Menu    3 ABR 8 
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF ALASKA



     In re                       )
                                 )            U.S.D.C. Appeal
     MICHAEL C. NORMAN and       )            No. A92-069 Civil 
     MARY J. NORMAN,             )             (Consolidated)
                                 )
                   Debtors.      )             
     ____________________________)                                                                        
                                 ) 
     CUMMINS FINANCIAL, INC.,    )
                                 )
                     Plaintiff,  )
                                 )              Bankruptcy Court
            VS.                  )              No. A91-00032-HAR 
                                 )
    MICHAEL C. NORMAN and MARY J.)
    NORMAN,                      )              Adv. No. A91-00032-001
                     Defendants. )              BANCAP No. 91-3048
    _____________________________)  
ORDER ON APPEAL
I.
Background Facts


The facts as found by the bankruptcy court are essentially as follows. In 1981, Dr. Michael C. Norman and his wife, Mary J.   TOP    3 ABR 9  Norman, began operating a charter boat service out of Seward. Dr. Norman is an anesthesiologist who derives income from a corporate practice with Anchorage Anesthesia Affiliates, Inc., as well as a private practice at Providence Hospital.

In 1986, the Normans wanted to build a new vessel to operate in Prince William Sound. They formed a corporation, M/V Endeavor, Inc., for the purpose of constructing and operating the vessel. Dr. Norman was president of the corporation and one of four directors, while Mrs. Norman was active in the management of the business.

On April 16, 1986, the corporation obtained a construction loan from Cummins Financial, Inc. Cummins Engine Company, Inc., manufactures engines for seagoing vessels, and Cummins Financial Corp., Inc., hereinafter "Cummins", provides financing for the construction of vessels that use Cummins' engines. Although the directors of M/V Endeavor, Inc., originally wanted Cummins to provide 100% of the financing necessary to construct the vessel, Cummins agreed to provide 80% of the cost of construction if a 20% down payment were made. The vessel was to be built by Marine Fire-fighters, Inc., a construction company in Bellingham, Washington. The cost of construction was estimated at $355,000.00, so the 20% down payment would have amounted to $71,000.00.

The down payment was never made. Cummins presented evidence to the bankruptcy court, and the court found, that the principals of M/V Endeavor, Inc., including the Normans, deceived Cummins   TOP    3 ABR 10  into believing that Marine Firefighters had received the down payments. After partially completing the vessel, Marine Firefighters went into bankruptcy. Cummins agreed to extend the term of the loan with M/V Endeavor, Inc., to allow time to complete construction of the vessel. After numerous delays, the Normans spent approximately $60,000.00 of their own money to finance further construction. The vessel was completed and put into service in 1987. However, in 1989, the Exxon Valdez oil spill virtually wiped out the tourist industry in Prince William Sound.

The vessel was repossessed by Cummins. After foreclosure and sale, Cummins obtained a deficiency judgment against the Normans in Washington for approximately $169,000.00. The judgment was recorded in Alaska on September 27, 1990, and Cummins began executing the judgment soon thereafter.

On January 15, 1991, the Normans filed a joint petition in bankruptcy in the District of Alaska under Chapter 7 of the Bankruptcy Code. Cummins then filed a complaint which sought a determination that the Normans' debt to Cummins was non-dischargeable. Count I of Cummins' complaint alleged that under section 523(a) of the Code, the debt could not be discharged because it was obtained through fraud. Counts II, III, and IV of the complaint also alleged, respectively, that under sections 727(a) (2), 727(a) (4), and 727(a) (5), the court should deny the Normans' request for a discharge because: the Normans had transferred or concealed property in an effort to hinder or delay Cummins' collection efforts; the   TOP    3 ABR 11  Normans had committed false oaths in connection with the bankruptcy proceeding; and they had failed to satisfactorily account for the loss of a significant amount of assets.

Trial was held on December 18, 1991, before Bankruptcy Judge Donald MacDonald, who filed his judgment and memorandum of decision and order ("Decision") on January 2, 1992. Judge MacDonald ruled in favor of Cummins insofar as he denied the Normans' request for a discharge under section 727, but he ruled against Cummins by rejecting its argument that the debt fell under an exception to discharge under section 523.

On January 6, 1992, the Normans filed their appeal of the bankruptcy court's decision that the debt was non-dischargeable under sections 727(a)(2), (4), and (5) (Counts II, III, and IV of Cummins' Complaint). When filed with this court, the appeal was designated No. A92-070 Civil and was assigned to Judge Singleton. On January 16, 1992, Cummins filed an appeal of the court's refusal to deny the Normans' discharge under section 523 (Count I of Cummins' complaint). That appeal was designated No. A92-069 Civil in this court and was also assigned to Judge Singleton. On June 11, 1992, the two cases were consolidated. On July 30, 1992, Judge Singleton recused himself from the case and it was reassigned to Judge Holland. Oral argument has not been requested by either party and both appeals are ripe for ruling.

