UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA

This is an action for exception to discharge under 11 U.S.C. § 523(a)(2), (4) and (6). This court has jurisdiction over the controversy pursuant to 28 U.S.C. § 1334(b) and 28 U.S.C. § 157(b)(2)(I). I find for the plaintiff.

Background

The defendant Jeffrey R. O'Neill is a former professional bowler. He now works as an assistant manager at an Anchorage bowling alley. His wife, Laurel Branstiter O'Neill, works for the U.S. Fish and Wildlife Service as a budget assistant. Jeffrey was married once before his current marriage. As a result of his first divorce, he had a poor credit history.

In the summer of 1992, Jeffrey worked at "Bowler's Strike Zone," the pro shop at Center Bowl in Anchorage. He received a percentage of the profits from the sale of inventory consigned by Center Bowl and its owners, the Clappers, as compensation. To simplify operations, the Clappers wanted Jeffrey to purchase minor items of shop inventory instead       4 ABR 237  of proceeding with monthly inventories of consigned items. Clapper would retain a consignment arrangement on the sale of bowling balls and shoes, the major items, while Jeffrey would own the minor items outright. Because of his poor credit history, Jeffrey approached Laurel, who was at that time his girlfriend, with a proposal to purchase the inventory on his behalf. Laurel did not have the cash necessary to purchase the inventory. She contacted First National Bank of Anchorage (the Bank) for a loan sometime in July of 1992. She met with Bill Inscho, a vice-president, and explained her desire for a loan. Jeffrey accompanied her. Jeffrey provided the Bank with a handwritten financial statement (the handwritten statement) for "Bowler's Strike Zone" which indicated assets of over $17,199.87 and no liabilities. Included in the "assets" of the business was an itemized list of eleven items of equipment having a value of $9,143.45, listed numerically, as well as inventory, set forth as follows:

The listed equipment was not owned by either Jeffrey or Laurel. It was owned by Center Bowl, as was the inventory.

Inscho required a personal financial statement from Laurel on the Bank's form and a copy of her federal tax return. He also obtained a       4 ABR 238  credit report. Laurel's personal financial statement did not include the $9,143.45 of equipment listed as assets in the original handwritten statement prepared by Jeffrey. Rather, she listed $8,056.42 as the value of "Bowler's Strike Zone," despite the fact that as of July 31, 1992, Bowler's Strike Zone owned no inventory or equipment. Her entry was not itemized. It simply appeared under the heading "ASSETS" as "Bowlers' Strike Zone" with a lump sum value of "$8056.42".

Inscho allowed a $10,000 loan for the purchase of inventory, to be secured by inventory and equipment of "Bowler's Strike Zone." Laurel executed the loan documents on August 5, 1992, as owner of "Bowler's Strike Zone" and disbursed the funds to Jeffrey.

Payments were made on the loan and the balance gradually declined to nearly $6,000 in February of 1993. Around this time, according to Jeffrey, the Clappers wanted to sell 314 bowling balls and other miscellaneous inventory items to him for $28,000. Jeffrey asked Laurel to obtain a new loan for $36,000, enough to both pay off the first loan and purchase the new inventory. Laurel complied with his request. She contacted Inscho regarding a new loan. He required new financial statements from her. She prepared typed financial statements indicating that Bowler's Strike Zone had assets of $36,557 (which again included $9,143 worth of Center Bowl equipment) and was seeking to purchase over $28,000 in additional inventory. Jeffrey supplied her with all of the information. The typed statements were dated February 9, 1993. Again, the assets were itemized in a manner similar to Jeffrey's handwritten statement of July, 1992. The contents of the balance sheet portion on one of the typed statements is set forth below.

ASSETS:
Cash in Checking Account		$ 4,700.00
Drill Press		$ 4,995.00
Drill Bits	36 @ $36.25	1,305.00
Bevel Sander	2 @ $89.95	179.90
Durometer		358.00
Name Engraver		585.00
Letters		86.20
Ball Fitter		149.50
Pitch Gauges		119.95
4 ABR 239
Quarter Scales	2 @ $23.95	47.90
Dodo Scale		912.00
Gravity Balance System		405.00
Inventory: Balls, Bags, Shoes, Miscellaneous		22,714.25
	Total Assets	$36,557.70

LIABILITIES:
1st National Bank of Anchorage Loan	$ 6,000.00
Total Liabilities	$ 6,000.00

Rent $ 900.00/month vs. $1,500.00/month currently by purchasing equipment at 15% over cost of Center Bowling Supply.

/s/Laurel A. Branstiter

02-09-93

The February 9, 1993 typed statement also itemized current inventory and purchase inventory as follows:

* Miscellaneous includes rosin bags, wrist bands/braces, shoelaces, skin patch, bowling towels, finger grips, etc.

Additionally, Laurel submitted a form personal financial statement, also dated February 9, 1993, and solely in her name. This form did not itemize equipment or inventory. Rather, it simply listed "Bowler's Strike Zone" under the heading "ASSETS" with a lump sum value of $22,714. She included other "Bowlers' Strike Zone" assets and liabilities in the       4 ABR 240  form statement, however, without specifically identifying them. She included $9,700 in cash as an asset on her form statement and also set forth the $6,000 payable to the Bank as a liability.

