Opinion
CASE NO. 02-30603 HCD, PROC. NO. 02-3088
February 23, 2004
Peter J. Agostino, Esq., Anderson, Agostino Keller, South Bend, Indiana, for plaintiffs
R. William Jonas, Jr., Esq., Hammerschmidt, Amaral Jonas, South Bend, Indiana, for plaintiffs
MEMORANDUM OF DECISION
Before the court is the Complaint to Determine Dischargeability of Debt filed by Romayne Gibler and Robert and Mary Jackowiak, plaintiffs and creditors, on August 9, 2002, against Michael F. Boehm, the defendant and debtor in this adversary proceeding, pursuant to 11 U.S.C. § 523(a)(2)(A). The two-day trial on the complaint was held on July 7 and 8, 2003. Following the filing of post-trial briefs, the court took the matter under advisement.
Jurisdiction
Pursuant to 28 U.S.C. § 157(a) and Northern District of Indiana Local Rule 200.1, the United States District Court for the Northern District of Indiana has referred this case to this court for hearing and determination. After reviewing the record, the court determines that the matter before it is a core proceeding within the meaning of § 157(b)(2)(I) over which the court has jurisdiction pursuant to 28 U.S.C. § 157(b)(1) and 1334. This entry shall serve as findings of fact and conclusions of law as required by Federal Rule of Civil Procedure 52, made applicable in this proceeding by Federal Rules of Bankruptcy Procedure 7052 and 9014. Any conclusion of law more properly classified as a factual finding shall be deemed a fact, and any finding of fact more properly classified as a legal conclusion shall be deemed a conclusion of law.
Background
The plaintiffs invested money with the defendant. On April 14, 1999, Romayne Gibler ("Gibler") paid to the defendant $50,000 as an investment which was to generate a 20% interest return, later adjusted to earn 21% interest. Gibler invested another $50,000 with the defendant on May 25, 1999, under the same arrangements. The investments were evidenced by a promissory note executed by the defendant, as partner of M D Whirlwind ("M D"), and personally guaranteed by the defendant and Dorothea M. Bressler. On September 30, 1999, plaintiffs Robert and Mary Jackowiak ("the Jackowiaks"), who are Gibler's daughter and son-in-law, paid to the defendant $10,000 as an investment which was to reap an interest rate of 20%. The defendant is in default on these notes. The three creditors seek a determination that the defendant's debts under the promissory notes are excepted from the defendant's discharge under 11 U.S.C. § 523(a)(2)(A).
M D Whirlwind is a general partnership owned and operated by Dorothea M. Bressler and the defendant. An involuntary bankruptcy petition was filed against M D on February 11, 2002. Neither the partnership nor Dorothea Bressler is a defendant in this adversary proceeding.
An involuntary bankruptcy petition was filed against Michael Boehm on February 11, 2002, when the involuntary was filed against M D. The debtor filed his voluntary petition on June 4, 2002. The Order discharging the debtor was issued on February 13, 2003, and the case was closed on March 7, 2003.
In their complaint, the plaintiffs stated that they are not sophisticated investors and that they made the investments in reliance upon the defendant's representations that they were risk-free, personally guaranteed investments. They asserted that the defendant failed to disclose fully to them the nature of the investments or the methods for generating funds to repay the plaintiffs. According to the plaintiffs, the defendant deceived them into believing that their investments were growing and that they would be paid. They alleged that the defendant, intending to deceive them, made representations that he knew to be false or made with reckless disregard for the truth of the representations. They claimed that they reasonably relied upon his representations, to their detriment, and that the defendant breached his promise to repay them and now is in default under the notes. They asked the court to find nondischargeable, under § 523(a)(2)(A), the unpaid principal and interest on the promissory notes, the litigation costs, and reasonable attorney's fees.