  TOP    3 ABR 12 

II.
Norman's Appeal
A. Objections Under Section 727(a) (2)
(1) "Transfer" of Funds to North Rim Bank

Under section 727(a) (2) a bankruptcy court may refuse to grant the debtor a discharge when he transfers or conceals assets within one year of the date of the petition with the intent to hinder, delay or defraud the creditor.1 Cummins objected to the discharge of the Norman's debt because soon after the petition was filed, the Normans closed their existing bank accounts and opened new accounts at North Rim Bank. At a creditor's meeting, the Normans testified that Cummins had garnished their old accounts and they transferred the funds to North Rim Bank to avoid further garnishment. Trial Transcript (hereinafter "Tr.") at 54-58, 70-76.   TOP    3 ABR 13  At trial Dr. Norman recanted and suggested that he was more comfortable doing business with the bankers at North Rim. Tr. at 70-71.

In order to prevail upon an objection to discharge under section 727(a)(2), a creditor must show that:

(1) the debtor transferred or concealed property; (2) the property belonged to the debtor; (3) the transfer occurred within one year of the bankruptcy filing; and (4) the debtor executed the transfer with the intent to hinder, delay or defraud a creditor.
In re Aubrey, 111 B.R. 268, 273 (Bankr. 9th Cir. 1990). The bankruptcy court in this case found that the transfer of funds to North Rim Bank met all of these elements. It is undisputed that the funds belonged to the debtor and that the transfer occurred within one year of the filing of the petition.

The Normans attack the bankruptcy court's ruling on two grounds. First, they contest the court's finding that the transfer was made with the intent to hinder, delay, or defraud Cummins. This court reviews factual findings under the "clearly erroneous" standard. Rule of Bankruptcy Procedure 8013; In re Rubin, 875 F.2d 755 (9th Cir. 1989). The bankruptcy judge had the opportunity to observe the Normans' testimony and examine their demeanor on the stand. The Normans ask this court to accept the explanation of their motivation for transferring their funds that Dr. Norman offered at trial. The bankruptcy court found, as being more credible, the explanation offered by both Dr. and Mrs. Norman at the meeting of creditors: that they transferred the funds to avoid garnishment. Where there are two permissible views of the evidence,   TOP    3 ABR 14  the fact-finder's choice between them cannot be clearly erroneous. Anderson v. City of Bessemer City, 470 U.S. 564 (1985). The bankruptcy court's finding that the transfer was made with the intent to delay, hinder, or defraud Cummins in its collection efforts is adopted by this court.

Second, the Normans argue that the transfer of funds to North Rim Bank was not a "transfer" in the sense that the term is used in the Bankruptcy Code. They argue that for an objection under subsection 727(a) (2) to be sustained, the debtor must part with or dispose of legal title to the property. They maintain that since the North Rim accounts were in their names, and since they did not transfer title to the money to a third party, no "transfer" took place within the meaning of section 727.

The term "transfer" is defined in 11 U.S.C. § 101(54)2 which reads:

(54) "transfer" means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property, including retention of title as a security interest and foreclosure of the debtor's equity of redemption[.]
The Normans argue, in essence, that since they did not dispose of or part with the money, there was no transfer. They cite In re Adeeb, 787 F.2d 1339 (9th Cir. 1986), for the proposition that the   TOP    3 ABR 15  terms in subsection 727(a) should be construed strictly against the creditor objecting to discharge and liberally in favor of the debtor. Cummins cites Aubrey and In re Martin, 88 B.R. 319 (D. Co. 1988), in support of their position, but in both cases the debtor transferred property to a third party. Neither party has provided the court with any dispositive authority.

However, resolution of this issue is relatively simple. The authors of Collier's Bankruptcy Manual state that the term "transfer" must be given the broadest possible meaning:

A short-hand definition of transfer might be stated as "a disposition of an interest in property." Any interest in property is sufficient, and there is no requirement that any change of title occur for a transfer to exist. A transfer of possession, custody or control of property is a "transfer" within the general Code definition.
Collier's Bankruptcy Manual, ¶ 101.54A at 101-86. Thus, legal title to the property does not have to change hands for a transfer to take place. Even more significant, however, is the fact that banks have legal title to the funds deposited by their customers. It is an axiom of banking law that a bank owns the deposits made in it, in the sense of having legal title to them, and depositors are creditors of the bank in the amount of the deposits. C.I.R. v. Hendrickson, 873 F.2d 1018 (7th Cir. 1989). Thus, when the Normans withdrew their funds from the garnished accounts and redeposited the money at North Rim, title changed from the first bank to the Normans, and then from the Normans to North Rim. Under the reason-   TOP    3 ABR 16  ing used in Collier's, such a transfer could also be considered a transfer of possession or custody of the funds.

