Ledford, In re

• Decision Date: 17 September 1992
• Docket Number: Nos. 91-5594,91-5649,s. 91-5594
• Parties: , 23 Bankr.Ct.Dec. 398, Bankr. L. Rep. P 74,797 In re Thomas E. LEDFORD and J. Gregg Sikes, Debtors. BancBOSTON MORTGAGE CORPORATION, Plaintiff-Appellee, v. Thomas E. LEDFORD (91-5649); J. Gregg Sikes (91-5594), Defendants-Appellants.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1556

970 F.2d 1556

61 USLW 2110, 23 Bankr.Ct.Dec. 398, Bankr.

L. Rep. P 74,797

In re Thomas E. LEDFORD and J. Gregg Sikes, Debtors BancBOSTON MORTGAGE CORPORATION, Plaintiff-Appellee, v. Thomas E. LEDFORD (91-5649); J. Gregg Sikes (91-5594) Defendants-Appellants.

Nos. 91-5594, 91-5649.

United States Court of Appeals Sixth Circuit.

Argued April 3, 1992.

Decided July 31, 1992.

Rehearing and Rehearing En Banc

Denied Sept. 17, 1992.

Paul S. Davidson (argued and briefed), D. Reed Houk (briefed), Stokes & Bartholomew, Nashville, Tenn., for plaintiff-appellee.

Joseph P. Rusnak, Tune, Entrekin & White, William Caldwell Hancock (argued and briefed), Paul E. Jennings (argued and briefed), Nashville, Tenn., for defendants-appellants.

Before: KEITH and NELSON, Circuit Judges; and TIMBERS, Senior Circuit Judge. ^*

DAVID A. NELSON, Circuit Judge.

This is a bankruptcy case that involves the dischargeability of bank debt incurred by a partnership to build a condominium project. After the bank had advanced the loan proceeds to the partnership in apparent reliance on the existence of a specified number of contracts for the purchase of individual condominium units, it turned out that the character of the contracts had been fraudulently misrepresented to the bank by one of the partners.

Two questions are presented: (1) whether the bankruptcy court erred in finding, as it did, that the bank acted reasonably in disbursing the money, and (2) whether, for purposes of determining dischargeability under 11 U.S.C. § 523(a)(2)(A), the fraud of one general partner should be imputed to a second general partner who had no actual knowledge of it. The district court answered no to the first question and yes to the second. We agree, and we shall affirm the judgment of the district court.

I

The debtors, Thomas Ledford and J. Gregg Sikes, M.D., were general partners in a venture formed for the purpose of constructing a condominium project in Nashville, Tennessee. Mr. Ledford was also the sole stockholder and president of a development company used by the partnership in this connection. The partnership's business was managed by Mr. Ledford, and Dr. Sikes was not involved in day-to-day operations.

BancBoston lent the partnership $1.6 million to buy the land on which the project was to be built, and the bank agreed to make a construction loan in the additional amount of $4.625 million. It is only the construction loan that concerns us here.

Disbursement of the construction funds was originally contingent on the partnership's submitting contracts for the purchase of 20 individual condominium units, with down payments of at least 10%. The bank was to take a security interest in the contracts, and the loan documents provided that the contracts could not be "contingent."

Apart from the value that the purchase contracts had as collateral, the bank viewed the contracts as a measure of market interest in the condominium project. BancBoston had previously financed another Ledford condominium development, and had required the submission of individual purchase contracts there for the same reasons.

Experiencing difficulty in finding the requisite number of buyers willing to sign contracts before the Nashville project was built, Mr. Ledford persuaded BancBoston to reduce the number from 20 to 14 and to reduce the required down payment from 10% to 7%. In return, the bank took a $100,000 letter of credit that was to remain in force until 20 contracts meeting the bank's approval had been executed. The parties also entered into formal agreements specifying that the contracts had to be legally enforceable and had to be prepared on a form provided by BancBoston.

Although 14 contracts were submitted by the agreed deadline, several of them were subject to undisclosed side agreements not in conformity with the loan agreement. Two of the contracts were signed as an accommodation to Mr. Ledford--one by a Ledford employee and the other by a friend of an employee. Neither of the accommodation signers had any intention of actually going through with a purchase. The bankruptcy court found that Mr. Ledford had committed fraud, and this finding is not challenged on appeal. It was further found that Dr. Sikes did not know of the fraud.

BancBoston disbursed the construction funds to the partnership without contacting any of the prospective purchasers named in the contracts. The bankruptcy court found that the funds would not have been disbursed but for the bank's belief that 14 bona fide non-contingent purchase contracts were in existence. The court further found, by "clear and convincing evidence," that the bank acted reasonably in relying on the partnership's representations concerning the contracts. ¹

The condominium project was not completed on schedule, and by the time it was finally finished, all of the purchase contracts had expired. The partnership defaulted on its loans, and the two general partners filed for bankruptcy.

