Mayer v. Spanel Intern. Ltd.

• Decision Date: 10 March 1995
• Docket Number: Nos. 94-1389,s. 94-1389
• Citation: 51 F.3d 670
• Parties: , 33 Collier Bankr.Cas.2d 101, Bankr. L. Rep. P 76,445 In the Matter of John E. MAYER and Deborah Mayer, Debtors-Appellants, v. SPANEL INTERNATIONAL LTD. and Bank One-Rockford, N.A., Creditors-Appellees. & 94-3870.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 670

51 F.3d 670

63 USLW 2655, 33 Collier Bankr.Cas.2d 101,

Bankr. L. Rep. P 76,445

In the Matter of John E. MAYER and Deborah Mayer, Debtors-Appellants, v. SPANEL INTERNATIONAL LTD. and Bank One-Rockford, N.A.,

Creditors-Appellees.

Nos. 94-1389 & 94-3870.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 14, 1994.

Submitted March 10, 1995 ^*.

Decided March 31, 1995.

Rehearing and Suggestion for Rehearing En Banc Denied April

24, 1995.

William Moroney (argued), Law Offices of Lawrence Friedman, Chicago, IL, for Spanel Intern., Ltd.

Kenneth A. Michaels, Jr. (argued), Michaels & Associates, Chicago, IL, for John E. Mayer and Deborah J. Mayer.

Gloria E. Block (submitted), Block & Block, Chicago, IL, Stephen Ellis, Ellis & Ellis, Rockford, IL, for Bank One-Rockford, N.A.

Before LAY, ^** EASTERBROOK, and RIPPLE, Circuit Judges.

EASTERBROOK, Circuit Judge.

Two bankruptcy appeals present a common question: whether a liar may obtain a discharge in bankruptcy by showing that the victim did not do enough to nose out the truth. Debts attributable to fraud may not be discharged, 11 U.S.C. Sec. 523(a)(2)(A), and intentional deceit concerning a material proposition is fraud whether or not a more-alert target would have smelled a rat. Victims of intentional torts need not take special precautions.

The first transaction occurred in December 1987. John and Deborah Mayer jointly borrowed more than $135,000 to purchase the Bess Hotel, a residence for transients in Rockford, Illinois. The Mayers presented financial statements showing assets exceeding $800,000 and tax returns showing annual income exceeding $150,000. John Mayer promised to subsidize the hotel's operations until it turned a profit. Yet the Mayers had no intention of operating the hotel, underwriting its losses, or paying off the loan. They were serving as fronts for their friends Donald and Rosemarie Monti. Donald Monti and John Mayer had engaged in other real estate transactions; Rosemarie Monti and Deborah Mayer are first cousins, "inseparable" friends who rode horses together daily. The Montis could not have obtained the loan in their own names, because Donald was in bankruptcy and Rosemarie had no income. So the Mayers lent their name and financial statement; John Mayer signed a power of attorney authorizing the Montis to transfer the hotel to their own name by quit-claim deed and adding: "I have agreed to help Rosemarie K. Monti obtain a loan From the 1st Natl. Bank of Rockford. I, Dr. John E. Mayer, have no legal interest in the Bess Hotel." Any correspondence the Mayers received from the bank was passed, unopened, to the Montis.

The Montis could not make a go of the hotel and did not pay off the loan. The Mayers refused to pay a cent. A state court determined that the Mayers had taken out a loan, had signed all the papers, and are liable. The court ordered the hotel sold at foreclosure; a deficiency judgment of $187,665.35 (including attorneys' fees and accrued interest) was entered against the Mayers on January 3, 1992. The Mayers sought to discharge that debt in their federal bankruptcy proceeding. The bankruptcy judge denied discharge under Sec. 523(a)(2)(A) after concluding that the Mayers had defrauded the bank. The state court's judgment conclusively determines that the Mayers borrowed and owe the money. Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991). The Mayers concede that they never intended to repay. As the bankruptcy court saw things, that left only the question whether the bank reasonably relied on the Mayers' promise to pay. The Mayers said not, because the bank either saw or should have tracked down the power of attorney revealing that the Mayers were straw purchasers. The bank's loan officer testified that she had not seen that power of attorney, and the bankruptcy judge believed her. The bank had no obligation to search out such papers, the judge concluded, and was entitled to rely on the Mayers' written and oral promises. The district court affirmed. 173 B.R. 373 (N.D.Ill.1994).