The plaintiffs also alleged conversion and violations of the Indiana Securities Regulation Act, Ind. Code § 23-2-1-1 et seq. However, the plaintiffs did not raise these arguments at trial. In their post-trial brief, they acknowledged that "this is not strictly a securities fraud case." R. 29 at 9. The conversion claim never was developed. Both claims therefore are waived. See In re Forum Group, Inc., 82 F.3d 159, 163n. 1 (7th Cir. 1996) ( citing Teumer v. General Motors Corp., 34 F.3d 542, 545-46 (7th Cir. 1994)). The court, like the parties, focuses entirely on the dischargeability of the debts at issue, pursuant to 11 U.S.C. § 523(a)(2)(A).
The defendant responded that his obligations to the plaintiffs under the promissory notes are dischargeable because he did not commit actual fraud or engage in other activity proscribed by § 523(a)(2)(A).
The first witness at trial was the plaintiff Romayne Gibler, a widow and school teacher nearing retirement. She first met Boehm in 1999 at the Windsor Park Conference Center, which was owned and operated by her daughter and son-in-law, Rita and Markus Knipp. Markus had recommended that Gibler meet Boehm. In their discussion, Boehm told Gibler that, if she invested money with him, interest would be paid monthly, at the rate of 20%, and she could get her money back whenever she wanted it. She realized that Boehm's interest rate was much better than the bank's. She had kept her money only in the teachers' pension plan and certificates of deposit. She had not invested or put money in the stock market. She testified that Boehm did not tell her how the money would be invested. However, she thought her money was safe because he told her she could get it back whenever she asked. Her son-in-law knew Boehm and recommended him, she said, and Boehm seemed reputable and honest.
She gave him $50,000 on April 14, 1999, two weeks after the meeting. Boehm gave her a promissory note stating that she could get the money back any time she wanted:
If all or any part of any installment is not paid when due, or if Lender feels insecure for any reason whatsoever, then at the option of Lender, all unpaid indebtedness evidenced by this promissory note, together with all other liabilities of the Borrower to Lender, shall become immediately due and payable without notice. . . .
Pl. Ex. 1. Gibler stated that she thought that paragraph meant that there was no risk. Boehm personally guaranteed the note, as well: "M D Whirlwind, as a general partnership, provides Romayne Gibler the personal guaranty of both Dorothea M. Bressler and Michael F. Boehm on this note." Id. She relied on those statements, she testified. The promissory note was issued for 90 days. The interest then was rolled into the principal and a new note was reissued for a 90-day period. The note was renewed six times; the last note, dated October 9, 2000, was issued for $67,918.25. See PL Ex. 7.
On May 25, 1999, Gibler made a second investment of $50,000 with him. Boehm again assured her that he would take good care of her money. However, he did not say where the money was going or how it would be generated to pay her back. The promissory note contained the same language that it was immediately payable whenever she wanted it. She believed, based on his oral representations and on the language in the promissory notes, that she could rely on him and that her money was safe. He encouraged her to leave her money with him because she could get it back any time she wanted. In fact, he increased the interest rate to 21% when she recommended that her other daughter and son-in-law, Mary and Robert Jackowiak, invest with Boehm. Gibler's second investment was renewed five times, and the last renewal note, dated November 23, 2000, was executed in the amount of $50,000. The interest accruing from the second note was to be paid to Gibler monthly.
Gibler testified that only some of the interest payments on the $50,000 were made. The payments were sent irregularly, usually after she called Boehm. Sometimes his checks to her were returned because his account had insufficient funds, she said. She did not discuss with him where he invested the money she gave him. Nevertheless, she continued to renew the loans. She had to call him more frequently, however, when more of the monthly interest checks arrived late. When her patience ran out she filed a state court action. She testified that, had he disclosed to her that her payments would come from other peoples's loans to him, she would not have invested with him.
On cross-examination, Gibler testified that she met Boehm at the Windsor Park Conference Center because that Center was her daughter's and son-in-law's business. However, she said she was not aware (and did not believe) that M D Whirlwind had lent money to her daughter and son-in-law in order for them to open the Center. She could not remember how many interest payments she received or when she began having to call about late interest payments, but testified that he paid through the year 2000 only. She admitted that, on January 17, 2000, Boehm sent her a letter apologizing for the returned check and paying her the funds to cover the bank's charge on the insufficient check. See Pl. Ex. 21. She also conceded that she had not questioned Boehm about his planned use of her funds or the level of risk involved in her investment.
