In re Smigel

• Decision Date: 12 September 1988
• Docket Number: 84 A 1117.,No. 82 B 470,82 B 470
• Citation: 90 BR 935
• Parties: In re Victor B. SMIGEL, Debtor. FEDERAL DEPOSIT INSURANCE CORP., Plaintiff, v. Victor B. SMIGEL, Defendant.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

90 B.R. 935 (1988)

In re Victor B. SMIGEL, Debtor FEDERAL DEPOSIT INSURANCE CORP., Plaintiff, v. Victor B. SMIGEL, Defendant.

Nos. 82 B 470, 84 A 1117.

United States Bankruptcy Court, N.D. Illinois, E.D.

September 12, 1988.

Arthur S. Gold, Levenfeld, Gallagher & Gold, Chicago, Ill., for Victor Smigel.

John B. Huck, McBride, Baker & Coles, Chicago, Ill., for FDIC.

MEMORANDUM OPINION AND ORDER^*

DAVID H. COAR, Bankruptcy Judge.

This cause coming on to be heard on the motion of the Federal Deposit Insurance Corporation FDIC to alter or amend this Court's Memorandum Opinion and Order determining the dischargeability of a debt, entered on April 5, 1988, or for a new trial, and the Court, having considered the record and pleadings on file, having considered the memoranda of law submitted by the parties in support of their respective positions, and being fully advised in the premises, now enters its ruling;

This is a core matter over which the Court has jurisdiction, pursuant to 28 U.S.C. § 157(b). For the reasons set forth below, the FDIC's motion to alter or amend this Court's Memorandum Opinion and Order of April 5, 1988, or for a new trial is denied, and the following constitutes the Court's findings of facts and conclusions of law, pursuant to Bankruptcy Rule 7052.

BACKGROUND

On March 12 and March 13, 1987, the Court conducted an evidentiary hearing to determine the dischargeability of the debt owed to the FDIC, as successor in interest to Drovers National Bank Drovers. At the conclusion of the hearing the Court took the matter under advisement. On April 5, 1988, the Court entered an order finding and concluding, inter alia, that the FDIC had failed to establish by clear and convincing evidence the requirements of 11 U.S.C. § 523(a)(2)(B). Specifically, the Court held that the FDIC failed to meet its burden of proving that Drovers reasonably relied on the financial statement submitted by the debtor in connection with a $75,000.00 unsecured loan.¹ At the core of the Court's April 5 opinion and order was the determination that the FDIC had failed to establish that Drovers had verified or otherwise conducted an investigation of the information contained in the statement.² The Court also found that the testimony of the Drovers' officers who had approved the loan was insufficient to establish that Drovers had followed even its own internal standards in approving the loan. These findings and conclusions are the principal focus of the FDIC's instant motion.

DISCUSSION

There are three possible grounds on which a court may alter or amend a judgment or grant a new trial in a matter tried by a court: 1) manifest error of law; 2) manifest error of fact; or 3) newly discovered evidence. FDIC v. Meyer, 781 F.2d 1260 (7th Cir.1986). A motion to alter or amend a judgment or for a new trial cannot be used to raise argument that could and should have been made before the judgment was entered, or to argue a case under a new legal theory. Id. at 1268.

A. The Reasonableness Requirement.

The FDIC's principal position is that Drovers was not required to make any verification under the circumstances of this case and the applicable law in 1976. The FDIC also asserts that Drovers did in fact verify the statement. Although it is not clear from the pleadings, the Court takes these assertions as arguments that the Court's ruling that Drovers' failure to verify the information contained in the financial statement is a manifest error of law.

The FDIC argues that Drovers was not required to verify the statement under applicable law in 1976. The FDIC is correct that the case law prior to 1976 did not specify just what verification a creditor must make or when, if ever, verification was necessary. It does not follow, however, that the law in 1976 recognized no duty to verify. The test to be applied in assessing a creditor's conduct in extending credit was not in 1976 and is not now whether the creditor did or did not verify a financial statement. Rather the standard is whether the creditor acted reasonably under the circumstances of a particular loan transaction. See Matter of Bogstad, 779 F.2d 370, 372-73 n. 4 (7th Cir.1985). If reasonableness requires verification, then a creditor cannot be said to have acted reasonably if no verification took place. The fact that there are few cases in which courts have found lack of reasonableness because of a failure to verify may be significant, but only to the extent that the decided cases are factually similar to this case.

