A recent opinion from the Fifth Circuit demonstrates that non-dischargeable claims for false financial statements can extend beyond the traditional lender-borrower relationship and that a third party's error can create liability when it is knowingly adopted by the debtor. Matter of Morrison, No. 07-51118 (5th Cir. 1/16/09).
David Morrison was president of Morrison Excavation. Like many construction contractors, the firm was short of cash and looking for new work. On February 6, 2002, the company's CPA informed David that the company's financial condition was dire. To make things worse, on February 15, the company's bookkeeper found an accounting error which inflated the company's accounts receivable by $857,000. When the inflated receivables were removed, the company was insolvent. The previous day, the company had submitted a bid for a subcontract with Western Builders. After reviewing the company's work at several job sites and performing a credit check, Western requested a financial statement. On February 22, David faxed the financial statement containing the inflated receiveables to Western. On March 6, Morrison Excavation entered into a subcontract with Western and started taking draws on March 28. During that time, the company used the draws from Western to pay off lienholders who they said had previously been paid. David also gave himself a raise and paid off a personal home equity loan from company funds. By mid-August, Morrison Excavation abandoned the job. Western hired another contractor to finish the job at and additional cost of over half a million dollars. David Morrison filed chapter 7 on March 13, 2004.
Western filed a non-dischargeability action against David based upon submitting a false financial statement. At trial, two company employees testified that David was informed about the error in the financial statement somewhere around February 15, which was prior to the time that he provided the statement to Western. The bankruptcy court found that the subcontract created a debt which could be nondischargeable under Sec. 523(a)(2)(B) because Morrison could be held liable for the misrepresentation which benefited Morrison Excavation. The bankruptcy court also entered a money judgment against David in the amount of $549,773.63. On appeal, the Fifth Circuit affirmed, finding that the Bankruptcy Court had the jurisdiction to enter a money judgment in a dischargeability action (agreeing with five other circuits) and affirming the Bankruptcy Court's conclusions on liability and non-dischargeability.
While the result in this case is not particularly remarkable, it demonstrates how personal liability for a non-dischargeable debt can arise in a business setting.
1. While false financial statement cases often arise from a loan application, the Morrison case shows that they can arise in any context. What is interesting about this case is the fact that Western Builders did a substantial amount of due diligence before entering into the contract with Morrison Excavation. It observed job sites, ran a credit check and requested a financial statement. Although reliance was not discussed in the Fifth Circuit opinion, it seems clear that Western was trying to protect itself from doing business with a financially shaky subcontractor who would not be able to complete the job.
2. It did not matter that the financial statement was for Morrison Excavation or that David Morrison was not the person responsible for preparing the financial statement. When David Morrison faxed the financial statement to Western for the purpose of being awarded the subcontract and after being informed that it erroneously showed a positive net worth instead of a negative one, he fell within the statutory language of receiving money or property based upon "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 . . . reasonably relied; and
(iv) that the debtor caused to be made or published with intent to deceive."
The financial statement was materially false because it showed the company as solvent rather than insolvent. It depicted the financial condition of an insider. The creditor reasonably relied on the statement as shown by the fact that it conducted several types of due diligence before entering into the contract. Finally, the debtor's intent to deceive was shown by the fact that he had been told that the statement was inaccurate but faxed it anyway.
3. It was not necessary to pierce the corporate veil to impose liability on the corporate officer. Under Texas tort law, an individual may be held liable for "fraudulent or tortious acts commited while in the service of his corporation."
4. The creditor was allowed to obtain both a judgment of non-dischargeability and a money judgment in the same proceeding. This allowed the creditor to obtain all of the necessary relief in one action.
Wednesday, February 11, 2009
Tuesday, February 03, 2009
Judge to Secured Creditor: The Loan has been PAID!!!!!
In the latest opinion from a single asset real estate case which has taken on the ferocity of a cage match brawl, the bankruptcy court has told a secured lender that it must treat its credit bid under Section 363(k) the same as if it had received a cash payment. The audacious secured creditor had asserted that its credit bid applied to reduce its bankruptcy claim but not its debt, so that it was still free to pursue guarantors and other collateral. Spillman Investment Group, Ltd. v. American Bank of Texas, Adv. No. 08-1018 (Bankr. W.D. Tex. 1/29/09).