Laurel obtained the new loan on February 11, 1993, and the funds were disbursed. As with the first loan, this loan was secured by inventory and equipment of "Bowler's Strike Zone." The loan proceeds were not used by Jeffrey as represented, however. The outstanding balance on the first loan was paid. Jeffrey purchased only $22,000, rather than $28,000, worth of inventory from the Clappers. His disposition of the remaining $6,000 from the loan is unknown.

Despite his receipt of the new loan proceeds in February of 1993, and having an additional $9,700 in cash on hand with Laurel per her February 9, 1993 form statement, Jeffrey defaulted almost immediately on his rental obligations to the Clappers. He failed to pay the March rental in full and also defaulted on nearly every payment thereafter through January of 1994. This prompted a February 28, 1994, work out agreement with Clapper Enterprises, Inc., for past due rent. The agreement was signed solely by Jeff O'Neill dba "The Strike Zone" and was not signed by Laurel.

Jeffrey also defaulted on Laurel's obligation to the Bank. He failed to make the February, March, and April payments in 1994. He did not tell Laurel, who had become his wife, of the defaults. In a letter agreement dated May 25, 1994, the Bank agreed to reduced payments. Because the loan had been transferred to the Bank's Special Credit Department, an inventory was required prior to the agreement. Marty Miller, the Bank's representative, toured the "Bowler's Strike Zone" facility on May 18, 1994. Jeffrey supplied an inventory which indicated that the business had $21,036.58 in balls, shoes, and miscellaneous inventory on hand. It also indicated that rent had been reduced to $600 per month for 1994, which was contrary to the Clapper lease. It was at this time that the Bank was first informed that the equipment previously listed in the defendants' financial statements was owned by Center Bowl and not the O'Neills.

The defendants defaulted on the reduced payment agreement with the Bank. Jeffrey vacated the pro shop in early June. Marty Miller attempted to repossess the Bank's collateral on July 5, 1994. He was       4 ABR 241  advised that the defendants intended to file bankruptcy. The defendants filed for bankruptcy relief on July 11, 1994. Their bankruptcy schedules indicated possession of inventory worth $5,000.

On August 24, 1994, the Bank sought relief from the stay as to equipment and inventory. The motion was unopposed and the Bank obtained stay relief on September 14, 1994. Miller again attempted to repossess the inventory. He discussed the collateral with Ty Clapper, who also claimed a security interest in the collateral for Clapper Enterprises. A meeting ensued. The Bank received a copy of the February 1994 lease that acknowledged the Clappers' ownership of equipment. Following the meeting, the Bank took no action to repossess or sell inventory or equipment. The Bank decided that further pursuit of its collateral was not economically prudent, particularly against the Clappers, who were good customers of the Bank. The principal amount due the Bank on the second loan to Laurel is $25,618.03.

Analysis

11 U.S.C. § 523(a)(2)(B) excepts debts or the refinance of debts from discharge to the extent they are obtained by using a written statement:

(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.

A creditor must show reasonable, rather than justifiable, reliance when the case involves a written financial statement. Field v. Mans, ___ U.S. ___, 116 S.Ct. 437 (1995). The Bank must prove the elements of its nondischargeability claim by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991).

The four written statements the O'Neills provided the Bank were materially false in the following respects. Jeffrey's handwritten statement included $9,143.45 in equipment as an asset of "Bowlers's       4 ABR 242  Strike Zone." "Bowlers' Strike Zone" did not own the equipment. Laurel's July 31, 1992, form financial statement included an entry under the heading "ASSETS" for "Bowlers' Strike Zone" in the sum of $8,056.42. Laurel did not own "Bowler's Strike Zone" outright and "Bowlers' Strike Zone" had no value and owned no assets. Laurel's typed statements for "Bowler's Strike Zone" dated February 9, 1993, were also materially false because they listed equipment valued at $9,143.45 that "Bowlers' Strike Zone" did not own. They also included "purchase inventory" of $28,208.74. The correct purchase inventory number was $22,000. Laurel's form financial statement of February 9, 1993, was materially false solely with regard to her ownership of "Bowler's Strike Zone." Accordingly, the requirement of § 523(a)(2)(B)(i) is satisfied.

Unquestionably, the false statements were with respect to the debtor Laurel O'Neill's financial condition. The requirement of §523(a)(2)(B) (ii) is met. The issue of reasonable reliance is not quite as simple. Reasonableness is a factual determination to be made in light of the totality of the circumstances. In re Ledford, 970 F.2d 1556, 1560 (6th Cir. 1992). Here Jeffrey and Laurel submitted the first three financial statements with material false representations regarding the equipment. There was a $1,087 difference in the value given the equipment between the handwritten statement and the July 31, 1992 form statement. The debtors contend this discrepancy should have caused the Bank to add the inventory values and realize that the equipment was not an asset. I find this inconsistency was not so significant as to warrant further inquiry by the Bank.

