In Re: David Louis Cohn ( 1995 )

Opinions of the United
1995 Decisions States Court of Appeals
for the Third Circuit
5-10-1995
In Re: David Louis Cohn
Precedential or Non-Precedential:
Docket 94-1742
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 94-1742
IN RE: DAVID LOUIS COHN,
Debtor
INSURANCE COMPANY OF NORTH AMERICA,
Appellant
v.
DAVID LOUIS COHN
Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. No. 91-cv-06073)
Argued February 13, 1995
BEFORE: STAPLETON, GREENBERG and COWEN,
Circuit Judges
(Filed May 10, l995 )
Kenneth F. Carobus (argued)
Morris & Adelman
Suite 400
1920 Chestnut Street
P.O. Box 30477
Philadelphia, PA 19103-8477
Counsel for Appellant
Insurance Company of North America
Alan M. Seltzer (argued)
Ryan, Russell, Ogden & Seltzer
1100 Berkshire Boulevard
P.O. Box 6219
Reading, PA 19610-0219
Counsel for Appellee
David Louis Cohn
OPINION
COWEN, Circuit Judge.
Insurance Company of North America ("INA") objects to
the discharge in bankruptcy of a debt owed to it by David Cohn.
This appeal turns on the proper interpretation of 11 U.S.C. §
523(a)(2)(B). The bankruptcy court concluded, and the district
court affirmed, that INA did not meet its burden of proving that
it reasonably relied upon a materially false statement contained
in an investor bond application submitted by Cohn, and the debt
was therefore dischargeable. Because the bankruptcy court based
its decision upon facts that were not in the record, and because
the district court acted beyond its authority in making its own
factual findings, we will remand the case to the district court
with instructions to remand to the bankruptcy court for further
fact-finding.
I.
Between September 1984 and September 1985, David Cohn
was involved in a business relationship with a financial
consultant, Christopher Scutto, an employee of Cigna Individual
Financial Services Company ("Cigna Financial Services"). Cohn
became interested in a limited partnership known as The Village
Apartments Associates Ltd. ("Village Apartments"). In order to
become a limited partner, Cohn was required to sign a promissory
note for his share, and to obtain a surety for the note. On
September 12, 1985, Cohn submitted an investor bond application
("the application") to INA, requesting INA to act as a surety on
a promissory note in the principal amount of $47,500 which was to
be executed between Cohn, as obligor, and the Bank of New York,
as obligee.
Cohn relied upon Scutto and his staff to fill out the
application and related documentation based upon financial and
other information that Cohn had provided to Scutto over the
previous year. After Scutto completed the application, Cohn
reviewed it (though he contends that he did not read each page of
the various documents), and signed it.
At the top of the application, the first paragraph
read:
FOR THE PURPOSE OF PROCURING CREDIT OR
GUARANTEE OF CREDIT FROM INSURANCE COMPANY OF
NORTH AMERICA (SURETY), THE UNDERSIGNED
FURNISH THIS APPLICATION AND THE INFORMATION
CONTAINED THEREIN INCLUDING A TRUE AND
ACCURATE STATEMENT OF THE UNDERSIGNED'S
FINANCIAL CONDITION AS OF THE DATE OF THIS
APPLICATION.
Item 9 on the second page of the application requested that the
applicant list "Real Estate Registered in own name," and
instructed, "See Sched. No. 5." Scutto indicated in Item 9 that
Cohn had real estate valued at $110,000. Schedule No. 5 required
as follows: "The legal and equitable title to all the real estate
listed in this statement is solely in the name of the
undersigned, except as follows: . . . ." Two blank lines were
then provided for entries by the applicant. Also in Schedule No.
5, immediately below the two blank lines, the application
provided a table for the applicant to fill out, requesting
information regarding, inter alia, the description, dimensions,
improvements, mortgages or liens, and assessed value of each
property. It is not clear from the application whether this
information was requested only regarding real estate not solely
in applicant's name, or all real estate to which the applicant
holds legal and equitable title. Neither the two blank lines nor
the table were filled in on Cohn's application.1
Cohn admits that at the time that he signed the
application, he did not own real estate valued at $110,000
registered in his own name. Cohn testified that before he signed
the application, he was assured by Scutto that using the ultimate
value of the asset he was seeking to purchase as part of his
present net worth, when applying for credit to purchase that very
same asset, was "an accepted procedure." Scutto testified that
such a practice was followed by other individuals in his office.