The other transaction occurred in September 1990. By then John Mayer was in financial distress and unable to borrow from banks. He located Spanel International, which was willing to lend at substantially higher rates. A clinical psychologist specializing in adolescents with drug problems, Mayer told Dennis King, Spanel's owner, that he was working on a manual that would help schools deal with substance abuse among pupils. To add verisimilitude to this claim (and to fortify his representation that he would be able to pay back the 90-day loan of $100,000), Mayer showed King a purchase order issued by the Chicago Board of Education for 5,000 copies of the manual, at a total price of $725,000. Spanel made the loan; Mayer did not repay the debt; the purchase order turned out to be a fake, with a forged signature. Mayer denied knowing that the purchase order was bogus and blamed his literary agent. The bankruptcy judge found that Mayer knew that the order was spurious and rejected his contention that King should have investigated its validity more thoroughly. (King had called the Board about the subject, but Mayer told him to stop snooping.) On reconsideration the bankruptcy judge withdrew his finding that Mayer knew of the forgery but concluded that Mayer was reckless in presenting the order to King. The bankruptcy court concluded that the debt may not be discharged, and the district court affirmed. 164 B.R. 83 (N.D.Ill.1994).

Section 523(a)(2)(A) forbids the discharge of any debt incurred by

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

Each of the district judges turned to In re Kimzey, 761 F.2d 421 (7th Cir.1985), for an exegesis of this text.

To succeed on a claim that a debt is nondischargeable under section 523(a)(2)(A), a creditor must prove three elements. First, the creditor must prove that the debtor obtained the money through representations which the debtor either knew to be false or made with such reckless disregard for the truth as to constitute willful misrepresentation. Carini v. Matera, 592 F.2d 378, 380 (7th Cir.1979). The creditor also must prove that the debtor possessed scienter, i.e., an intent to deceive. Gabellini v. Rega, 724 F.2d 579, 581 (7th Cir.1984). Finally, the creditor must show that it actually relied on the false representation, and that its reliance was reasonable. Carini, 592 F.2d at 381. The party objecting to discharge must prove the facts establishing each element by clear and convincing evidence.

761 F.2d at 423-24. The Mayers insist that their creditors did not "reasonably" rely on their false statements--a term understood by both district judges (and by bankruptcy judges in some other cases) to entail proof that the creditor conducted an investigation reasonably designed to discover whether the would-be borrower is telling the truth. E.g., In re Iaquinta, 98 B.R. 919 (Bankr.N.D.Ill.1989); In re Smigel, 90 B.R. 935 (Bankr.N.D.Ill.1988). John Mayer adds that he did not intend to deceive Spanel.

We confess to some doubt that Kimzey is an accurate guide to Sec. 523(a)(2)(A). Kimzey's fourth requirement--that the creditor prove the statutory elements by clear and convincing evidence--has been disapproved by the Supreme Court, which thought Kimzey unduly influenced by the goal of providing debtors with fresh starts. Grogan v. Garner, 498 U.S. 279, 283 n. 7, 111 S.Ct. 654, 657 n. 7, 112 L.Ed.2d 755 (1991). Only the "honest but unfortunate" debtor can start anew, the Court observed, id. at 287, 111 S.Ct. at 659-60, and the process of classification should be conducted without a thumb on the scales. The rest of Kimzey's list likewise seems designed to stack the deck in debtors' favor, even to the point of doubling up on intent requirements (factors one and two require proof of different forms of intent to defraud). The exclusions in Sec. 523 serve vital functions. Congress concluded that preventing fraud is more important than letting defrauders start over with a clean slate, and we must respect that judgment. See Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 273-79 (1986) (identifying other restrictions on the fresh start policy).

Kimzey finds three ingredients in Sec. 523(a)(2)(A): falsity, fraudulent intent, and reasonable reliance. The statute itself specifies only the first of these, speaking of "false pretenses, a false representation, or actual fraud". The word "fraud" implies a requirement of intent to deceive, see Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); Neal v. Clark, 95 U.S. 704, 709, 24 L.Ed. 586 (1877), but "fraud" is only one of three elements in the statutory list. By including "false pretenses [and] false representation" Congress may have done away with an obligation to show intent to defraud; otherwise what function do these words serve? Redundancy is common in statutes; we do not subscribe to the view that every enacted word must carry independent force. Neither, however, should one in a list of related but not identical terms be treated as if it were the whole shebang--not, at least, without strong evidence that at the time of enactment the words were understood as equivalents.

Kimzey took the intent requirement from Carini v. Matera, which interprets the Bankruptcy Act of 1898. Section 17(a)(2) of that Act, 11 U.S.C. Sec. 35(a)(2), the portion closest in spirit and effect to Sec. 523(a)(2)(A), forbade discharge of "[l]iabilities for obtaining money or property by false pretenses or false representations," language that to modern ears differs from "fraud" in lacking an intent component. It turns out that cases interpreting the 1898 Act got the intent ingredient from the Bankruptcy Act of 1867, which disallowed the discharge of debts "created by fraud." This was the language understood in Neal to require proof of...