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First Circuit Holds Bankruptcy Debtor May Be Subject To Fraud Discharge Exception Through Agency

The First Circuit has held that a bankruptcy debtor may be subject through agency to a discharge exception for money procured through a materially false financial statement. 11 U.S.C. 523(a)(2)(B). Further, the Circuit Court said that reckless indifference to the accuracy of the financial statement was sufficient culpability to apply the exception.

The debtor is an experienced real estate investor. In two transactions before the one at issue in the appeal the debtor retained a certain Smith to prepare the financial paperwork to obtain financing. The bankruptcy court found the debtor took a "hands off attitude" when it came to supervising Smith's work. The creditor said he wanted personal financial guarantees to provide financing for the subject transaction. Smith prepared two personal financial statements ("PFS"). Much of that process was unclear including who signed the PFSes and how one of the PFSes got to the creditor. Smith acknowledged he forwarded the other PFS to the creditor. What was clear was that the debtor did not provide enough information to Smith to complete the PFSes and the information that the debtor did not provide was materially false.

The bankruptcy court determined that Smith was acting as the creditor's agent in preparing the PFSes and that the creditor was "recklessly indifferent" to whether the PFSes were false. It held the discharge exception applied. The Bankruptcy Appellate Panel affirmed.

The First Circuit said the bankruptcy court's determination that Smith was the debtor's agent for purposes of preparing and transmitting the PFSes was not clearly erroneous. The Court noted that the debtor had used Smith to prepare and transmit PFSes for prior transactions. The debtor contacted Smith to assist on the subject transaction. The debtor knew the information that he had provided to Smith would be insufficient to complete the PFses, that Smith would have to obtain and use additional information to complete the forms, and that Smith would transmit the completed PFSes to the creditor.

With respect to the applicable level of culpability, the First Circuit held that reckless indifference to or reckless disregard for the falsity of the written statement was sufficient. It said the bankruptcy court can infer recklessness from the totality of the circumstances. Here, the debtor was experienced in real estate financing. He did not give Smith enough information to complete the PFSes and it could be inferred that he knew Smith would have to come up with additional information to do so. The debtor would also know that Smith would have to transmit the PFSes to the creditor if the debtor was to get the financing. Yet, the debtor never asked to review Smith's work at any point and he accepted the financing knowing that Smith must have provided PFSes to the lender with information the debtor did not provide. The First Circuit said the bankruptcy court could reasonably infer reckless indifference from these circumstances. It affirmed.

In re David O'Donnell, No. 13-9001, 2013 WL 4504825 (1st Cir. Aug. 26, 2013)

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