In re Berr
Decision Date | 14 September 1994 |
Docket Number | BAP No. EC-93-1436-RVJ. Bankruptcy No. 90-25580-C-7. Adv. No. 90-2458. |
Citation | 172 BR 299 |
Parties | In re Edward M. BERR, Debtor. Edward M. BERR, Appellant, v. FEDERAL DEPOSIT INSURANCE CORPORATION, Appellee. |
Court | U.S. Bankruptcy Appellate Panel, Ninth Circuit |
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Roy L. Anderson, Honolulu, HI, for appellant.
Gary T. Lafayette, San Francisco, CA, for appellee.
Before RUSSELL, VOLINN and JONES, Bankruptcy Judges.
The Federal Deposit Insurance Corporation ("FDIC"), as successor-in-interest, filed a complaint to determine the nondischargeability of debt pursuant to 11 U.S.C. §§ 523(a)(2)(A)1 and 523(a)(2)(B) of the Bankruptcy Code. The bankruptcy court determined that the debt owing to the FDIC was nondischargeable under § 523(a)(2)(B) since it had reasonably relied on a materially false financial statement. The debtor appeals. We REVERSE and REMAND.
The debtor, Edward Berr ("Berr") was a resident of Hawaii. Berr had worked hard in the real estate business, having obtained a MBA degree, a real estate sales license, and a real estate broker's license all before the age of 30. Berr was employed by Sam Daily Realty on the island of Oahu. The owner of Sam Daily Realty was Sam Daily ("Daily"), whom Berr referred to as his "mentor."
In the spring of 1982, Daily, Franklin Winkler ("Winkler"), Fred Figge ("Figge"), and their related business entities were in default or delinquent on various loans. The loans were secured by real estate owned by these individuals and their businesses. Approximately $3 million was necessary to cure arrearages and reinstate the mortgages in default. To help pay the indebtedness on the real estate, Daily, Winkler, and Figge devised a scheme whereby they would form limited partnerships, which would then purchase the real estate from them at greater than market prices. Toward that end, the three men formed two limited partnerships, Haiku Holdings and Haiku Partners. Daily, Winkler, and Figge served as the general partners of both partnerships.
The most extraordinary feature of the limited partnerships was that none of the limited partners invested a dime of his or her own money; all of it was to be borrowed from Indian Springs State Bank ("ISSB"), a very small, unsophisticated bank operating in a single location in a Kansas City area shopping center. The general partners met with William LeMaster ("LeMaster") and Anthony Russo ("Russo"), President and Vice President of ISSB, respectively, to discuss financing for the scheme. The general partners promised to refer investors to ISSB to apply for loans of up to $100,000 each at a specified interest rate subsequently determined to be 16%. The investors were to use the loans to purchase interests in the limited partnerships. Although it was contemplated that the loans would be repaid out of profits from the partnerships and not from the personal funds of the individual borrowers, each note clearly indicated that the loan would be a full recourse loan and that each borrower would be personally liable for repayment. Moreover, it was anticipated that if the Haiku partnerships did not generate sufficient profits to pay off the notes within one year, the notes were to be "rolled-over" for an additional two years.
The limited partner format was necessary because ISSB could not simply loan the partnership the $3 million; ISSB was subject to regulations limiting loans for an individual or out-of-state entity to $100,000 each. In effect, the Haiku Holdings and Haiku Partners partnerships were going to use the investors' personal financial statements to obtain a $3 million loan for the partnership.
Daily, Winkler, and Figge worked together to develop a private placement memorandum ("PPM"), an investor's disclosure document, to raise the $3 million they needed. A series of meetings were set up to recruit investors under the PPM. Daily was the principal salesman at these meetings. The pitch: investors would split $600,000 in tax benefits, due to depreciation of $400,000 and negative cash flow of $200,000 per year.2
To induce their participation, investors were allegedly told by the general partners that: (1) the applications for the loans were a mere formality and would not be scrutinized by the bank and that all debts need not be listed on the applications; (2) the partnerships would make all the loan payments and the investors would have no personal liability; (3) condominiums, which could be sold in short order, would be transferred to one of the partnerships; (4) there were adequate reserves set aside to offset any negative cash flow; and (5) investors would not be required to make any further contributions. In some instances, investors were told by Daily, Winkler and Figge to beef up their applications by adding false statements. In other cases, the general partners altered or completed the applications such that they evidenced material falsehoods without investors' knowledge.