The Normans' position has no merit. The first three elements of an objection under subsection 727(a)(2) as set out in Aubrey have been met, and the bankruptcy court's finding that the transfer was made to hinder, delay or defraud Cummins is not clearly erroneous. This conclusion is consistent with the purpose of subsection 7237(a)(2). If the court were, for some reason, to agree with the Normans that a "transfer" had not taken place when they withdrew funds from the garnished account and redeposited them in another bank, a debtor would theoretically be able to avoid garnishment by a creditor as long as he was able to stay one step ahead of his creditors. Section 727 was designed to thwart this kind of conduct. The bankruptcy court's decision that the Normans' debt should not be discharged on these grounds is affirmed.

(2) "Transfer" of Funds to Dauqhter's Accounts

Shortly after Cummins began executing against the Normans' property, the Normans deposited two checks into a bank account owned by one of the Normans' minor daughters. Mrs. Norman was the custodian of the account. Both checks were payable to Mr. Norman. One was from Medcare International and the other was from the Alaska Permanent Fund. The checks totalled $3,290.91. Tr. at 118-123. At trial Mrs. Norman testified that the funds were in repayment of a loan to them from the daughter's account. She testified that in 1988 they (Dr. and Mrs. Norman) borrowed $2,141.00 from the   TOP    3 ABR 17  daughter's account to be spent in furnishing the daughter's room. Tr. at 126-7. On one occasion prior to trial the Normans were required to disclose the identity of any such unsecured debts but they failed to list the debt to the daughter. On another occasion they were required to identify any accounts on which they were cosignors, but they failed to mention the daughter's account. Tr. at 130-6. They also failed to identify the two checks made out to Dr. Norman as income and the deposit as an expense in their responses to Cummins' interrogatories.

Cummins argued to the bankruptcy court that these omissions amounted to a transfer or concealment under subsection 727(a) (2). The trial court agreed and concluded that the transaction was an improper "transfer" (Decision at 7). The Normans now argue that it was neither a transfer nor a concealment, and Cummins argues that the court's conclusion should be affirmed.

As discussed above, since legal title to the funds vested in the bank when the checks were deposited, a transfer of funds did in fact take place. The checks were made out to Dr. Norman and the transfer took place within one year of the filing of the petition for bankruptcy. Thus, the first three elements listed in Aubrey are met. At trial, Mrs. Norman indicated that the deposit was merely the repayment of a loan and was in no way intended to be an attempt to conceal assets from their creditors. Tr. at 184-7. Cummins' evidence indicated the following: the Norman's schedules and statement of affairs failed to list the purported loan to their daughter;   TOP    3 ABR 18  their statement of affairs failed to list the debt repayment; their response to an interrogatory requesting items of income during that period failed to disclose the deposited checks as income; their failure to list the account in response to an interrogatory requesting the identity of such accounts; their failure to list the accounts in response to a direct question at the first meeting of creditors; the fact that the amount deposited is about 25% more than the amount owed on the claimed debt; Mrs. Norman's inconsistent explanation for the deposits given at deposition; and the transfer took place when the Normans were otherwise admittedly attempting to keep assets from Cummins.

The bankruptcy judge apparently felt that the Normans' testimony at trial did not adequately explain these discrepancies. His finding, that the deposits were made with the intent to hinder Cummins in its collection efforts, is not clearly erroneous. The court's conclusion, that the deposits amounted to an improper transfer of funds under section 727, is affirmed.

The same evidence supports a finding that the Normans attempted to conceal the existence of the two checks from Cummins. The failure to reveal the existence of the accounts could conceivably have been an inadvertence, as alleged by the Normans; but considering all of the evidence before the court, the court's finding to the contrary is not clearly erroneous.