Scutto submitted the application to INA in October
1985, and it was accepted later that month. In the interim, INA
made no inquiry of Cohn or his financial consultant regarding any
aspect of the real estate questions in the application, including
the listing of real estate registered in Cohn's own name and the
absence of any mortgages, liens or other indebtedness as
reflected in Schedule No. 5. INA did obtain information from a
1
. For clarity, the application is made an addendum to this
opinion.
credit report that indicated that Cohn had no mortgage, real
estate payments, or other indebtedness.
INA became the surety for the promissory note and Cohn
became a limited partner in the Village Apartments. Scutto was
compensated for the sale by Village Apartments. Cohn executed an
indemnification agreement under which Cohn agreed to indemnify
INA against any loss INA might incur in the event that Cohn
defaulted on the promissory note. Thereafter, Cohn defaulted on
the note and a claim was made against INA based upon the investor
bond. Cohn later filed a Chapter 7 proceeding under the
provisions of the Bankruptcy Code, and listed INA in his schedule
of creditors whose debts were to be discharged. INA filed a
complaint with the bankruptcy court seeking an exception to
Cohn's discharge for the indebtedness arising from this
transaction.
The bankruptcy court found that INA did not meet its
burden of proof to demonstrate that it reasonably relied on a
materially false statement when it accepted Cohn's application
and refused to exempt Cohn's indebtedness to INA from discharge.
Insurance Company of North America v. Cohn (In re Cohn), 131 B.R.
19 (Bankr. E.D. Pa. 1991). While finding that Cohn's application
contained a materially false statement regarding his financial
condition, the bankruptcy court based its ultimate conclusion on
its finding that Cigna Financial Services is the parent company
of INA. The court found "troublesome" that INA was "attempting
to have a debt declared nondischargeable based upon the fraud
masterminded by an employee of its own parent company." Id. at
21. The bankruptcy court held that "any reliance placed upon the
application by INA was done at its own risk and must be found
unreasonable." Id. Further, the court concluded that INA must
be estopped from having the debt found nondischargeable because
it had "unclean hands" in that an "employee of INA's parent
company" was the ultimate source of the wrongdoing. Id. at 21-
22.
The district court affirmed the order of the bankruptcy
court, but on different grounds. It found that INA did not
reasonably rely on the statement in Item 9:
in that the most reasonable reading of
[Schedule No. 5] is that it provides blank
lined spaces for the applicant to note which
scheduled properties are not held solely in
his name but otherwise requires the applicant
to specify, inter alia, the location,
dimensions, liens against and assessed value
of each property and indeed it being
illogical to assume that a lender or
guarantor would require such information only
for collateral not solely registered to an
applicant, in that the failure of the debtor
to identify any property on schedule 5 was
sufficient to trigger further inquiry by a
reasonable lender or guarantor, see In re
Martz, 88 B.R. 663, 674 (E.D. Pa. 1988), and
in that a simple request of the debtor to
identify the property listed on line 9 would
have revealed that this was the value of the
property the debtor proposed to acquire by
investment of the borrowed funds.
Insurance Company of North America v. Cohn (In re Cohn), No. 91-
6073 (E.D. Pa. June 28, 1994) (order denying appeal and
dismissing action). This appeal followed.
II.
The district court had jurisdiction to hear this case
pursuant to 28 U.S.C. § 158(a). Our jurisdiction rests on 28
U.S.C. § 1291 and 28 U.S.C. § 158(d).
As a proceeding tried initially before the Bankruptcy
Court for the Eastern District of Pennsylvania, the standard of
review for the district court is governed by Rule 8013 of the
Bankruptcy Rules, which provides:
On an appeal the district court or bankruptcy
appellate panel may affirm, modify, or
reverse a bankruptcy judge's judgment, order,
or decree or remand with instructions for
further proceedings. Findings of fact,
whether based on oral or documentary
evidence, shall not be set aside unless
clearly erroneous, and due regard shall be
given to the opportunity of the bankruptcy
court to judge the credibility of the
witnesses.
Bankruptcy Rule 8013.
Our review of the district court's order is plenary
because in bankruptcy cases the district court sits as an
appellate court. Brown v. Pennsylvania State Employees Credit
Union, 851 F.2d 81, 84 (3d Cir. 1988) (citing Universal Minerals,
Inc. v. C.A. Hughes & Co., 669 F.2d 98, 101-02 (3d Cir. 1981)).
We review the findings of fact of the bankruptcy court only for
clear error. Id. (citing In re Morrissey, 717 F.2d 100, 104 (3d
Cir. 1983)). Findings of fact by a trial court are clearly
erroneous when, after reviewing the evidence, the appellate court
is "left with the definite and firm conviction that a mistake has
been committed." Anderson v. City of Bessemer City, N.C., 470
U.S. 564, 573, 105 S. Ct. 1504, 1511 (1985) (citation omitted).