The other plaintiff to testify was Robert Jackowiak, son-in-law of Gibler. He worked at United Postal Service and was married to Gibler's daughter Mary, who remained at home to raise their five children. He explained that he was not an investor; he has a 401 K plan and invested in mutual funds, not stocks or bonds. The Jackowiaks invested $10,000 with the defendant. His wife dealt with Boehm and wrote the check. He testified that he reviewed the promissory note and agreed that they should invest with him. He found the language of the note, particularly the statement that the money would be returned if he felt insecure, very important. He saw that the note did not report any risk in the investment. Of course, he added, the interest rate was important to them, too.
Once the interest payments stopped coming in, however, the Jackowiaks demanded payment on the note. When Robert Jackowiak phoned, Boehm told him that some real estate deals were going through and that the Jackowiaks just had to wait for their payment. He did not hear again from Boehm. He stated that he would not have given his money to Boehm if Boehm had told him that he was getting other borrowers in order to pay the Jackowiaks back. He testified that he himself had no contact with Boehm before the investment or until the payments stopped and he telephoned Boehm in 2001. He later admitted that he probably received interest payments of $833.34 in 1999, $2,056.90 in 2000, and $873.34 in 2001.
The plaintiffs presented four witnesses whose testimony was offered under Federal Rule of Evidence 404(b) to demonstrate that Boehm's conduct toward them, as toward the plaintiffs, reflected a pattern or scheme of fraudulent intent. The first of those witnesses was Liane Kable, a South Bend resident for 26 years who buys, updates and re-sells houses with her husband. She testified that she and her husband turned their retirement funds over to Boehm. She first met Boehm in the fall of 1998 through a friend, Betty Morehead, who recommended him. She and Morehead had coffee at a restaurant with Boehm. He explained to them that he lends money to people on a short-term basis at a 35-45% interest rate, and that's why he can pay back 20% or 21% interest to his investors. He used the example that someone might want to buy an airplane and need the cash right away. He told them that he only lends to people in a 100-mile radius, too. In Kable's view, his business philosophy made sense. She checked with all the people he named as references. In the end, she gave Boehm money because she trusted him. He told her the money was safe and she could have it whenever she wanted it. She relied on the promise in the promissory notes. She testified that he owes her (and her son, grandson, and mother, who contributed) $377,000. She believed that they could increase their capital by leaving the interest in the note. Boehm never disclosed that the interest payments to her would come from other investors, she stated. However, she testified on cross-examination that she understood that Boehm, on behalf of M D Whirlwind, was lending money to other people in order to repay her.
Liane Kable's grandson, Kenneth Lindow, also took the witness stand. He testified that his grandmother invested money on his behalf. He received an interest payment of $79. But after 2 or 3 months, he said, the checks were late and Boehm delivered the checks personally to the house. He did not know how the defendant was going to invest the money.
Betty Morehead, a retired dress shop owner, invested $18,000 with Boehm in 1994. She told the court that a lady who had worked for her recommended Boehm, because of the high interest rate he offered, and that other friends had invested with him, as well. She explained that she did not have much saved for retirement — her money was in the bank and in an IRA account — and wanted a better interest rate than the bank was giving. She testified that Boehm was nice and had a good plan. Because she was nervous, however, she asked a friend to meet with Boehm, as well. Her friend told her that he would invest his own money with Boehm if he had it. She was attracted by the promise of 20% interest, she said. So she invested $18,000 with him. She received interest payments at first. She just wanted a little money to get buy, she said, and it felt very good to get more than a little money. She relied on his promise in the note that at any time she could draw out the money. His "philosophy statement" led her to believe that her money was safe. She did not think her money was less safe because it was not at the bank. She continued to give him money; her investment came to a total of $102,000.