  TOP    3 ABR 19  (3)Avoidance of Process Server

A process server testified at trial that he had made several unsuccessful attempts to serve court papers on Dr. Norman at his office. On January 2, 1991, the process server went to the Norman residence to serve the papers. When he arrived, Dr. Norman was outside the house and the server asked if he were Dr. Norman. Norman replied, "No, he lives down the street." The server talked to a neighbor down the street and was told that he had gone to the right house in the first place. He went back to the Normans' house and knocked for a long time before Mrs. Norman finally answered the door. After asking for Dr. Norman again, whom he could see inside the house, the server was told by Mrs. Norman that Dr. Norman did not want to come to the door to talk to the server. He identified the papers as relating to their bankruptcy proceeding and told her that he would leave them with her. Mrs. Norman accepted the paperwork and the server left. Tr. at 139-41.

Cummins argued to the court that Norman hindered or delayed Cummins' collection efforts by failing to identify himself to the server. The court found, at page 7 of its decision, that "by lying about his identity, Dr. Norman effectively concealed his property in Anchorage Anesthesia Affiliates, Inc. from Cummins Financial, Inc."

The Normans did not appeal this conclusion of the bankruptcy court. In their responsive brief,3 Cummins argues that this   TOP    3 ABR 20  conclusion was an independent basis for the court's decision, and since the Normans failed to appeal this issue, the denial of discharge must be affirmed.

In their reply brief, the Normans argue that the server did not testify that he ever identified himself to Dr. Norman as a server, and thus Dr. Norman was under no obligation to confirm his own identity to the server. Although this issue has only scant relevance to the case as a whole, there is some merit in the Normans' argument. If the server did not identify himself as such to Dr. Norman, it is possible that Norman thought he was simply a stranger, solicitor, door-to-door salesman, etc. However, considering all of the other dispositive conclusions in this appeal, this issue is considered moot.

B. Objections under 727(a)(4)
(1) Statements Regarding Cash on Hand

At trial, Cummins presented evidence to support its contention that while the Normans' schedules listed only $700.00 in bank accounts and $65.00 in cash on hand on the day they filed their petition for bankruptcy, they actually had $5,138.66 in bank accounts and between $1,243.00 and $3,780.34 in cash on that day.4 The bankruptcy court denied the Normans' request for a discharge   TOP    3 ABR 21  under subsection 727(a)(4) for knowingly and fraudulently making a false oath in connection with the case.5

In order to establish a false oath or account, a creditor must prove that: (1) the debtor's oath was made knowingly and fraudulently; and (2) the false oath was related to a material fact. Aubrey, 111 B.R. at 274.

The Normans argue that the bankruptcy court failed to take into account the fact that the balance as stated by the Normans reflected outstanding checks. This argument is specious. The Normans have presented absolutely no evidence to this court in support of this assertion and, more importantly, they did not raise this issue before the bankruptcy court. Even if they were able to substantiate this claim by presenting evidence in this appeal, the court would have to disregard the evidence because it was not presented below. Matter of Colorado Corp., 531 F.2d 463 (10th Cir. 1976). If evidence regarding outstanding checks existed, it should have been easily ascertainable and should have been presented to the trial court to rebut Cummins' arguments.

  TOP    3 ABR 22 

In an attempt to explain their lack of cash on hand, the Normans refer this the court to a financial statement which outlines the Normans' income and expenses. They assert that, based on the great number of obligations they had to meet, the court should have believed that all of their cash had been spent to pay living expenses. At trial, Cummins presented evidence that the Normans had cashed two checks shortly before they filed their financial statement. Tr. at 99-114. The trial court found that although the Normans received a check for $5,023.54 the day before they filed their statement, they deposited only $3,780.34 the next day, raising the inference that they retained the rest as undisclosed cash. The trial court found that the Normans intentionally dealt in cash to avoid garnishment by Cummins. All of the evidence presented by the Normans on this issue was earlier presented to the trial court judge. The judge believed Cummins' version of the events and the Normans have not demonstrated that the findings of the trial court were clearly erroneous.

(2) Value of Anchoraqe Anesthesia Affiliates

Two years before he filed bankruptcy, Dr. Norman listed the value of his one-half interest in Anchorage Anesthesia Affiliates as approximately $*50,000.00. In their schedules, the Normans listed the value of the stock at $-0-. He testified that he had tried to sell his interest to a third party, but his offer was refused. Since he could not sell it, he reasoned, it was worth nothing. At trial, Dr. Norman admitted that the corporation had at   TOP    3 ABR 23  least $200,000.00 in accounts receivable with no appreciable debt on the petition date. Dr. Norman had a one-third interest as of the petition date. The court found that the liquidation value alone appeared to be at least $60,000.00, but was likely to be higher due to the Normans' propensity to understate the value of their assets. Decision at 9. The court therefore concluded that this misstatement constituted a false oath under subsection 727(a)(4).