The FDIC cites Carini v. Matera, 436 F.Supp. 947, 949 (E.D.Wis.1977), aff'd, 592 F.2d 378, 381 (7th Cir.1979), as authority for its assertion that Drovers was not required to verify the statement under the circumstances of this case and applicable case law in 1976. Carini was decided by the Court of Appeals for the Seventh Circuit in 1979. The FDIC cites this case for the proposition that as late as 1979, the case law in this circuit did not require a creditor to verify information contained in a financial statement submitted in connection with a loan application. The FDIC's reliance on Carini is puzzling. The creditor in that case was financially naive. He did inquire about the debtor's books but was either put off by the debtor or was unable to understand them. He met with the debtor's accountant who assured him that the debtor's business had been profitable.

The circuit court, after commenting on the district court's finding of actual reliance, said:

Matera next contends, correctly, that § 17(a)(2) requires a finding that the creditor actually relied upon the false representation. And of course such reliance must be reasonable. But here again it cannot be said that the court committed clear error in finding that Carini acted reasonably in relying on the debtor\'s representations. . . . Taking into account, as both courts have, the close friendship between the parties, Carini\'s observations of the debtor\'s spending habits, the repetition of the false representations over a six month span, and the other circumstances prior to the loan, the finding of reasonable reliance is supported by the evidence.

592 F.2d at 381. It is clear that the creditor in Carini did more than simply rely on the debtor's representations. The question was not whether the creditor did or did not verify the debtor's representations, as the FDIC would have the Court read that case, but rather whether the creditor's conduct was an exercise of ordinary prudence.

The issue in 1976 and in 1988 is whether the creditor's reliance on the false financial statement was reasonable under the circumstances. Stated differently, the issue is whether the creditor has acted with ordinary prudence. To hold that a creditor is obligated to verify information contained in a financial statement is simply to say that under the circumstances of the particular case, ordinary prudence would require verification.

In determining the circumstances under which verification is required, many courts have focused on the relationship between the creditor and the debtor. In In re Garman, 643 F.2d 1252, 1257-59 (7th Cir.1980), and In re Kreps, 700 F.2d 372, 376 (7th Cir.1981), the Seventh Circuit recognized that the existence of an on-going business relationship between a creditor and a debtor may excuse that creditor from verifying (in whole or in part) information contained in a financial statement. But where the debtor and creditor are strangers (as was the situation in this case) there is no controlling case in this circuit which states, as a matter of law, that a creditor is not obligated to verify. In In re Bogstad, No. 84-C-91-S, p. 4 (W.D.Wis. February 28, 1985), the district court, in reversing an order of the bankruptcy court which held that a creditor's reliance was not reasonable, made the following observation:

this court believes that in today\'s less than candid society the failure of a lending institution to conduct a credit investigation of the applicant or to obtain an appraisal of the real estate constitutes improper internal office procedure. However, the failure . . . to verify . . . does not as a matter of law render its reliance unreasonable . . .

Mr. Bogstad was not clothed with a scarlet letter when making his application. Had there been evidence of applicant\'s prior reputation for untruthfulness, any reliance upon Robert Bogstad\'s statement would, of course, have been unreasonable.

Thus, in the district court's view, absent facts and/or circumstances (a scarlet letter) suggesting the inaccuracy of information contained in a financial statement, a creditor is under no obligation to investigate.

In reversing the district court decision in the Bogstad case on other grounds, the Seventh Circuit felt obliged to comment on the district court's discussion of the requirement to verify:

The question of the reasonableness of a creditor\'s reliance may be highly dependent on the particular facts of the lending transaction. Courts should not, however, be eager to intrude into the business practices of lending institutions. Nonetheless, the conclusion of the district court in this case makes us uneasy. There seems to be a significant difference between the on-going business relationships which, we held in In re Garman, 643 F.2d 1252, 1257-59 (7th Cir. 1980), cert. denied sub nom. Garman v. Northern Trust Co., 450 U.S. 910, 101 S.Ct. 1347, 67 L.Ed.2d 333 (1981), and In re Kreps, 700 F.2d 372, 376 (7th Cir. 1981), can excuse a bank from verifying a financial statement and the absence of a "scarlet letter" on the breast of a loan applicant who is, basically a stranger to the lender . . . We also note that neither Garman nor Kreps involved almost necessarily arguable estimates of land values. Here land values are central.

Further, we believe that the purpose of excluding from discharge debts obtained by fraud is to protect lenders from dishonest debtors. But the requirement of "reasonable" reliance added

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