We have plenary review over questions of law. Epstein Family
Partnership v. Kmart Corp., 13 F.3d 762, 765-66 (3d Cir. 1994).
It is error for a district court, when acting in the capacity of
a court of appeals, to make its own factual findings. Universal
Minerals, 669 F.2d at 104.
III.
The overriding purpose of the Bankruptcy Code is to
relieve debtors from the weight of oppressive indebtedness and
provide them with a fresh start. Exceptions to discharge are
strictly construed against creditors and liberally construed in
favor of debtors. See, e.g., United States v. Stelweck, 108 B.R.
488, 495 (Bankr. E.D. Pa. 1989). Title 11, section 523(a)(2) of
the United States Code provides for exceptions to discharge as
follows:
(a) A discharge under section 727, 1141,
1228(a), 1228(b), or 1328(b) of this title
does not discharge an individual 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 . . . .
11 U.S.C. § 523(a)(2) (1988). The burden of proving that a debt
is nondischargeable under § 523(a) is upon the creditor, who must
establish entitlement to an exception by a preponderance of the
evidence. Grogan v. Garner, 498 U.S. 279, 287-88, 111 S. Ct.
654, 659-60 (1991). Thus, pursuant to § 523(a)(2)(B), INA must
prove that Cohn used a statement in writing: (1) that is
materially false; (2) respecting his financial condition; (3)
upon which INA reasonably relied; and (4) with the intent to
deceive INA.
A.
The bankruptcy court held that "[i]t cannot be disputed
that debtor's application contains a materially false statement
regarding debtor's financial condition." Cohn, 131 B.R. at 21.
The court noted Cohn's admission that at the time he executed the
application he did not have legal and equitable title to real
estate valued at $110,000. Id. Citing Century Bank of Pinellas
County v. Clark (In re Clark), 1 B.R. 614, 617 (Bankr. M.D. Fla.
1979), the bankruptcy court held that Cohn's financial statement
was sufficiently overstated such that it was a materially false
statement within the meaning of § 523(a)(2)(B)(i). Id.
While Cohn does not deny that his statement was false,
he asserts that the statement was not material. He cites
Landmark Leasing Inc. v. Martz (In re Martz), 88 B.R. 663, 671
(Bankr. E.D. Pa. 1988) and Afsharnia v. Roland (In re Roland), 65
B.R. 1003, 1006 (Bankr. D. Conn. 1986) for the proposition that
the "materially false" component of § 523(a)(2)(B)(i) requires a
showing both that the statement was in fact false, and that the
falsehood was material to the creditor's decision to enter into
the transaction. We note, however, that In re Bogstad, 779 F.2d
370 (7th Cir. 1985), the case upon which both the Martz and
Roland courts rely, in actuality has a narrower holding than the
proposition asserted by Cohn. The Court of Appeals for the
Seventh Circuit wrote:
Material falsity has been defined as "an
important or substantial untruth." A
recurring guidepost used by courts has been
to examine whether the lender would have made
the loan had he known of the debtor's true
financial condition.
Bogstad, 779 F.2d at 375 (citations omitted) (emphasis added).
Thus, it would appear that the effect of the falsity on the
creditor's decision to enter into the transaction should be used
only as one indicia of the materiality of the falsity; it is not
in fact a second requirement of § 523(a)(2)(B)(i).
The materiality prong of the "material falsehood" test
includes a certain reliance component. Under a materiality
analysis, we refer to a creditor's reliance upon a false
statement in the sense that an untruth can be considered
important (or "material") if it influences a creditor's decision
to extend credit. However, a statement can still be material if
it is so substantial that a reasonable person would have relied
upon it, even if the creditor did not in fact rely upon it in the
case at hand. Cf. Kungys v. United States, 485 U.S. 759, 771,
108 S. Ct. 1537, 1547 (1988) (materiality turns on whether the
misrepresentation "was predictably capable of affecting, i.e.,
had a natural tendency to affect, the official decision"); United
States v. Keefer, 799 F.2d 1115, 1127 (6th Cir. 1986) ("[T]he
test for materiality is not whether the agency actually relied on
the false statement, but whether the statement was capable of
influencing, or had a natural tendency to influence, the agency's
decision.").
We note that there is also a reliance component in the
"reasonable reliance" requirement of § 523(a)(2)(B)(iii). See
discussion below in part III B. These are certainly overlapping
concepts. Section 523(a)(2)(B)(iii), however, requires that the
creditor actually rely on the debtor's statement. Accordingly,
if it were reasonable to rely on a debtor's statement, but the
creditor did not in fact rely upon the false statement, (B)(iii)
would not be satisfied.