However, at some point the payments came later and later. The last payment came in August 2001. She testified that she also took Boehm's advice, when she planned to purchase a car, around 2000. He advised her to draw money out of the equity in her home and to invest it with him, before she bought a car, to make more money on the money. She borrowed $22,000 on her home's equity, but never got the money back. When she got the new car, again she followed his advice and leased rather than bought a car. So, now she has two payments to make to the bank: the car lease and the equity payments.
Florence Kopca, a retired nurse and widow for almost ten years, invested with Boehm. She had a pension from the Mishawaka Police Department, some social security funds, and money in the bank. She met him in 1998 through her friend, Betty Morehead. She thought it was very interesting that he could pay 20% interest, but she couldn't believe it was possible. The interest rate and the promise that she could redeem her money at any time caught her attention. Skeptical, she questioned him. He explained to her that, for example, someone might want to buy a boat and would borrow the money from him at a 40% interest rate. When he received the repayment of the loan, she would get 20% and he would get 20%, he said. He did not say anything about the risk of the investments. She testified that sometimes there were insufficient funds to cover the checks he sent, but that he would take care of the payments. She stated that she kept waiting for the borrowers to give him back the money so that he could give the interest payments to her. However, when asked on cross-examination if she would borrow money from a bank or from a person who was lending at 40%, she admitted that she would not want to pay 40% for a loan.
The plaintiffs called the defendant Michael Boehm as a witness. He testified that he is self-employed as a financial consultant and that he delivers newspapers for the South Bend Tribune. He stated that he does not sell securities; he works with business owners to help them finance their businesses, for a fee. He has a business accounting degree from Notre Dame; he does not have a CPA and never practiced as an accountant. He did earn a real estate license in 1986 or 1987, but is not in the real estate profession. He is not licensed as a financial consultant because a licence is not required in Indiana. In 1999, he worked with business owners, helping them to manage or expand their businesses. In short, he helped businesses get loans. He pointed out that the M D Whirlwind partnership was a separate business from his consulting business.
Boehm worked as a commercial lending officer at two area banks until 1981. He left his employment with a bank in Niles, Michigan, because the management felt he exceeded good loan practices and lending limits. He was convicted of bank fraud in 1985. He noted, however, that the investigation found that he personally had not reaped any gain.
Boehm testified that he first met Romayne Gibler in 1999, on the recommendation of her son-in-law, Markus Knipp. They discussed investments. He gave her a sample promissory note to review before she gave him any funds. He testified that he explained to her how M D worked: M D would provide short-term loans at high interest rates, and those transactions would allow him to pay premium interest rates back to the people who provided the money for the loan. He said he believed in the loans he made, believed in the borrowers' ability to repay the loans, and therefore put his signature on the promissory notes. Because he guaranteed his loans, he said, he wanted them all to be safe investments. The "investment philosophy" statement that he gave to potential investors said nothing about the risk of his transactions because he would not have signed the promissory notes if he had believed the investments were risky.
Gibler gave him her $50,000 investment a few weeks later. He conceded that the promissory note said nothing about risks in the investment. He believed that he had explained to her, however, as he did to other investors, that the payments to her depended on his getting loan repayments and other investments. He told his investors that he was lending out their money because that's how M D worked. He believed his loans were collectible, and from those funds he would pay her and others. Of course, ultimately it was the responsibility of M D and the two partners to pay the investors, he said.
Boehm made interest payments to Gibler in 1999, 2000, and 2001. However, by mid-2001, he admitted, collectibility became a problem. Several large loans he made were not paid back, and for that reason he could not pay the investors. He conceded that some interest payment checks bounced, but he took care of them. However, his own reported income was under $50,000 in the years 1999, 2000 and 2001, he stated.
At the end of Boehm's testimony, the plaintiffs rested their case. The defendant made a motion for judgment on the evidence. The court found that the plaintiffs had presented sufficient evidence to survive the motion. It denied the defendant's motion.
