In re Roberts

• Decision Date: 04 November 1985
• Docket Number: 84-05581,Adv. No. 85-7014.,Bankruptcy No. 84-05501
• Citation: 54 BR 765
• Parties: In re Kenneth R. ROBERTS and Colleen K. Roberts, each individually and d/b/a C-K Stables, Debtors. Gregory F. BUTLER, Plaintiff, v. Kenneth R. ROBERTS and Colleen K. Roberts, each individually and d/b/a C-K Stables, Defendants.
• Court: U.S. Bankruptcy Court — District of North Dakota

54 B.R. 765 (1985)

In re Kenneth R. ROBERTS and Colleen K. Roberts, each individually and d/b/a C-K Stables, Debtors.

Gregory F. BUTLER, Plaintiff, v. Kenneth R. ROBERTS and Colleen K. Roberts, each individually and d/b/a C-K Stables, Defendants.

Bankruptcy Nos. 84-05501, 84-05581, Adv. No. 85-7014.

United States Bankruptcy Court, D. North Dakota.

November 4, 1985.

Robert O. Wefald, Bismarck, N.D., for plaintiff.

David L. Evans, Bismarck, N.D., for defendants.

MEMORANDUM AND ORDER

WILLIAM A. HILL, Bankruptcy Judge.

The Plaintiff, Gregory F. Butler (BUTLER), commenced the above-entitled adversary proceeding by Complaint filed on January 25, 1985, seeking a determination that two loans made to the Debtors, Kenneth R. Roberts and his wife, Colleen K. Roberts (DEBTORS), in 1981 and 1983 are non-dischargeable pursuant to sections 523(a)(2)(A) and 523(a)(2)(B) of the Bankruptcy Code. The Debtors generally deny the allegations and, as an affirmative defense, allege that the 1983 loan was taken in satisfaction of the 1981 loan, the effect of which was to efface Butler's security interest taken in consequence of that loan along with any fraud allegedly perpetrated by them in obtaining the 1981 loan. Trial was held on October 10, 1985. From the evidence submitted at trial, the Court finds the material facts to be as follows:

FINDINGS OF FACT

The Debtor, Kenneth Roberts, is a developer who, with his wife, also raises horses through a partnership known as C-K Stables. He and Butler are long-time acquaintances, and in 1981 Butler became associated with Econ, Inc., a waste oil processing business. The Debtor was president and general manager of the company, and Butler was on the Board of Directors.

On June 5, 1981, the Debtors borrowed $10,000.00 from Butler which was used in financing Econ, Inc. Although a note evidencing this loan was not produced, Kenneth at trial acknowledged its existence. As security therefor, the Debtors extended to Butler a continuing security interest in eleven registered quarter horses located in Burleigh County. The security agreement, dated June 5, 1981 and filed as a financing statement on June 9, 1981, provides that the horses are in the actual or constructive possession of the Debtor and that the Debtor "warrants that no financing statement covering any of the collateral is on file in any public office; that the Debtor is, and will be, the lawful owner of all of the collateral free of all liens and claims whatsoever, other than the security interest hereunder . . . ".

The 1981 loan remained unpaid, and on May 31, 1983, the Debtors signed another note for the principal sum of $16,084.93 with interest at the rate of 15% per annum. This note is a two-page typed document prepared by Butler's attorney. The note itself makes no reference to the 1981 note nor in any way suggests that it is a renewal or replacement. Attorney Thomas Smith, its drafter, testified that it was in part a renewal of the 1981 note, together with accrued interest, plus $5,000.00 in new money. The Debtor, Kenneth Roberts, testified that he understood the 1983 note included the previous $10,000.00 note plus $5,000.00 in new money. Similarly, Butler testified it incorporated the previous $10,000.00 note and is the basis for the instant proceeding. Mrs. Roberts did not recall the circumstances of the 1983 loan. The $5,000.00 was used by the Debtor for personal obligations.