The Normans argue that the court erred by attributing the accounts receivable to Dr. Norman, a shareholder, rather than to the corporation itself. This argument misses the point of the court's decision. The bankruptcy judge concluded that Dr. Norman's interest in Anchorage Anesthesia Associates had a greater value than zero, and therefore the Normans had knowingly given false testimony under oath in connection with their bankruptcy case. The court's conclusion that his interest in the corporation had a significant value was based, presumably, on Dr. Norman's testimony that as of 1989 he listed the value at $150,000.00 and that the business had not changed significantly since that time. The court's finding was not clearly erroneous.

(c) Objections under Subsection 727(a)(5)

Under subsection 727(a) (5), the court may deny a request for a discharge if, in the opinion of the judge, the debtor has failed to satisfactorily explain any significant loss of assets.6   TOP    3 ABR 24  The court found that a financial statement filed by the Normans on March 7, 1989, showed a positive net worth of $780,655.00. The schedules filed with the court show a negative net worth of approximately $1.5 million. The court stated:

The turnaround represented by the debtors' March 7, 1989 financial statement to the January 15, 1991 statement is approximately $2.3 million dollars. While losses concerning the M/V Pacific Star, Inc. were understandable, this massive turnaround in a period of approximately 22 months was never satisfactorily explained. The debtors alluded to the loss of some records. Michael Norman testified vaguely as to his interest in Anchorage Anesthesia Affiliates, Inc. declining due to the lack of a prospective purchaser. I find the debtors' explanations insufficient as a matter of law. In re Stuerke, 61 B.R. 623 (9th Cir. BAP 1986).
Decision at 10. The Normans argue, very briefly, that the "abject business failure caused by the Exxon Valdez oil spill was sufficient explanation for Dr. Norman's failure to pay his debts." Appellate Brief (Clerk's Docket No. 5 at 16).

The Normans have not shed any new light on this issue. Considering the evidence presented to the trial court as a whole-- i.e., the large amount of the Normans' income, the concealment and   TOP    3 ABR 25  misrepresentation of funds, the size of the Normans' investment in the vessel, the value of his stock in the professional corporation, etc.--this finding is not clearly erroneous.

The bankruptcy court's denial of discharge is affirmed.

III.
Cummins' Appeal

In Count I of Cummins' complaint, Cummins sought a determination that the Normans' debt be excepted from any discharge pursuant to 11 U.S.C. § 523. Subsection 523(a) provides that a discharge in bankruptcy shall not discharge a debtor from certain kinds of obligations, including those for money obtained by fraud or the use of a false statement in writing.7 Cummins argued to the bank-   TOP    3 ABR 26  ruptcy court that the Normans' debt should not be discharged because it was obtained by fraud and by false statements made in writing. The court found that the Normans had falsely represented to Cummins that the 20% down payment had been made on the vessel. The court also found that this misrepresentation was made with the intent to deceive Cummins, and concluded that the loan was therefore obtained through fraud (Decision at 4).

In its memorandum decision, the bankruptcy court began its discussion of this issue by listing the elements of non-dischargeable fraud as established by the Ninth Circuit in In re Rubin, 875 F.2d 755 (9th Cir. 1989):

"The elements of a claim for fraudulent misrepresentation under section 523 (a)(2)(A) are: (1) a representation of fact by the debtor, (2) that was material, (3) that the debtor knew at the time to be false, (4) that the debtor made with the intention of deceiving the creditor, (5) upon which the creditor relied, (6) that the creditor's reliance was reasonable, and (7) that the damage proximately resulted from the misrepresentation."
  TOP    3 ABR 27  Rubin, 875 F.2d at 759, quoting Mortgage Guar. Ins. Corp. v. Pascucci (In re Pascucci), 90 B.R. 438, 444 (Bankr. C.D. Cal. 1988).8 The court found that although Cummins had proved each of the first six elements, it had failed to show that the damage proximately resulted from the misrepresentations of the Normans. The court reasoned as follows:
Cummins failed to link the defendants' fraud with actual damages. Cummins maintains that because there was fraud in the inducement of their financing, they would not have made the loan. Thus any damages resulting from the loan are nondischargeable. I disagree. There must be a link between the fraudulent misrepresentation and the damages. In re Smith, 61 B.R. 742 (Bankr. D. Mont. 1986). If there is no link between the misrepresentation and damage, an exception to discharge claim has not been proved. Here, after some delay, Cummins received a first mortgage upon a completed boat. That boat was completed primarily due to the efforts of the defendants and their expending of approximately $60,000.00 for completion. Despite the fraudulent misrepresentations of the Normans, Cummins eventually received the benefit of its bargain: a first lien upon a completed vessel. While Cummins sold the completed vessel at a loss, that easily could have occurred if no actual misrepresentations had been made. Because Cummins has failed to show that its damages proximately resulted from the misrepresentation, it has failed to sustain its burden of proof. I cannot speculate on its fraud damages. Plaintiff's [Cummins'] claim   TOP    3 ABR 28  for exception to discharge based on fraud must be denied.
Decision at 4-5. Cummins argues that the bankruptcy court misread the Ninth Circuit's treatment of the causation requirement in Rubin. Under Cummins' interpretation of the law, when the court finds that the creditor would not have made the loan but for the debtor's false representations, the debt cannot be discharged. Since the bankruptcy court made these findings, it should have refused to discharge the debt under section 523.