We recognize that the distinction between the two
reliance concepts is somewhat subtle, and to a degree, the
reliance concept in (B)(i) is subsumed within (B)(iii). However,
it is important to keep the distinction intact in light of the
long-established cannon of statutory construction that in
construing a statute, courts are obliged to give effect, if
possible, to every word Congress used. See, e.g., Gustafson v.
Alloyd Company, Inc., U.S. , 115 S. Ct. 1061, 1069 (1995)
("the Court will avoid a reading which renders some words
altogether redundant"); United States v. Menache, 348 U.S. 528,
538-39, 75 S. Ct. 513, 519-20 (1955).
The element of materiality under § 523(a)(2)(B)(i) is a
question of law. Cf. United States v. Greber, 760 F.2d 68, 73
(3d Cir. 1985) (materiality element of the crime of making a
false statement pursuant to 18 U.S.C. § 1001 is a question of
law); United States v. Slawik, 548 F.2d 75, 79 (3d Cir. 1977) (in
a perjury prosecution materiality is "a question of law, decision
upon which is reserved for the court"). See also United States
v. Gaudin, 28 F.3d 943, 955-65 (9th Cir. 1994) (Kozinski, J.,
dissenting) (surveying case law regarding whether materiality is
a question of fact or law). As such, we review materiality under
a plenary standard of review. See, e.g., Epstein Family
Partnership, 13 F.3d at 765-66.
We believe that the material falsity element has
sufficiently been established. INA offered the testimony of its
employee, Steven Hollberg, who gave his expert opinion that the
bond would not have been issued if the application had not
indicated that Cohn held $110,000 in real estate. Cohn contends
that Hollberg's conclusion is speculative and unsupported since
he did not participate in the development of the underwriting
criteria governing investor bonds, he did not specifically review
or have any input in determining Cohn's eligibility, nor did he
participate in INA's decision to act as surety.
We are unpersuaded by Cohn's arguments. Because the
element of materiality under § 523(a)(2)(B)(i) is an objective
one, our determination does not have to turn on Hollberg's
credibility regarding INA's actual reliance on the false
statement. It is sufficient that the false statement is one that
is capable of influencing, or had a natural tendency to
influence, a creditor's decision. As INA points out, Cohn's
application indicated a total net worth of $259,000. The false
asset of $110,000 constituted a substantial portion of his
purported net worth. Under the circumstances of this case, we
find it fully logical and reasonable that such a substantial sum
could have influenced a creditor's decision to enter into such a
transaction. We conclude that the bankruptcy court did not err
in its determination that Cohn's financial statement was both
false and material.
B.
Both the bankruptcy court and the district court found
that INA did not meet its burden of proof on the "reasonable
reliance" component of § 523(a)(2)(B)(iii). The courts, however,
based their determinations on different grounds and we address
their analyses separately.
1.
The bankruptcy court held:
[W]e find troublesome the fact that INA is
attempting to have a debt declared
nondischargeable based upon the fraud
masterminded by an employee of its own parent
company. For this reason, we conclude that
any reliance placed upon the application by
INA was done at its own risk and must be
found unreasonable. See, Signal Consumer
Discount Company v. Malachosky (In re
Malachosky), 98 B.R. 222, 224 (Bankr. W.D.
Pa. 1989).
Cohn, 131 B.R. at 21. In Signal, cited by the bankruptcy court,
the same corporation that extended the loan also knew that the
written statement of the debtor's financial condition was false.
Signal, 98 B.R. at 223. Nonetheless, the corporation tried to
rely upon the truth of the written statement. Id. at 223-24.
The Signal court found that the creditor had not reasonably
relied upon the statement. Id. at 224. If INA knew that the
written statement was untrue prior to granting the investor bond,
then it, like the creditor in Signal, could not have reasonably
relied upon the written statement. Indeed, the bankruptcy court
based its holding on the factual predicate that Cigna Financial
Services is the parent company of INA. The bankruptcy court's
determination, however, is flawed for two reasons. First, we
find that the trial record lacks sufficient facts from which the
bankruptcy court could determine the exact relationship between
Cigna Financial Services and INA. Second, there is no basis in
the record to impute the knowledge of a Cigna Financial Services
employee to INA.