But what of the discrepancies between the February 9, 1993 typed statement and the form statement? The typed statement indicated a net worth of $30,000 for "Bowler's Strike Zone," while the business was valued on the form statement at just $22,714. Again, I do not think the discrepancy was substantial enough to make the Bank's reliance on the statements unreasonable for several reasons. First, the form statement contained another business asset, even though it was not listed as such. Cash in the sum of $4,700 was placed in the personal statement without identification, but was the same amount of cash as reflected on the typed statement for "Bowler's Strike Zone." The discrepancy could simply represent a failure to categorize this asset properly on the form.

Secondly, the Bank had a satisfactory credit report on Laurel as well as a copy of her tax return. Finally, Laurel had performed well on the first loan, and the business net worth, according to her statements, had nearly tripled. Under all the facts and circumstances, the Bank's reliance was reasonable.

The defendants also contend that the Bank did not actually rely on the financial statements in making the second loan. William Inscho, the Bank's loan officer, refused to speculate as to whether the second loan would have been granted if the equipment had been deleted from the February 9, 1993 financial statements. This refusal to speculate has to be taken in context. Inscho previously testified that he had relied on the equipment as security when making the loan. The Bank's documentary evidence is consistent with that position. The Bank made the second loan premised upon representations that the "Bowler's Strike Zone" had inventory and equipment with a value in excess of $60,000 when in actuality, the Bank received less than $45,000 of highly specialized collateral for its $36,000 loan. Also, contrary to the typed financial statement, Laurel did not purchase $28,000 worth of inventory. These two misrepresentations resulted in a substantial overstatement of collateral which the Bank actually and reasonably relied upon.

The final issue facing the court is whether or not the written statements were made with the intent to deceive the Bank. I find that neither defendant intended to deceive the Bank with regard to the ownership of the business. Jeffrey's involvement was clear to Inscho from the inception of the loan relationships, even though it was not well defined. Any misrepresentations regarding the ownership of the business were more the product of ignorance and a lack of sophistication than deviousness on the O'Neills' part.

However, I find that Jeffrey O'Neill caused the handwritten statement of July 1992 and the typed statements of February 9, 1993, to be published with the intent to deceive the Bank. Jeffrey was the source of all financial information for the Bank. He had no ready source of credit and sought to bolster the collateral available for the Bank so that his agent, Laurel, could obtain loans. I did not find his testimony to the contrary credible. His rendition of the facts changed from day to day in the courtroom. One day he denied submitting the handwritten       4 ABR 244  financial statement to the Bank in July of 1992 and the next day he admitted it. Moreover, the circumstances surrounding the $36,000 loan were highly questionable and never satisfactorily explained. The February 9, 1993, typed and printed statements indicate that Laurel, either personally or through the business, had $9,700 cash on hand. Despite this cash and at least $30,000 in loan proceeds, after the Bank extended the $36,000 loan, Jeffrey promptly went into default on his rent to Clapper Enterprises in March of 1993 and continued in default until February of 1994. Jeffrey deceived the Bank and failed to buy all of the inventory he listed in the typed statement as "purchase inventory." Jeffrey offered no plausible explanations for his conduct. I conclude that he acted with the intent to deceive.

Laurel was less culpable than Jeffrey because she relied on him for the information she passed on to the Bank. Unfortunately, she is responsible for the loans regardless of her intent. She was a partner with her husband in the enterprise. Even as an essentially innocent partner, she remains liable for his fraud. In re Ledford, 970 F.2d 1556 (6th Cir. 1992). Nor can Jeffrey hide from liability because the financial statements and loans were in Laurel's name. He was the principal party and the partner who directed the business. He remains fully responsible for actions initiated by Laurel on his behalf. W. Page Keeton, Prosser and Keeton on Torts, § 46 (5th ed. 1984).

The Bank also seeks exceptions to discharge under 11 U.S.C. § 523(a)(4). The Bank has failed to prove the defendants committed fraud or defalcation while acting in a fiduciary capacity. They were not trustees of a pre-existing trust as required by Ragsdale v. Haller, 780 F.2d 794 (9th Cir. 1986). Nor has the Bank submitted evidence of embezzlement or larceny. The Bank's (a)(4) count will be dismissed with prejudice.

Finally, the Bank seeks exception to discharge for conversion under 11 U.S.C. § 523(a)(6). This section excepts debts for "willful and malicious injury" to another. Conversion of secured property is a willful and malicious injury subject to exception from discharge. In re Cecchini, 780 F.2d 1440 (9th Cir. 1986). The Bank has failed to meet its burden of proof on the issue. While the true disposition of the defendants' inventory remains questionable, insufficient evidence was produced concerning conversion. The Bank's attempt to buttress its       4 ABR 245  position through use of hearsay testimony from the Clappers has been rejected. Other than the Jeffrey's admission as to taking five bowling balls from inventory, the claim fails. Additionally, having recovered on the fraud claim, the Bank cannot receive a double recovery.

Conclusion

The defendants utilized false financial statements to obtain loans from the Bank. These loans will be excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(B). The remaining counts of the complaint will be dismissed with prejudice. A separate order and judgment will be entered consistent with this memorandum.

DATED: January 8, 1996.

BY THE COURT
DONALD MacDONALD IV
United States Bankruptcy Judge