Business Debts - The Bankruptcy Court Will Not Discharge A Debt Where The Underlying Loan Was Procured Through Fraud

In Ojeda v. Goldberg, No. 09-2008, the Seventh Circuit affirmed a determination of the District Court (Judge Gottschall) that a debt was not dischargeable because the underlying loan was procured through fraud.

This case is of interest even to those who do not practice in the bankruptcy area as bankruptcy considerations often govern corporate transactions.

Facts:

The Goldbergs were creditors of Ernest and Beverly Ojeda. The parties executed a short-term high-interest-rate loan in August 1998. The Ojedas were unable to pay the principal when the loan came due. However, they obtained numerous extensions of the loan's maturity date until January 2006 when the Ojedas defaulted.

In February 2006, the Ojedas filed for bankruptcy. Gail Goldberg filed an adversary proceeding against the Ojedas seeking a declaration that the $600,000 loan was not dischargeable because it was procured fraudulently.

The Ojedas owned (through corporations) two McDonald's restaurants. The Ojedas later sold the McDonald's franchises.

When the loan came up for renewal, the Ojedas did not disclose to the Goldbergs that they had sold the McDonald's restaurants. The District Court held that the entire debt $600,000 should be exempt from discharge because the Ojedas led Gail Goldberg to believe that they still owned the McDonald's restaurants when they did not. In fact, the district court noted that the Ojedas continued to use the checkbook for the McDonald's restaurants to pay interest long after the restaurants were sold.

The Seventh Circuit, in an opinion by Judge Kanne, affirmed. The legal standard is as follows:

For a creditor to receive an exception from discharge under 11 U.S.C. Section 523(a)(2)(A), the creditor must show that (a) the debtor made a false representation; (b) that the debtor knew was false and was made with intent to deceive; (c) upon which the creditor justifiably relied.

The Seventh Circuit agreed with the Bankruptcy and District Court that the Ojedas had made false representations with the intent to deceive the Goldbergs. The more difficult question was whether Gail Goldberd had justifiably relied on the Ojedas representations that they still owned the McDonald's restaurants. As the Court noted, "justifiable reliance is a less demanding standard than reasonable reliance" and Ms. Goldberg met that standard.

The Court noted that the Ojedas continued to use checks bearing the McDonald's information. Unless the Plaintiff possessed outside information, "there was no conceivable way that [Ronald Goldberg] could have been alerted to the sale (of the restaurants) when the Ojedas continued to give the impression that the sale never occurred." In sum, the Seventh Circuit was satisfied that the sale of the McDonald's restaurants was concealed and that the Goldbergs justifiably relied on the misrepresentations.

The Seventh Circuit further held that "a fraudulently induced forbearance constitutes an extension or renewal of credit for purposes of Section 523." The Goldbergs met their burden of proving that the forbearance was fraudulently induced in that (a) they had valuable collection remedies at the time of the misrepresentation; (b) they did not exercise those remedies based upon the misrepresentation; and (c) the remedies lost value during the extension period." Opinion at page 13.

Comment: Clients often believe that filing bankruptcy will wipe away their debts. However, bankruptcy courts often scrutinize transactions to determine if they were fair to all parties. Here, the debtors' trickery (hiding the fact that two fast food restaurants were sold) proved to be their undoing.


Edward X. Clinton, Jr.