BancBoston contended that the claim it filed with respect to the construction loan was not dischargeable as to either partner, under 11 U.S.C. § 523(a)(2)(A), because the loan had been procured through fraud. The bankruptcy court agreed that Mr. Ledford was not entitled to a discharge, but held that Dr. Sikes was. The district court reversed the decision as to Dr. Sikes, concluding that knowledge of Ledford's fraud should be imputed to him as a matter of law. 127 B.R. 175.

Both Ledford and Sikes have appealed, contending that BancBoston's reliance on the 14 purchase contracts was unreasonable. Dr. Sikes also contends that his indebtedness is dischargeable in any event because of his lack of actual knowledge of Ledford's fraud.

II

The debtors argue that it was unreasonable for the bank to rely on the contracts because the bank admittedly made no independent inquiry into their authenticity. We think that the debtors are reading too much into the "reasonableness" requirement that our caselaw has interpolated into the text of § 523(a)(2)(A).

Section 523(a) provides, in pertinent part, that an individual debtor will not be discharged from any debt

"(2) for money ... to the extent obtained by--

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition; [or]

(B) use of a statement in writing--

(i) that is materially false;

(ii) respecting the debtor's or an insider's financial condition;

(iii) on which the creditor to whom the debtor is liable for such money ... reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive...."

Subparagraph (a)(2)(A), unlike (a)(2)(B), contains no explicit requirement that a creditor's reliance be reasonable. We have nonetheless required creditors asserting nondischargeability under § 523(a)(2)(A) to show that their reliance met a loose standard of reasonableness. In re Phillips, 804 F.2d 930, 933 (6th Cir.1986); In re Ward, 857 F.2d 1082 (6th Cir.1988).

The predecessor to the current § 523(a)(2), section 17(a)(2) of the Bankruptcy Act, did not require that a creditor's reliance be reasonable. ² In deciding cases under Section 17(a)(2), however, the courts did consider the reasonableness of a creditor's asserted reliance as evidence bearing on the question whether the creditor had actually relied on the representation in question. See, e.g., In re Garman, 643 F.2d 1252 (7th Cir.1980), cert. denied, 450 U.S. 910, 101 S.Ct. 1347, 67 L.Ed.2d 333 (1981). After § 523(a)(2)(B) of the Bankruptcy Code was enacted, we adopted the Garman approach for cases arising under that section. In doing so we noted that the explicit reasonableness requirement of § 523(a)(2)(B) was merely intended to incorporate the caselaw existing at the time of enactment. In re Martin, 761 F.2d 1163, 1166 (6th Cir.1985); Knoxville Teachers Credit Union v. Parkey, 790 F.2d 490 (6th Cir.1986).

In In re Phillips, 804 F.2d 930, 933 (6th Cir.1986), we concluded that even though there is no explicit reasonableness requirement in § 523(a)(2)(A), the approach spelled out in Garman and Martin applied to § 523(a)(2)(A) as well. ³ The reasonableness requirement of Phillips was not particularly rigorous; we viewed the requirement as a filter intended to isolate creditors who had acted in bad faith. Id. As the Garman court said, the decisions that refer to "reasonable" or justifiable reliance do not require the court to undertake a subjective evaluation of a creditor's lending policy and practices; the decisions teach only that dischargeability should not be denied where a creditor's asserted reliance would be so unreasonable as to negate any actual reliance. Garman, 643 F.2d at 1256. It was the test enunciated in Garman that we held appropriate under § 523(a)(2)(B), In re Martin, 761 F.2d at 1166, and it was the Garman test that we applied under § 523(a)(2)(A) in Phillips.

Whether a creditor's reliance was reasonable is a factual determination to be made in light of the totality of the circumstances. Among the circumstances that might affect the reasonableness of a creditor's reliance are: (1) whether the creditor had a close personal relationship or friendship with the debtor; (2) whether there had been previous business dealings with the debtor that gave rise to a relationship of trust; (3) whether the debt was incurred for personal or commercial reasons; (4) whether there were any "red flags" that would have alerted an ordinarily prudent lender to the possibility that the representations relied upon were not accurate; and (5) whether even minimal investigation would have revealed the inaccuracy of the debtor's representations. See, e.g., Phillips, 804 F.2d at 933; Ward, 857 F.2d at 1084; Martin, 761 F.2d at 1166-67; Knoxville Teachers Credit Union, 790 F.2d at 492-93; Garman, 643 F.2d at 1257-59.

In the case at bar, BancBoston (which had a previous business relationship with Mr. Ledford that had given the...