Although a bankruptcy court's finding of proximate cause is reviewed for clear error, Rubin, 875 F.2d at 758, the issue raised by Cummins in this appeal is legal in nature and is subject to de novo review, Siriani, 967 F.2d at 304. It appears to this court that the bankruptcy court has erroneously imported its analysis of proximate causation from tort law. As discussed below, a number of courts have held that a different analysis of causation should be used in a bankruptcy discharge proceeding.

The Restatement of Torts distinguishes between "cause in fact" and "legal causation". In order to prove that a borrower's misrepresentation is the cause in fact of a lender's loss, the lender must show that the loss would not have taken place but for his reliance on the misrepresentation.9 However, the borrower will   TOP    3 ABR 29  not be held liable for the lender's loss unless the lender can also establish "legal causation." The Restatement defines legal causation as follows:

A fraudulent misrepresentation is a legal cause of a pecuniary loss resulting from action or inaction in reliance upon it if, but only if, the loss might reasonably be expected to result from the reliance.
Restatement, § 548A. The comments to section 548A make clear that in a commercial lending situation, the borrower who defrauds the lender into making a loan will be held liable for the lender's subsequent loss only if the reason for the borrower's default was a reasonably foreseeable result of the borrower's fraudulent misrepresentation. If the borrower's default is caused by an unforeseeable event, the lender will not have a cause of action for fraudulent misrepresentation.l0

Under a tort analysis, the bankruptcy judge's conclusion is correct. It is undisputed that the Normans defaulted on the loan because they were unable to book tourists for the cruise season as a result of the Exxon Valdez oil spill. The reason for their default was therefore unrelated to the Normans' misrepresentations.   TOP    3 ABR 30  Consequently, under a tort analysis, Cummins did not establish that its loss was proximately caused by the misrepresentations.

However, Cummins argues in essence that in a bankruptcy discharge proceeding, the lender should have to prove only "cause in fact"--that the lender would not have made the loan but for the borrower's fraud--and not "legal causation"--that the reason for the default was related to the misrepresentations. The court agrees. The policies that govern the law of tort damages are significantly different from those that govern the discharqe of a debt in bankruptcy. Several courts have ruled in this fashion, and the Ninth Circuit's treatment of causation in section 523 cases is consistent with this view.

In re Gerlach, 897 F.2d 1048 (10th Cir. 1990), was an appeal from a bankruptcy court's ruling that a debtor's obligation is non-dischargeable only to the extent that the creditor can prove that it suffered actual damages as a result of the debtor's fraud. The Tenth Circuit disagreed and held that if the loan were obtained through fraud, the entire amount of the loan that was obtained through fraud was non-dischargeable. The bankruptcy court relied on state tort law for the proposition that the creditor must prcve it was damaged by its reliance upon the defendant's fradudulent conduct. The circuit court stated:

While state fraud law may often be helpful by analogy in interpreting the scope of the fraud exceptions to discharge, "the dischargeability of a fraudulently incurred debt and the measure of damages for the underlying fraud are separate and distinct questions." Birmingham Trust
  TOP    3 ABR 31  National Bank v. Case, 755 F.2d 1474, 1477 (llth Cir. 1985). Section 523(a)(2), by its terms, only requires an objecting creditor to prove an extension of credit was "obtained by" fraud for the debt to be excepted from discharge.
Gerlach, 897 F.2d at 1051. The court went on to hold that, unlike tort damages, dischargeability is an "all or nothing" proposition. Id. 11 Also, as the Supreme Court and the Ninth Circuit have noted, one of the primary purposes of the bankruptcy act is to "relieve the honest debtor from the weight of oppressive indebtedness and permit him to "start afresh".12 Since the bankruptcy court is a court of equity, and a debtor seeking discharge is asking the court to wipe out a debt that he voluntarily incurred, leaving the creditor holding the bag, a debtor who obtained the loan through fraud enters the court with unclean hands. This view is reflected in the Ninth Circuit's statement: "section 523 reflects the policy that the fresh start is for the "honest but unfortunate debtor, not the defrauder." Siriani, 967 F.2d at 306, quoting Grogan v. Garner, ____ U .S.____, lll S. Ct. 654, 659 (1991).

