by When a debt is the result of fraud may the debtor still discharge it if he was not complicit in the fraud? What if the fraudulent actor was an agent of the debtor? Judge Posner of the Seventh Circuit answered both questions in the negative. Sullivan v. Glenn (In re Glenn), No. 14-3213 (7th Cir. Apr. 2, 2015).
When the Glenns ran into financial trouble, they sought the help of loan broker, Karen Chung, to help them. Ms. Chung asked a lawyer friend, Brian Sullivan, to make a short term loan to the Glenns in the amount of $250,000 at $5,000 interest per week. Ms. Chung told both Sullivan and the Glenns that the loan was merely a bridge loan to cover the Glenns until a one million dollar line of credit became available through a bank. Unbeknownst to Sullivan and to the Glenns, Chung never applied for the promised line of credit on the Glenns’ behalf. Both Chung and the Glenns signed promissory notes to Sullivan for the amount of the loan: Chung with the knowledge that no line of credit was on the horizon, the Glenns ignorant of that fact.
Both Chung and the Glenns ultimately filed for bankruptcy. Sullivan successfully sought to have Chung’s debt to him found nondischargeable on the basis of her fraudulent conduct.
In the Glenns’ bankruptcy Sullivan likewise sought to have the loan found nondischargeable but the bankruptcy judge found that Chung was not acting as an agent for the Glenns when she made the fraudulent statements. The court also rejected Sullivan’s argument that where the loan was induced by fraud it did not matter that the fraud was not committed by the Glenns for dischargeability purposes. Finally, the court found that the Glenns did not actually commit fraud with respect to the loan. The district court affirmed.
On appeal the circuit court rejected Sullivan’s theory of “debt not the debtor.” Though the argument was based on the literal language of section 523(a)(2)(A) which bars discharge of a debt “obtained by . . . false pretenses, a false representation, or actual fraud,” Judge Posner found that to disengage the fraud from the fraudulent actor cut too broad a swath. It would make debts nondischargeable when acquired from the fraudulent actor by an innocent purchaser—“It would be a form of attainder: an innocent person punished for the misdeed of an ancestor, or in this case an assignor.”
Sullivan’s agency argument was similarly rejected. Generally, a principal is liable for the misstatement of an agent if the misstatement induces action and the actor has no reason to doubt that the statement was endorsed by the principal. Judge Posner found that while these principles of agency would impose liability for the debt on the Glenns even in the absence of the promissory note, they were not dispositive of the issue of dischargeability in bankruptcy. Citing In re Walker, 726 F.2d 452 (8th Cir. 1984), the court found that a condition for nondischargeability is knowledge of the fraud on the part of the debtor. There was no question that the Glenns were liable for the debt, if only for having received the funds and made a promise to repay them, but they had no knowledge of the fraud.
The court was unpersuaded by Sullivan’s argument that the Glenns were in a better position to detect the fraud, noting that Sullivan could have taken the reasonable measure of confirming the existence of the line of credit with the bank, enlisting the Glenns’ help if necessary. The fact that the terms of the loan were extremely lucrative to Sullivan, and that he and Chung were good friends, diminished the credibility of his position that he made the loan solely in reliance on Chung’s position as the Glenns’ agent. The court also did not credit Sullivan’s contention that had he known that the Glenns intended to use the funds to pay off creditors rather than for actual work on the construction site, he would not have made the loan. The court found that the exorbitant interest rate the loan demanded was sufficient incentive to make the loan without regard to the purpose to which the money would be put.
Describing Sullivan’s behavior as irrational, the court pointed to evidence showing that Chung had already borrowed directly from Sullivan on more than one occasion and had defaulted on those loans. In contrast, the Glenns had little reason to doubt the existence of the bank line of credit because it was consistent with other loans they had received in the past.
Weighing the social benefit to holding the debtors liable for the actions of their agent, the court found that that factor was balanced by the “limited liability” created by bankruptcy that encourages transactions.
The circuit court affirmed.