The defendant then called to the stand the Chapter 7 Trustee in this case and in M D Whirlwind, Gary Boyn. Boyn has been a panel trustee since 1978. He conducted the section 341 meetings of the creditors in each case, and noted that Boehm exercised his fifth amendment right not to testify concerning securities issues. He stated that M D Whirlwind made some of its banking and tax records available to him. He reviewed the debtors' financial records — three years' worth of bank statements and cancelled checks and five years of tax returns — to determine whether there was enough collectible accounts receivable to pay off the secured creditors and to have something remaining for the unsecured creditors. The Trustee commented that Boehm cooperated with his investigation, filed his petitions and schedules, and even agreed to modifications of the automatic stay.
The Trustee stated that he, in the execution of his duties, did not find any evidence that there was a fraudulent scheme that would have warranted a filing of a § 727 action. He said that he was contacted by many attorneys of M D's creditors and investors, and he urged them to send him information. He interviewed Boehm's partner Dorothea Bressler at length, as well. The explanations he was given by Bressler and Boehm were consistent, he noted. He testified that, although he is not a forensic investigator, he examined the materials available and did not discover any evidence that would cause him to pursue an objection to Boehm's discharge in bankruptcy. Moreover, he found no evidence that Boehm made any personal financial gains. He believed that the records provided to him were sufficient to determine whether there was fraud. Had he found the evidence of such a scheme, he said, he would have filed a § 727 action.
The Trustee also commented that there were $4-5 million of potential accounts receivable and about the same amount, $4-5 million, in outstanding debts. Had the accounts been collectible, there would have been sufficient funds to pay creditors. However, most of the accounts receivable, he determined, were not collectible. He explained that he made that determination by meeting with the secured creditors, going over their records, hearing the statements of investors at the 341 meetings, and learning from Bressler which accounts were outstanding and which were collectible. He investigated specific large outstanding loans, such as the loan to Scott Foreman (who could not be found), and the Ohio mortgage loans, and found them to be uncollectible. He concluded that, with what remained, he could not pay off even the secured creditors.
On cross-examination, plaintiffs' counsel noted the Trustee's busy schedule and his limited time to interview creditors and to investigate fraud. The Trustee conceded that the fact that he did not find fraud does not mean that there was no fraud. He said he had not talked to Gibler and the Jackowiaks, but would have taken their allegations into consideration if they had come forward. He was aware of the creditors' frustration as a result of Boehm's invocation of the Fifth Amendment for most of the questions at the first 341 meeting. He noted that Boehm's partner, Dorothea Bressler, felt that she had been misled by Boehm. She told the Trustee that she had put much time and money into M D, and she ended up filing a chapter 13 petition in Michigan. In the end, he testified, he determined that Boehm lacked liquidity and lacked assets. He found that the only assets of M D were promissory notes. It had no real property, no personal property, nothing tangible. He suspected that Boehm was engaged in a practice of borrowing money to pay prior lenders, but he never had actual evidence of it. He had no knowledge that any of the other 75 creditors filed complaints against the debtor.
The defendant Michael Boehm then testified in his own defense. He commented that this experience was devastating to him, not because of the lost money or bankruptcy, but because he failed the people who trusted him. He explained how his business, M D Whirlwind, started in 1986. Boehm was working with a business in South Bend that needed to borrow $35,000. Bressler lent the money to Boehm; he then lent the money to the company, at apremium interest rate. The South Bend company completed the order, the transaction worked well, and everyone profited. Months later, Bressler suggested that she had money to make available to a partnership. They set up the partnership M D Whirlwind in December 1986. The business was established to borrow money from individuals and then to lend out the money on short-term credit to businesses or other entities. He believed strongly enough in the transactions he set up that he gave his personal guarantee.
The individuals who first had an interest in providing money to M D were hard-nosed business men who remained rock-solid lenders from 1987 on. He said that M D transacted dozens of loans with their money. It was his practice, he stated, to answer all questions posed by investors. He told them what was being done with their money, and they continued to provide money. Boehm described the investor group as large and varied — doctors, lawyers, businessmen, companies, members of his own family, and not just widows and retired women.