The 1983 note provides, "this note is secured by a mortgage made by the maker to the payee of even dates herewith, on property situated in the County of Burleigh and State of North Dakota." The 1983 note makes no reference to the earlier security given in 1981. As security for the 1983 note, the Debtors extended to Butler a mortgage on their home. The mortgage specifies that the property is free from all incumbrances, "except prior mortgages of record". No title search was conducted prior to making the note or recording the mortgage. Atty. Smith said he did not make a search because the Debtors and Butler were friends and Kenneth orally indicated there was more than enough equity to cover the note. Butler himself checked the courthouse records later when he had the mortgage recorded. At that time, he discovered there were numerous and substantial mortgages of record with priority over his. The home upon which the mortgage was given has a market value of $145,000.00 according to the Debtors. As guarantor of a $286,000.00 loan made by the Bank of Kirkwood Plaza, n/k/a Dakota Bank, to Econ, Inc., the Debtors in 1981 gave the Bank a mortgage on their home in the amount of $286,000.00. Kenneth testified that at the time of this guarantee, Econ, Inc. was worth over $1.4 million, and he felt the company would have no problem paying the debt. Exclusive of the Bank's mortgage, the priority incumbrances total approximately $97,000.00 which would leave enough equity to satisfy Butler's $16,000.00 mortgage. At the time of negotiations, Kenneth Roberts led Butler to believe the house had sufficient equity to cover the $16,000.00 note. Unfortunately, Econ, Inc. filed for Chapter 11 relief on May 4, 1984.

Butler, as a member of the Board, was aware the company had borrowed the $286,000.00 but from the facts it is not certain he knew the Debtors had pledged their home as security for the company debt. In any event, Butler testified that when asking for and obtaining a mortgage on the Debtors' home, his intent was to obtain additional security for the $5,000.00 in new money beyond the security interest in horses he had been previously given in 1981. Kenneth Roberts, on the other hand, said it was his understanding in 1983 that Butler no longer wanted any interest in the horses. His wife understood the 1983 loan was secured by the house alone. It must be noted that the 1981 security agreement and financing statement covering the horses has never been terminated.

When the Debtors gave Butler a purported security interest in the eleven horses, they had already been pledged as collateral to the Bank of Kirkwood Plaza by virtue of a security agreement dated January 8, 1981, covering livestock owned by the Debtor; and the Bank yet retains its paramount security interest in all of the Debtor's livestock. Kenneth Roberts claims that when he extended a security interest to Butler in the horses in June 1981, he did not realize the Bank's security interest covered them. He acknowledged, however, that he signed both the security agreement and the financing statement pledging livestock as collateral to the Bank and that the only livestock he owned were horses. His wife was not signatory to the Bank note or security interest pertaining to livestock. However, the note was made out to Kenneth Roberts, dba C-K Stables, a partnership between he and his wife.

Butler at trial did not state whether he relied on the existence of the horses as collateral or the existence of sufficient home equity as an inducement to making either the 1981 or 1983 loans. The debt of $16,084.93 represented by the 1983 note, plus interest thereon at the rate of 15% per annum from May 31, 1983, is the sum Butler seeks to have declared non-dischargeable by the instant action.

CONCLUSIONS OF LAW

1.

Before assessing the facts against the requisite elements of section 523(a)(2), it is necessary to identify the instances of misrepresentation claimed to have precipitated the 1983 loan. Although Butler is suing upon the 1983 note, he claims that note is a renewal made on the reasonable belief that the Debtors' statement regarding the home equity was correct and also upon his continuing belief that the Debtors had not pledged the horses to any other party. The Debtors argue that the 1983 note was not a renewal but a wholly new note taken not in reliance upon the existence of horses but rather upon wholly new security, that being the home equity. Accordingly, whatever false representations that might have occurred as regards the 1981 note cannot be claimed by Butler as a basis for recovery of the 1983 note. It is the Debtors' position that the 1983 note was taken and new money given solely in reliance upon a new promise of security with no reference to, or intent to rely upon, the old.

One of the elements of proof necessary in a section 523(a)(2) action is that of reasonable reliance on the part of a creditor. As it has evolved, the term has come to connote not only actual reliance but the concept of proximate cause as well. This is not to say that proximate cause is an independent element of proof but stems from the language of section 523(a)(2) which excepts a debt for money from discharge if obtained by means of a false representation or use of a statement in writing. The statute itself presupposes in the first instance that it was the representation or statement which was the causative factor, without which none of the other elements of section 523(a)(2) are reached. If the 1983 note was a wholly new obligation supported by and based upon new consideration, then Butler's claim of reliance upon the 1981 security agreement would be misplaced because the effect of the 1983 note would be the discharge of the 1981 obligation.

Under N.D.Cent.Code § 41-03-68(2) (U.C.C. § 3-601(2)), a party's liability on an instrument may be discharged by any act or agreement with such party which would apply to any other contract dispute under state law. This section allows for discharge of a negotiable instrument by novation. It is upon the theory of novation that the Debtors claim their obligation on the 1981 note and the Plaintiff's concomitant reliance upon the 1981 representations were extinguished. Novation, if found to have occurred, results in the new note being substituted for the old, the effect of which is discharge of the old. Novation is never presumed but must be proved by the party asserting its existence. Absent such proof, it is generally held that a new note merely evidences the same debt by a new...