In a fact pattern which is showing up more frequently these days, the case started off with a golf course development. The debtor borrowed money from American Bank of Texas and Fire Eagle, LLC. American Bank held the first lien and also held a CD and limited guaranties. Fire Eagle held a junior lien and did not have personal guaranties. After the loans went into default and the debtor filed chapter 11, Fire Eagle bought the American bank debt so that it held both the senior and junior liens. After a bidding process in which a group lead by insiders of the debtor offered $9.2 million in cash, Fire Eagle made a credit bid in the amount of $9.3 million and acquired the property. Fire Eagle also received cash collateral in the amount of $500,000, increasing its total amount credited and paid to $9.8 million. At the time, the amount of the first lien debt was approximately $9,250,000. Thus, the combination of the credit bid and the cash collateral clearly exceeded the amount of the first lien debt.
Notwithstanding the math, Fire Eagle asserted that the senior debt (and with it the right to collect against the CD collateral and the guarantors) remained alive because the credit bid under Section 363(k) reduced its bankruptcy claim, but not the underlying debt. The Bankruptcy Court did not have any trouble rejecting the distinction between debt and claim.
Memorandum Opinion, p. 27.
The Bankruptcy Court also rejected arguments that language in the guaranty agreements which provided that setoffs or defenses of other parties and discharge in bankruptcy would not impair the guarantees allowed continued pursuit of the guarantors. The Court noted that payment of the debt was neither a setoff nor a discharge, so that the guarantees were extinguished when the debt was paid.
To make sure that there was no room for confusion, the Court added the following conclusion:
Memorandum Opinion, p. 34.
First Post-Script:
Judge Monroe will be retiring this year after nearly twenty years on the bench. While Spillman is an example of his rather direct writing style, it is not the only time that he has used all capitals to make a point. In an opinion discussing allowance of late filed claims in chapter 11, he quoted from the then-recent Supreme Court opinion in Pioneer Investments v. Brunswick, followed by the exclamation: "WRONG." Judge Monroe has never had trouble telling us what he really thinks.
Second Post-Script:
This marks the 100th posting to A Texas Bankruptcy Lawyer's Blog.
In a fact pattern which is showing up more frequently these days, the case started off with a golf course development. The debtor borrowed money from American Bank of Texas and Fire Eagle, LLC. American Bank held the first lien and also held a CD and limited guaranties. Fire Eagle held a junior lien and did not have personal guaranties. After the loans went into default and the debtor filed chapter 11, Fire Eagle bought the American bank debt so that it held both the senior and junior liens. After a bidding process in which a group lead by insiders of the debtor offered $9.2 million in cash, Fire Eagle made a credit bid in the amount of $9.3 million and acquired the property. Fire Eagle also received cash collateral in the amount of $500,000, increasing its total amount credited and paid to $9.8 million. At the time, the amount of the first lien debt was approximately $9,250,000. Thus, the combination of the credit bid and the cash collateral clearly exceeded the amount of the first lien debt.
Notwithstanding the math, Fire Eagle asserted that the senior debt (and with it the right to collect against the CD collateral and the guarantors) remained alive because the credit bid under Section 363(k) reduced its bankruptcy claim, but not the underlying debt. The Bankruptcy Court did not have any trouble rejecting the distinction between debt and claim.
Fire Eagle's claim is also its debt. "Debt" is defined as liability on a claim. 11 U.S.C. Sec. 101(12). "Claim" means "right to payment, whether or not such right is reduced to jdugment, liquidated, unliquidated, fixed, contingent, matured, unmatued, disputed, undisputed, legal, equitable, secured or unsecured." 11 U.S.C. Sec. 101(5A). Payment against the claim necessarily reduces the debt. It cannot reduce one and not the other. This is the bankruptcy court; not fantasy land.
Memorandum Opinion, p. 27.
The Bankruptcy Court also rejected arguments that language in the guaranty agreements which provided that setoffs or defenses of other parties and discharge in bankruptcy would not impair the guarantees allowed continued pursuit of the guarantors. The Court noted that payment of the debt was neither a setoff nor a discharge, so that the guarantees were extinguished when the debt was paid.
To make sure that there was no room for confusion, the Court added the following conclusion:
Fire Eagle's Senior Loan was paid in full. As such Fire Eagle has no claim against the SIG CD or the Guarantors under their respective Guarantees. Fire Eagle's feigned ability to not understand the Court's reasoning falls on deaf ears. This is not rocket science. The Senior Loan has been PAID!!!!!
Memorandum Opinion, p. 34.
First Post-Script:
Judge Monroe will be retiring this year after nearly twenty years on the bench. While Spillman is an example of his rather direct writing style, it is not the only time that he has used all capitals to make a point. In an opinion discussing allowance of late filed claims in chapter 11, he quoted from the then-recent Supreme Court opinion in Pioneer Investments v. Brunswick, followed by the exclamation: "WRONG." Judge Monroe has never had trouble telling us what he really thinks.
Second Post-Script:
This marks the 100th posting to A Texas Bankruptcy Lawyer's Blog.
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