There is little evidence in the record regarding the
relationship between the two companies. INA maintains that there
are a number of "Cigna" companies: Cigna Company is the parent,
with subsidiaries including Cigna Holding, Inc., INA Holdings,
Inc., Insurance Company of North America, Cigna Investment Group,
Connecticut General Life, Ins. and Cigna Individual Financial
Services, Inc. The following testimony of Hollberg reflects how
confusing and muddled this issue is:
BY MR. SELTZER:
Q: Now, does Wade Hill Services of INA have
any relationship to Cigna Financial Services?
A: I believe INA is related to Cigna as a
subsidiary of Cigna.
Q: But Cigna, in fact, owns INA; is that
correct?
A: That is correct.
Q: Okay.
THE COURT: And they own
Connecticut General, right?
THE WITNESS: That's the company --
THE COURT: What's left of it.
THE WITNESS: Yeah, exactly.
BY MR. SELTZER:
Q: Okay. And based on the information you
have in your file, do you know who if anybody
Mr. Scutto was working with or for at the
time that you had dealings with him relative
to the financial application and investor
bond?
A: It's evident just from that letter that
he was working for Cigna as a financial
analyst, I believe it says.
Q: That being the parent company of INA?
A: That's correct.
Q: Okay. But you've never had any direct
contact with Mr. Scutto at all; right?
A: No, I have not.
App. at 112a-13a.
We are unable to determine from the record the
relationship between INA and Cigna Financial Services; it is
unclear from Hollberg's testimony which "Cigna" is the parent
company of INA -- Cigna Company or Cigna Financial Services. It
is not surprising that the relationship between INA and Cigna
Financial Services remained unresolved since the issue was
neither raised in the pleadings nor briefed before the bankruptcy
court.
Other testimony by Hollberg and Scutto indicated that
there was no contact or relationship between Cigna Financial
Services and INA regarding the transaction and the real estate
value.2 App. at 91a, 96a, 123a-24a. As INA correctly contends,
only when the corporate veil can be pierced can INA be said to
have knowledge of the falsity of the written statement. Well-
established precedent holds that in order for one company to be
held responsible for the actions of a related company, it is
necessary that there be sufficient facts to pierce the corporate
veil. See, e.g., Big Apple BMW, Inc. v. BMW of North America,
Inc., 974 F.2d 1358, 1373 (3d Cir. 1992) (statement of subsidiary
may be attributed to its corporate parent where parent dominates
activities of subsidiary), cert. denied, U.S. , 113 S. Ct.
1262 (1993); Culbreth v. Amosa (Pty) Ltd., 898 F.2d 13, 14 (3d
Cir. 1990) (party seeking to pierce corporate veil must establish
that controlling corporation wholly ignored separate status of
controlled corporation and so dominated and controlled its
affairs that separate existence was mere sham); A.K. Nahas
Shopping Center, Inc. v. Reitmeyer (In re Nahas), 161 B.R. 927,
932-33 (Bankr. W.D. Pa. 1993). The record is conspicuously
lacking any such facts.3
2
. Scutto testified that he had contact with INA regarding
Cohn's liquidity. This information exchange does not change the
fact that INA was not aware of the false real estate value.
3
. In addition to basing its determination of unreasonable
reliance on the putative relationship between the Cigna and INA,
2.
The district court affirmed the bankruptcy court's
holding of unreasonable reliance upon a false statement, but
based its determination on different grounds. The district court
found that INA unreasonably relied upon the application because
the failure of Cohn to identify any property on Schedule No. 5
was sufficient to trigger further inquiry by a reasonable lender
or guarantor. The district court predicated its holding on its
finding that:
the most reasonable reading [of Schedule No.
5] is that it provides blank lined spaces for
the applicant to note which scheduled
properties are not held solely in his name
but otherwise requires the applicant to
(..continued)
the bankruptcy court also concluded that INA must be estopped on
equitable grounds from attempting to have the debt found
nondischargeable, based upon the same factual predicate. The
bankruptcy court held:
Furthermore, we conclude that INA must be
estopped from attempting to have this debt
found nondischargeable due to its unclean
hands. It must be remembered that bankruptcy
courts are essentially courts of equity, and
as such, should render decisions with
equitable considerations in mind. We believe
that it would be extremely unfair to burden
debtor with a finding that this debt is
nondischargeable when the ultimate source of
the wrongdoing can be traced directly to Mr.
Scutto, an employee of INA's parent company.
Cohn, 131 B.R. at 21-22. This holding also cannot stand, based
on the same factual flaws as the unreasonable reliance
determination. There is insubstantial record evidence regarding
the exact relationship between Cigna Financial Services and INA,
as well as whether knowledge of a Cigna Financial Services
employee can be imputed to INA.
specify, inter alia, the location,
dimensions, liens against and assessed value
of each property and indeed it [is] illogical
to assume that a lender or guarantor would
require such information only for collateral
not solely registered to an applicant.