Thus, these cases support the conclusion that while a tort plaintiff must prove that the defendant's default was a reasonably foreseeable consequence of the defendant's fraud in obtaining the
  TOP    3 ABR 32  loan, there is no such requirement in a discharge proceeding. In order to obtain a ruling that a debt is non-dischargeable, a creditor in bankruptcy court must prove the first six elements as set out in Rubin; but with regard to causation, the creditor must only prove "cause in "fact", i.e., but for the debtor's fraud, the creditor would not have made the loan.

This conclusion is consistent with the Ninth Circuit's rulings in Rubin and Siriani. In Rubin, a real estate agent convinced a couple, who feared that their mortgagor would foreclose on their house, to sell their house to him at a price far below market value. The agent promised that he would rent the house back to the couple while he helped them obtain other financing to re-purchase the house from him. The agent failed to tender the purchase price and he deeded the house to third parties. He later began eviction proceedings against couple. Although the couple never regained possession of their home, they sued the agent for fraud in state court and the jury returned a verdict for $90,000.00 in compensatory damages and $500,000.00 in punitive damages. After the trial, the couple settled their claims against the agent for $125,000.00. The agent then filed a Chapter 7 bankruptcy petition. The bankruptcy court ruled that the entire debt was non-dischargeable and the Ninth Circuit Bankruptcy Appellate Panel affirmed. The Ninth Circuit Court of Appeals in turn affirmed the bankruptcy court's conclusions. The agent argued that the couple would have lost their house anyway because their mortgagor was about to foreclose, and thus   TOP    3 ABR 33  their loss was not directly caused by his fraudulent conduct. The court rejected this argument and concluded that the non-dischargeability of the debt turned on the agent's fraudulent conduct and left intact the couple's judgment for $125,000.00 against the agent. This holding can be read as consistent with Cummins' position. The judgment was non-dischargeable because the couple would not have entered into the transaction with the agent but for his misrepresentations.

In Siriani, which was decided after the briefing in this case was concluded, a borrower obtained an extension of an existing loan from a financial institution by understating the extent of its other financial obligations. The borrower defaulted on the loan and sought protection in the bankruptcy court. The bankruptcy court concluded that although the creditor had proved most of the elements of non-dischargeability due to fraud, it had failed to show that its losses were proximately caused by the borrower's conduct.

The Ninth Circuit was thus faced with the question of exactly what showing of proximate cause the lender was required to make. The debtor argued that in order to establish proximate cause, the lender had to show: first, that in extending the term of the loan it had foregone collection remedies that would otherwise have been available, and, second, that it would have pursued collection in a sufficiently timely fashion had it not extended the loan. The Ninth Circuit rejected this argument and held that the Bankruptcy Code does not impose a diligence requirement on a creditor who has
  TOP    3 ABR 34  been induced by fraudulent means into extending credit to a debtor. Thus, the Ninth Circuit again rejected a stringent construction of the causation requirement. Siriani is consistent with the conclusion that in a discharge proceeding, the causation element requires the creditor to prove only that he would not have made the loan but for the debtor's misrepresentations.

The Ninth Circuit's decision in Siriani was based in part on the reasoning in In re Collins, 946 F.2d 815 (llth Cir. 1991). In that case a borrower obtained a loan by presenting a lender with a false financial statement. The lender failed to protect itself by obtaining a security interest in the borrower's collateral. The borrower argued that his debt should be discharged because the lender's failure to protect itself, not his false statements, were the proximate cause of the lender's loss. The Eleventh Circuit rejected this argument. The court held that the lender could establish that the borrower's fraud was the proximate cause of the loss by showing that the lender would not have made the loan but for the borrower's false representation. Collins was cited with approval by the Ninth Circuit in Siriani.

In sum, the causation requirement imposed by the bankruptcy court in this case was too stringent. The court found that the Normans committed fraud in obtaining the financing, and that
  TOP    3 ABR 35  Cummins would not have made the loan but for that fraud. Those findings are not clearly erroneous. 13

Lastly, the Normans argue 14 that Cummins and the Normans entered into a novation in October of 1986 which superseded the original agreement made in April of 1986. Cummins was informed during the summer of 1986 of the Normans' alleged fraud in entering into the April contract. From this, the Normans conclude that even if they had fraudulently induced Cummins to enter into the April contract, the novation operated to foreclose any claims Cummins may have had under the April contract.