Boehm explained that he was trained as a loan officer. Therefore, he examined the financial information, sometimes took collateral, and filed the requisite papers when he gave a loan. The principals of the business guaranteed the investments in order to protect their lenders from risks. He got referrals from banks — Pinnacle, Valley American, First Source, Key, Michigan National — that had reached their loan ceiling but thought the company deserved a loan. He believed that perhaps 200 persons had loaned money to M D, and M D in turn had loaned money to many more companies than were listed on the bankruptcy schedule.
Boehm testified that, between 1986 and 1999, all his obligations were honored. He collected the principal and interest and paid out the proper amounts. Those who asked for their money back received it. M D began to experience financial problems in 1999, however. He discussed three problem loans: a Louisiana loan, an Ohio real estate transaction, and a loan to a Kalamazoo company named Pharmaceutical Medical Products, Inc. Then M D began to have trouble making its interest payments to its lenders. By 2001, it was struggling with its cash flow because of a lack of liquidity. It became the subject of several lawsuits, and they were listed in the Statement of Financial Affairs. Boehm stated that he spent most of his time trying to collect outstanding accounts receivable. He took a modest income during 2000 and 2001, he testified, but he did not receive any of the plaintiffs' investments lent to M D and did not use their funds to pay others.
Boehm testified that he had worked with Gibler's daughter and son-in-law Rita and Markus Knipp after First Source Bank determined that it was not going to lend them the money to finance Windsor Park Conference Center. The bank referred them to Boehm, and he helped them develop a business plan and get funding for the Center. For short periods during the construction, they made use of M D's money by borrowing for 10-14 days. Markus later put him in touch with Gibler. Boehm discussed the investment process with Gibler at the Conference Center. He explained that M D took investments, loaned the money to others, and signed the promissory notes to demonstrate that the principals, Boehm and Bressler, were responsible for the money lent and were personally obligated to pay back the money at the appropriate time. He testified that Gibler did not ask for financial information about M D, Boehm, or Bressler. However, he insisted that he told her that M D borrowed money from investors and lent it out, because that was M D's business.
According to Boehm, he did not ask potential investors about their financial status. He asked Gibler and other potential investors to decide for themselves the amount they wished to invest. Gibler chose to turn over $50,000 to him and to let the interest accrue on the first loan. When a CD came due and she decided to make a second loan of $50,000, she called him. On that second loan, she asked for monthly interest payments to be made to her. Boehm was sure she understood the promissory notes, the business of M D, and the risk. He explained that a loan inherently carries some risk, and that was why he covered the loan with his guarantee. He insisted that he never told anyone that these were risk-free transactions.
Boehm testified that M D made its interest payments in 1999 and 2000. He admitted that some of the payments were late, and one check was returned for insufficient funds in 2000, but he corrected the problem and refunded the bank fee. During 2001, he stated, only some of the interest on Gibler's note was paid. However, he testified that M D was solvent in 1999 — its assets exceeded its liabilities and its bills were paid. He insisted that he did not trick the plaintiffs into lending money to M D. He did his best to use their money the way he said he would.
On cross-examination, Boehm admitted that he did not tell Gibler how many investments he personally had guaranteed. However, he believed that he could pay those investors with his own assets. He testified that, in 1999 and in 2000, his personal net worth was $300,000-400,000. The debt for M D in those years was around $1 million. Although he personally could not pay back the entire debt, M D's assets included his partner's 7-figure net worth, he said, and it could cover all the debt.
Boehm agreed that he encouraged the investors to leave their investment with him and to re-invest the interest. He conceded, however, that he never told Gibler that her money was going into a general pool to be used for loans, and never told her that the only assets of M D were accounts receivable, promises by other people to pay back M D's investors. However, he insisted that he gave investors the information they needed, answered their questions, and provided security for them with his and Bressler's combined incomes. He tried to protect his investors, he said. He denied that he lied to the plaintiffs or that he put their money at risk. At the conclusion of the cross-examination, the defendant rested. Both parties gave concluding arguments and requested a schedule for the filing of briefs. The court took the case under advisement at the conclusion of the briefing schedule.