Cohn, No. 91-6073 (order denying appeal and dismissing action).
The district court opined that had INA requested Cohn to identify
the property in Item 9 and explain this inconsistency within the
application, Cohn would have revealed that the value listed in
Item 9 was the property Cohn proposed to acquire by investment of
the borrowed funds. Id.The district court appears to have applied the correct
standard in determining a creditor's reasonable reliance. The
reasonableness of a creditor's reliance under § 523(a)(2)(B) is
judged by an objective standard, i.e., that degree of care which
would be exercised by a reasonably cautious person in the same
business transaction under similar circumstances. Martz, 88 B.R.
at 673; Lesman v. Mitchell (In re Mitchell), 70 B.R. 524, 527
(Bankr. N.D. Ill. 1987); Signal Finance of Ohio v. Icsman (In Re
Icsman), 64 B.R. 58, 62 (Bankr. N.D. Ohio 1986).
A determination of reasonable reliance requires
consideration of three factors: (1) the creditor's standard
practices in evaluating credit-worthiness (absent other factors,
there is reasonable reliance where the creditor follows its
normal business practices); (2) the standards or customs of the
creditor's industry in evaluating credit-worthiness (what is
considered a commercially reasonable investigation of the
information supplied by debtor); and (3) the surrounding
circumstances existing at the time of the debtor's application
for credit (whether there existed a "red flag" that would have
alerted an ordinarily prudent lender to the possibility that the
information is inaccurate, whether there existed previous
business dealings that gave rise to a relationship of trust, or
whether even minimal investigation would have revealed the
inaccuracy of the debtor's representations). See Coston v. Bank
of Malvern (In re Coston), 991 F.2d 257, 261 (5th Cir. 1993) (en
banc); Mitchell, 70 B.R. at 527-28; Martz, 88 B.R. at 673-74.
We agree with the majority of courts of appeals which
have concluded that the determination of reasonable reliance by a
lender under § 523(a)(2)(B) is factual in nature and insulated by
the clearly erroneous standard of review. See Coston, 991 F.2d
at 260-61; Bank One, Lexington, N.A. v. Woolum (In re Woolum),
979 F.2d 71, 75 (6th Cir. 1992), cert. denied, U.S. , 113
S. Ct. 1645 (1993); In re Bonnett, 895 F.2d 1155, 1157 (7th Cir.
1989); Trattoria, Inc. v. Lansford (In re Lansford), 822 F.2d
902, 904 (9th Cir. 1987); Leadership Bank, N.A. v. Watson (In re
Watson), 958 F.2d 977, 978 (10th Cir. 1992); Collins v. Palm
Beach Savings & Loan (In re Collins), 946 F.2d 815, 817 (11th
Cir. 1991).
The district court based its holding of unreasonable
reliance upon a number of factual predicates: (1) that the most
reasonable reading of Schedule No. 5 is that the chart requires
the applicant to specify information regarding all property that
the applicant owns (not just property not solely registered in
the applicant's name); (2) that Cohn's failure to identify any
property in Schedule No. 5 was sufficient to trigger further
inquiry by a reasonable lender or guarantor (i.e., the existence
of a "red flag"); and (3) that a simple request of Cohn to
identify the property listed in Item 9 would have revealed that
Cohn did not hold legal or equitable title to $110,000 of real
estate.
While the district court may have applied the correct
legal standard in determining INA's unreasonable reliance, the
court acted beyond its authority in making its own factual
findings. As we held in Universal Minerals:
The district court did not set aside any of
these basic findings . . . . The district
court chose, however, to emphasize other
facts not mentioned in the bankruptcy court's
opinion and to draw opposing inferences from
the record. In doing so, the district court
erred. A reviewing court may not substitute
its own findings for those of the primary
tribunal merely because it finds other
inferences more likely.
669 F.2d at 104. Where, as here, the record is susceptible to
more than one reasonable reading, factual findings are only
properly made by the bankruptcy court after a hearing where both
parties have an opportunity to offer such evidence as they deem
appropriate. The bankruptcy court failed to make factual
findings on these matters. We have consistently deferred to the
fact-finding duties of the bankruptcy court and have held that
where sufficient facts have not been developed by that court, the
proper response is to remand. See, e.g., Wheeling-Pittsburgh
Steel Corp. v. McCune, 836 F.2d 153, 163 (3d Cir. 1987); In re
Abbotts Dairies of Pa., Inc., 788 F.2d 143, 150-51 (3d Cir.
1986).
