Lenders, who attempt to establish that a debt is not dischargeable on the grounds that the debtor provided the lender with a false financial statement, are often unsuccessful because bankruptcy courts frequently find that the lenders have failed to follow reasonable lending practices during the loan approval process. This type of cause of action is found in § 523 of the Bankruptcy Code which provides that an individual Chapter 7 or 11 debtor cannot discharge any debt if it is obtained by a false financial statement upon which the creditor reasonably relied.
The typical case involves a lender who obtains the financial statement of the borrower as part of the lender's due diligence in determining whether to make the loan. The borrower obtains the loan but later files a Chapter 7 or 11 bankruptcy case seeking to discharge a part or all of the balance of the unsecured loan indebtedness. The lender then seeks to have that debt declared nondischargeable under § 523 on the grounds that the financial statement provided to the lender was false. If the lender is successful, the debtor will remain liable for the debt after the bankruptcy case. While the lender may be able to prove most of the necessary elements, in many cases the lender may be unable to establish reasonable reliance. In such circumstances, the Court has no choice but to find the debt dischargeable.
Courts find that there can be no reliance by the lender where the financial statement is received after the loan has been approved.
Even if the lender can establish that it relied on the statement, the reliance must be reasonable. Four situations found to be unreasonable include:
1. when the creditor knows that the financial statement is not accurate or incomplete;
2. when the financial statement does not contain sufficient information to portray an accurate picture of the debtor's financial condition for credit analysis;
3. when the creditor's own investigations suggest that the financial statement is false or incomplete; and
4. where the creditor fails to verify any of the information.
If the court finds that any of these situations exist, then the court will likely find in favor of the debtor and the debt will be discharged. This is the probable result although there may be unequivocal evidence that the debtor provided the lender with a false financial statement. For all of these reasons, it is prudent practice for the lender to ensure that the financial statement contains complete information and to exercise reasonable due diligence in order for it to be in a position to later declare that it reasonably relied on the statement in a § 523 action against a debtor.
For more information on this topic and/or on implementing internal policies to protect the lender against these types of problems, please contact Mary Fran Ebersole, a partner at the law firm of Tydings & Rosenberg LLP, at 410/752-9754 or by e-mail at mebersole@tydingslaw.com.