The loan proceeds were then directly deposited into the Haiku Holdings' and Haiku Partners' account by ISSB; the borrowers never saw the money. In exchange for their deposit, the investors received a limited partnership interest in Haiku Holdings and/or Haiku Partners. Those partnership interests were then pledged to the bank as security for the loans.
The general partners were able to persuade at least forty individuals to obtain loans from ISSB.3 The total of the loans was nearly $3 million.
The relationship between Daily and Berr was close. Berr was one of Daily's best real estate salespersons. They had extensive interaction on both a business and personal basis.
Berr was one of the individuals who was personally contacted by Daily and the general partners during the initial solicitations in July 1982. Apparently, Berr was somewhat of a procrastinator when it came to investment decisions.
The initial loans to limited partners were funded in July 1982. Berr was one of the last investors to invest. He finally committed to the partnership in September 1982.
On September 3, 1982, Berr executed a credit application, financial statement, list of references and letter to ISSB to obtain the $100,000 loan. Once his application for credit was approved, Berr used the proceeds to purchase interests in the limited partnerships. Berr also executed a security agreement, which granted ISSB a security interest in Berr's interest in the partnerships.
The FDIC has claimed that the information on the financial statement and credit application submitted by Berr to ISSB was materially false, misleading and contained inflated values of his real property. The bankruptcy court concluded that Berr had made three material misrepresentations in the financial statement and credit application. First, Berr understated his income by falsely representing his actual income. Second, Berr failed to list a property he owned. Third, Berr improperly valued property which he owned.
Berr alleged that Daily and LeMaster orally represented to him that he would not be personally liable on the note. In addition, he alleged that Daily stated that the note would be "rolled-over" for up to three years. Berr also alleged that LeMaster, Russo, and the general partners made other misrepresentations, including statements regarding the solvency and profitability of the limited partnerships.
Beginning approximately in November of 1982, the FDIC began a three-month investigation of ISSB. During the course of the investigation, the FDIC specifically examined all of the Haiku-related loans. The FDIC criticized the bank's participation in financing the purchase of the Haiku limited partnership and informed ISSB that the loans were improper. Eventually, the FDIC classified the loans as "uncollectible," and required ISSB to write them off its books.
On May 3, 1983, Berr was contacted by LeMaster by a letter informing the borrowers that when the loans become due, the entire principal plus interest would be due as a result of the FDIC investigation. On August 16, 1983, another letter was sent to Berr by an attorney representing ISSB informing Berr that the loan was now due and payable as a result of a default provision in the security agreement arising from a missed interest payment.
On December 13, 1983, ISSB filed a complaint in the United States District Court for the District of Kansas seeking to recover on the note executed by Berr ("Kansas litigation").
On January 27, 1984, ISSB was declared insolvent by the Kansas State Bank Commissioner. The FDIC became the successor-in-interest to the Kansas litigation.
In 1986, the FDIC amended its complaint to allege that Berr had committed fraud in obtaining the loan. Sometime in 1986, summary judgment was granted in favor of the FDIC as to the contractual liability claim. Thereafter, the FDIC and Berr agreed to stipulate to a dismissal with prejudice of all claims pending in the Kansas litigation in return for an agreed upon judgment. On June 30, 1989, a judgment was entered against Berr and in favor of the FDIC for the sum of $100,000 with interest of $47,824.60 and interest accruing at the rate of $43.84 per day commencing September 11, 1985, until paid.
On August 28, 1990, Berr filed a Chapter 7 petition. On December 4, 1990, the FDIC filed a complaint to determine the dischargeability of Berr's debt pursuant to §§ 523(a)(2)(A) & (B). After an eight day trial, the bankruptcy court entered a final judgment on March 31, 1993, declaring the obligation to be nondischargeable under § 523(a)(2)(B). Berr timely filed his notice of appeal on April 8, 1993.
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