Accordingly, we will remand this matter to the district
court for that court to further remand the case to the bankruptcy
court for a determination of the reasonableness of INA's reliance
upon the application, based on either one of two theories: (1)
whether there are sufficient facts, consistent with established
Third Circuit precedent, to pierce the corporate veil and hold
INA responsible for the actions and knowledge of a Cigna
Financial Services employee; and/or (2) whether after considering
the creditor's standard practices in evaluating credit-
worthiness, the standards of the creditor's industry in
evaluating credit-worthiness, and the surrounding circumstances
existing at the time of the debtor's application, INA reasonably
relied upon Cohn's written statements in his application.
C.
Because both the bankruptcy court and the district
court held that INA unreasonably relied upon Cohn's application,
neither court reached the "intent to deceive" element of §
523(a)(2)(B)(iv). The legal parameters of intent to deceive may
arise on remand and, accordingly, we deem it instructive and
expedient to set forth directions for future guidance.
We acknowledge that because a debtor will rarely, if
ever, admit that deception was his purpose, this fourth element
of § 523(a)(2)(B) is extremely difficult for a creditor to prove
by direct evidence. Thus, we join with other courts, including
the Courts of Appeals for the Sixth, Tenth, and Eleventh
Circuits, in holding that the intent to deceive can be inferred
from the totality of the circumstances, including the debtor's
reckless disregard for the truth. See, e.g., Equitable Bank v.
Miller (In re Miller), 39 F.3d 301, 305 (11th Cir. 1994) ("A
bankruptcy court may look to the totality of the circumstances,
including the recklessness of a debtor's behavior, to infer
whether a debtor submitted a statement with intent to deceive.");
Driggs v. Black, (In re Black), 787 F.2d 503, 506 (10th Cir.
1986) ("The creditor must establish that a materially false
writing was made knowingly with the intent to deceive . . . .
However, the requisite intent may be inferred from a sufficiently
reckless disregard of the accuracy of the facts."); Martin v.
Bank of Germantown (In re Martin), 761 F.2d 1163, 1167 (6th Cir.
1985) ("The standard . . . is that if the debtor either intended
to deceive the Bank or acted with gross recklessness, full
discharge will be denied."). We hold that a creditor can
establish intent to deceive by proving reckless indifference to,
or reckless disregard of, the accuracy of the information in the
financial statement of the debtor when the totality of the
circumstances supports such an inference.
INA seeks to hold Cohn responsible for his agent
Scutto's misrepresentations. INA argues that when an agent
commits a fraud within the scope of the agency, that fraud is
imputed to the principal for purposes of § 523(a)(2)(B)(iv).
Cohn maintains that within an agency relationship, "intent to
deceive" can only be inferred when a principal is recklessly
indifferent to his agent's acts. While he does not dispute the
applicability of the agency relationship, Cohn argues that he had
no reason to doubt Scutto's recommendations regarding the INA
investment or the method used to fill out the application. At
the time Cohn was asked to sign the application, he questioned
Scutto about the $110,000 listed for real estate on Item 9 of the
application. Scutto advised Cohn that the $110,000 listed on
Item 9 represented the projected value of the limited partnership
investment and that this approach had been the practice of other
individuals in the office.
We agree with INA that under an agency scenario, common
law principles of agency law would probably dictate the
imputation of an agent's fraud to a principal under a §
523(a)(2)(B)(iv) analysis. If principles of imputability
applied, Cohn could be held responsible for Scutto's statements
and intent to deceive. However, under the facts of this case,
agency law is not directly applicable.
In the case at hand, Cohn signed the application; Cohn
made representations to INA; INA relied on Cohn's
representations. The third party -- INA -- never relied upon
anything Cohn's agent said on behalf of Cohn. Because INA relied
only upon the principal's representations, agency law is
irrelevant to this case. What Cohn relied upon -- the advice of
Scutto -- is relevant only to the question of his own state of
mind. Accordingly, on remand the question remains whether Cohn,
in light of the totality of the circumstances, intended to
deceive, or was reckless in making the representations.
Last, we find of interest discussion in certain
bankruptcy courts within this circuit regarding a rebuttable
presumption of intent to deceive that arises upon the making of a
false financial statement, see, e.g., Horowitz Finance Corp. v.
Hall (In re Hall), 109 B.R. 149, 155 (Bankr. W.D. Pa. 1990);
First Seneca Bank v. Galizia (In re Galizia), 108 B.R. 63, 67
(Bankr. W.D. Pa. 1989); Signal Consumer Discount Co. v. Hott (In
re Hott), 99 B.R. 664, 667 (Bankr. W.D. Pa. 1989), and a shifting
burden of production of evidence upon a creditor's establishing a
prima facie case, see, e.g., Beneficial Consumer Discount Co. v.
