fresh cash." Defendants made full monthly payments of $140.47 for three months, then, with the plaintiff's permission, made monthly payments of $70 for the next eight months.

On June 9, 1978, defendants both filed a voluntary petition in bankruptcy. On July 25, 1978, plaintiff filed a complaint to determine the dischargeability of the total refinanced debt in the amount of $5,546.60 (N.T. at 11), pursuant to § 17c of the Bankruptcy Act (11 U.S.C. § 35(c) (repealed 1978)) and Bankruptcy Rule 409, claiming that the defendants omitted from the list of debts on the credit statement completed on April 26, 1977, two debts — one to TSO, Inc. and another to BankAmericard, both incurred prior to the completion of the credit statements. The debt to TSO alone totalled $10,240 and monthly payments on account of that debt were $147.

Section 17a(2) of the Bankruptcy Act (11 U.S.C. § 35(a)(2) (repealed 1978)) renders nondischargeable those debts which arise due to the use of a false financial statement.²

The question of dischargeability of debts in bankruptcy is a federal question. In re Meyers, 1 BCD 1651, 1652 n. 4 (E.D. Mich.1975). The degree of proof which the plaintiff must offer in order to succeed is that degree of evidence which is "clear and convincing." In re Barlick, 1 BCD 412, 418 (D.R.I.1974); In re Brown, 6 Collier Bankruptcy Cases 679, 683 (E.D.Va.1975).

In order to succeed on a § 17a(2) complaint to determine the dischargeability of a debt, the plaintiff-creditor must show, by clear and convincing evidence, the following: (1) that the bankrupt made the representations; (2) that at the time the representations were made they were materially false (i.e., substantially untrue); (3) that the bankrupt made the representations with the intention and purpose of deceiving the creditor (or that they were made carelessly or with reckless indifference to the actual facts); (4) that the creditor relied on such representations; and (5) that the creditor sustained the damage alleged as the proximate result of the representations having been made.³Cf. In re McMillan, 579 F.2d 289, 292 n. 5 (3d Cir. 1978); In re Houtman, 568 F.2d 651, 655 (9th Cir. 1978); In re Taylor, 514 F.2d 1370, 1373 (9th Cir. 1975); Sweet v. Ritter Finance, 263 F.Supp. 540, 543 (W.D.Va.1967).

The creditor must carry the burden of persuasion on all five of the above-listed elements. However, once the creditor has made a prima facie showing that the debtor made a materially false representation in writing and that the creditor relied upon such representation to its detriment, the burden of production, viz., the burden of going forward with evidence to show that the bankrupt had no intention to deceive the creditor, shifts to the bankrupt. In re Tomeo, supra. See In re Matera, 592 F.2d 378 (7th Cir. 1979). See also In re Taylor, 514 F.2d 1370, 1373 (9th Cir. 1975).⁴

What happens mechanically, then, is this: Once the creditor has made its prima facie case, a presumption arises that the debtor made the representations with "intent to deceive." At that point, the burden of going forward with evidence to the contrary (not the burden of persuasion) shifts to the debtor.

The treatment to be accorded that presumption is governed by Rule 301 of the Federal Rules of Evidence, made applicable to bankruptcy proceedings and cases by Rule 1101 of the Federal Rules of Evidence.⁵ The effect of the presumption in a § 17a(2) case causes the debtor to be charged with a duty to come forward with some evidence that he had no intention of deceiving the creditor. At this juncture, the credibility of any such evidence introduced by the debtor is not legally relevant: "the mere introduction of evidence rebutting the presumed fact causes the presumption to disappear from the case." Hecht and Pinzler, Rebutting Presumptions: Order Out of Chaos, 58 B.U.L.Rev. 527, 527-533 (1978) (this approach has been referred to as the Thayer "bursting bubble theory").⁶

We now turn to the evidence presented in this case.

First, defendants do not deny that they submitted the financial statement in question. Neither is it disputed that, at the time of applying for both the initial loan and at its refinancing, defendant Paul Barrett knew that the information listed on the respective financial statements included an incomplete list of creditors.⁷ Hence, it is admitted by the bankrupts that representations were made, thereby satisfying the first § 17a(2) requirement listed above.

Second, it must be determined whether the bankrupts' representations were materially false, i.e., substantially untrue. See In re Tomeo, supra. We conclude that the omission on the April, 1977 credit statement of the debts owed to TSO, Inc. and Bank-Americard rendered that statement materially false within the meaning of § 17a(2).

The testimony of James Foley, branch manager for plaintiff, makes it clear that the information supplied by the applicants about their total indebtedness was a crucial factor in the evaluation of their creditworthiness and ability to repay. N.T. at 6-30. The use of a debt ratio is accepted practice for lending institutions; thus, credibility is accorded Mr. Foley's testimony concerning plaintiff Beneficial's development of a debt ratio and its role in the procedure employed in deciding whether to grant a loan. Foley testified that if the ratio of fixed monthly expenses to net income exceeds fifty percent, it is strict company policy not to make the loan (N.T. at 7-10).

The addition of the TSO, Inc. debt alone to those listed by Paul Barrett on the application for refinancing of the loan would have increased the debt ratio far beyond its allowable limit. Mr. Foley testified that, even without the two debts to BankAmericard and TSO, Inc., the debt ratio of 49.84 percent was marginal, so that he had to seek permission from his field supervisor to grant the loan. (N.T. at 9.) The additional $147 monthly payment to TSO, Inc. would have raised the debt ratio to 61.51 percent. Moreover, the addition of the $10,240 debt to TSO, Inc. would have swollen the defendants' total indebtedness, excluding the $33,000 mortgage, from $7,450 to $17,790.

In In re Hadley, No. 76-665-T (M.D.Fla. March 31, 1977), the creditor also relied heavily on a debt ratio based upon a credit statement submitted by the loan applicants. That creditor's loan policy provided that whenever the ratio exceeded fifty percent, no loan could be granted without the approval of the home office. The court found the financial statement to be materially false, citing, in addition to the effect of the omitted debts on the debt ratio, the number and amount of unlisted liabilities, the additional monthly service requirement, and the testimony of plaintiff's agent that plaintiff would not have lent the bankrupts any money if all the debts had been disclosed. So here, as in Hadley, there exists as sufficient evidence of materiality more than unsubstantiated testimony of an employee of the objecting creditor that the loan would not have been made but for the incomplete financial statement. See Universal C.I.T. Credit Corporation v. Tatro, 416 S.W.2d 696 (Mo.App.1967); Tower Finance Corporation v. McLarning, 83 Ill.App.2d 250, 227 N.E.2d 375 (1967).

Therefore, it can be seen that the omission of the TSO, Inc. and BankAmericard debts was material (i.e., substantial, important).

Mr. Barrett asserts that the statement was not false (or untrue) because he thought that he was expected to list only local credit references. N.T. at 37. That claim does not stand close scrutiny. Both Paul and Catherine Barrett had considerable experience in applying for credit. At the time of the application for refinancing of the loan from plaintiff, defendants apparently owed money to four banks, two credit card companies, and three loan companies. They were not unsophisticated...