This theory was presented to the trial court. The court apparently believed the testimony of the Cummins representative who explained that the October agreement was merely an extension of the terms of the April agreement, not a novation. Tr. at 20-31. This issue involves the intent of the parties and is therefore an issue of fact. This finding of fact by the trial court is not clearly erroneous.

  TOP    3 ABR 36  Consequently, the bankruptcy court's dismissal of Count I of Cummins' complaint is reversed. Judgment is entered in favor of Cummins on that count.

IV.
Summary

The bankruptcy court's decision that the Normans' debt is non-dischargeable under section 727(a)(2),(4), and (5) is affirmed.

The bankruptcy court's decision that the Normans' debt should not be excepted under 523(a) is reversed.

    DATED at Anchorage, Alaska, this 5th day of November, 1992.


              M. Russell Holland
              United States District Judge


N O T E S:

* This decision was scanned. Neither the scanned version nor the printed version is readable with respect to this character. The case is not readily available for review. Please see the case file to determine this character.

1.  TOP    3 ABR 12  11 U.S.C. S 727(a)(2) reads:

    (a) The court shall grant the debtor a discharge, unless--
      (2) the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed--
        (A) property of the debtor, within one year before the date of the filing of the petition; or
        (B) property of the estate, after the date of the filing of the petition....

2.  TOP    3 ABR 14  11 U.S.C. § 101 contains two subsections designated "(54)". One of them defines the term "stockbroker" and the other defines "transfer". Apparently this duplication was an inadvertent mistake by Congress. See Collier's Bankruptcy Manual, ¶ 101.54A, at 101-85 n.56v.

3.  TOP    3 ABR 19  Clerk's Docket No. 9.

4.  TOP    3 ABR 20  See Cummins' opposition brief at 13 and Tr. at 99-114.

5.  TOP    3 ABR 21  11 U.S.C § 727(a)(4) reads in part:

    (a) The court shall grant the debtor a discharge, unless--
    . . . .
    (4) the debtor knowingly and fraudulently, in or in connection with the case--
      (A) made a false oath or account[.]

6.  TOP    3 ABR 23-24  11 U.S.C. § 727(a)(5) reads in Part:

    (a) The court shall grant the debtor a discharge, unless--
    . . . .
      (5) the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities[.]

7.  TOP    3 ABR 25-26  Title 11 U.S.C. § 523(a) provides in pertinent part:

    Exceptions to discharqe
      (a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt--
        (2) for money, property, services, or an extension, renewal, or refinancing of credit, 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;
          (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, property, services, or credit reasonably relied; and
            (iv) that the debtor caused to be made or published with intent to deceive[.]

8.  TOP    3 ABR 27  This seven-factor list was later re-adopted by another panel of the Ninth Circuit in In re Siriani, 967 F.2d 302 (9th Cir. 1992); but in an even more recent case, In re Kirsh, 973 F.2d 1454 (9th Cir. Aug. 31, 1992), the court whittled the number of factors down to five by eliminating number (2) and consolidating numbers (6) and (7). However, for purposes of the issues in this case, the elements as set forth in Rubin are functionally the same as the elements in Kirsh.

9.  TOP    3 ABR 29  Section 546 of the Restatement (Second) of Torts, reads:

The maker of a fraudulent misrepresentation is subject to liability for pecuniary loss suffered by one who justifiably relies upon the truth of the matter misrepresented, if his reliance is a substantial factor in determining the courts of conduct that results in his loss.
See also comments a and b.

10.  TOP    3 ABR 29  See comment B and illustrations 1 and 2.

11.  TOP    3 ABR 31  While Gerlach was cited by the Ninth Circuit in Siriani, the court did not express an opinion on the merits of the Tenth Circuit's decision. Siriani, 967 F.2d at 304 n.2.

12.  TOP    3 ABR 31  Siriani, 967 F.2d at 306, citing In re Collins, 946 F.2d 815, 816-17 (llth Cir. 1991), quoting Williams v. U.S. Fidelity and Guarantee Co., 236 U.S. 549 (1915).

13.  TOP    3 ABR 35  On page one of their opposition brief, the Normans state that they take issue with Judge MacDonald's findings but they do not identify any portion of the record that was in error. Their brief is devoted to a discussion of the law on section 523 exceptions from discharge. The facts were disputed but the Judge found in Cummins' favor. In light of the Normans' complete failure to allege any specific error, this court concludes that the Normans have not perfected an appeal as to those facts.

14.  TOP    3 ABR 35  Opposition brief (Clerk's Docket No. 7) at 5-7.