Russell (In re Russel), 18 B.R. 325, 327 (Bankr. E.D. Pa. 1982)
(once creditor satisfies the first three elements of §
523(a)(2)(B), a prima facie case is established and the debtor
then has the burden of going forward with evidence on the
question of intent to deceive); Bucks County Teachers' Federal
Credit Union v. McVan (In re McVan), 21 B.R. 632, 634 (Bankr.
E.D. Pa. 1982); Wybro Federal Credit Union v. Mann (In re Mann),
22 B.R. 306, 308 (Bankr. E.D. Pa. 1982).4 We understand that
4
. We note that in construing § 14, sub. c(3) of the now
repealed Bankruptcy Act, 11 U.S.C. § 32(c)(3), this Court has
held that "once it is established that a bankrupt has benefitted
from his issuance of a materially false written statement
respecting his financial condition, the burden is then on him to
show by way of excuse that his conduct was not attended by a
blameworthy attitude or state of mind." In re Barabato, 398 F.2d
572, 574 (3d Cir. 1968); see also In the Matter of Perlman, 407
F.2d 861, 862 (3d Cir. 1969) ("reasonable and sufficient grounds
were laid at the hearing to show the falsity of the statement and
the credit relied thereon, and the burden thereupon shifted to
the bankrupt to prove by competent evidence that he had not
committed the offense charged"). Section 14, sub. c(3) of the
repealed act has been incorporated into 11 U.S.C. § 727(a)(4),
the current provision pertaining to general discharge. Whatever
these bankruptcy courts were motivated to formulate the
presumption and shifting burdens of persuasion in order to assist
creditors in proving the elusive element of a debtor's intent.
As a preliminary matter, we are not aware of any courts
outside of the Eastern and Western Districts of Pennsylvania that
have utilized a shifting burdens approach. Further, we conclude
that it is not necessary to utilize a presumption of intent or a
shifting burden of production in processing objections to the
discharge of a debt. We observe that in other areas of
commercial litigation in which fraud is alleged, courts have not
utilized a shifting burden of production. A shifting burden is
no more necessary in the realm of discharge in bankruptcy than in
any other area of commercial litigation in which fraud is
alleged. It is sufficient that fraud must be pled and proven
with particularity. See Fed. R. Civ. P. 9(b).5 Thus, the
(..continued)
precedential value our prior interpretations of the former "false
financial statement" exception to general discharge has to
current § 727(a)(4), it does not extend to our present
interpretation of § 523(a)(2). See, e.g., 4 Collier on
Bankruptcy ¶ 727.01[1], at 727-6 n.5 (15th ed. 1985) ("The
concept of nondischargeability of a debt under section 523 is not
to be confused with denial of discharge under section 727. It is
entirely possible for a debtor with nondischargeable debts to
receive a discharge."); Fluehr v. Paolino (In re Paolino), 75
B.R. 641, 647-48 (Bankr. E.D. Pa. 1987); Citizens State Bank of
Maryville v. Walker (In re Walker), 53 B.R. 174, 176-182 (Bankr.
W.D. Mo. 1985).
5
. Rule 9 of the Federal Rules of Civil Procedure provides:
(b) Fraud, Mistake, Condition of the Mind.
In all averments of fraud or mistake, the
circumstances constituting fraud or mistake
shall be stated with particularity. Malice,
intent, knowledge, and other condition of
mind of a person may be averred generally.
creditor at all times retains both the burden of proof and the
burden of production regarding all four elements of §
523(a)(2)(B).
We believe that the standards adopted today (i.e., that
"intent to deceive" includes both recklessness and subjective
intent and that it is not appropriate to use a shifting burdens
analysis) achieve the preferable balance between a creditor's
difficult burden of proof and the underlying purpose of
bankruptcy law to provide the debtor with a "fresh start." Upon
remand, if the bankruptcy court determines that INA reasonably
relied upon the application and thereby reaches the element of
intent to deceive, it should proceed to determine intent to
deceive in accordance with the principles we have articulated
today.
IV. CONCLUSION
For the foregoing reasons, the order of the district
court affirming the judgment of the bankruptcy court will be
reversed. We will remand this matter to the district court with
instructions that it remand the case to the bankruptcy court for
further fact-finding and determinations on the issues of
reasonable reliance and intent to deceive, pursuant to 11 U.S.C.
§ 523(a)(2)(B), in accordance with the legal standards
articulated in this opinion.
(..continued)
Fed. R. Civ. P. 9(b).