Discussion
The plaintiffs alleged that they invested substantial sums of money with the defendant in reliance upon misrepresentations and material omissions he made concerning the nature of the investments and the risks involved. They asked the court to declare that the defendant's debts to them are excepted from the debtor's discharge pursuant to 11 U.S.C. § 523(a)(2)(A).
"The most straightforward reading of § 523(a)(2)(A) is that it prevents discharge of `any debt' respecting `money, property, services, or . . . credit' that the debtor has fraudulently obtained." Cohen v. De La Cruz, 523 U.S. 213, 218, 118 S.Ct. 1212, 1216, 140 L.Ed.2d 341 (1998). The party seeking to establish an exception to the discharge of a debt bears the burden of proof. See In re Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998). The burden of proof required for a creditor raising a § 523(a) claim is a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 291, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); In re Bero, 110 F.3d 462, 465 (7th Cir. 1997); In re McFarland, 84 F.3d 943, 946 (7th Cir.), cert. denied, 519 U.S. 931 (1996). However, because the policy underlying bankruptcy law is to provide a debtor with a fresh start, exceptions to discharge are construed strictly against a creditor and liberally in favor of the debtor. See In re Morris, 223 F.3d 548, 552 (7th Cir. 2000) (citing cases); Goldberg Secs., Inc. v. Scarlata (In re Scarlata), 979 F.2d 521, 524 (7th Cir. 1992).
Section 523(a)(2) states that a debtor is not discharged from any debt "for money, property, [or] services, . . . to the extent obtained by — (A) false pretenses, a false representation, or actual fraud." With respect to a debt obtained by false pretenses or a false representation, § 523(a)(2)(A) renders it nondischargeable when a creditor establishes three elements: (1) that the debtor obtained the property, money or services through representations which the debtor either knew to be false or made with such reckless disregard for the truth as to constitute willful misrepresentation; (2) that the debtor had an intent to deceive the creditor; and (3) that the creditor actually and justifiably relied on the false representations. See In re Sheridan, 57 F.3d 627, 635 (7th Cir. 1995); Field v. Mans, 516 U.S. 59, 74-75, 116 S.Ct. 437, 446, 133 L.Ed.2d 351 (1995) (holding that § 523(a)(2)(A) requires justifiable, not reasonable, reliance). The plaintiff must demonstrate every one of those elements to support a finding of a false pretense or misrepresentation. See Bletnitsky v. Jairath (In re Jairath), 259 B.R. 308, 314 (Bankr. N.D. Ill. 2001) (citing Clark v. Bryant (In re Bryant), 241 B.R. 756, 765 (Bankr. M.D. Fla. 1999)).
A different analysis is used in this circuit when a plaintiff alleges the third type of fraud listed in § 523(a)(2)(A), actual fraud. The Seventh Circuit Court of Appeals adopted abroad view of § 523(a)(2)(A) fraud in McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000). The appellate court noted that fraud usually involves a deliberate misrepresentation or a deliberately misleading omission, but that actual fraud is broader than misrepresentation.
Fraud is a generic term, which embraces all the multifarious means which human ingenuity can devise and which are resorted to by one individual to gain an advantage over another by false suggestions or by the suppression of truth. No definite and invariable rule can be laid down as a general proposition defining fraud, and it includes all surprise, trick, cunning, dissembling, and any unfair way by which another is cheated.
Id. at 893 (quotation omitted); see also id. (quoting 4 Collier on Bankruptcy ¶ 523.08[1][e], p. 523-45 (15th ed., Lawrence P. King, ed., 2000) (defining actual fraud to include "any deceit, artifice, trick or design involving direct and active operation of the mind, used to circumvent and cheat another")). To state a claim for actual fraud under § 523(a)(2)(A), therefore, "the plaintiff must allege that: 1) a fraud occurred; 2) the debtor was guilty of intent to defraud; and 3) the fraud created the debt that is the subject of the discharge dispute." In re Jairath, 259 B.R. at 314 (citing McClellan, 217 F.3d at 893-94); see also Schroeder v. Busick (In re Busick), 264 B.R. 518, 524, 527 (Bankr.N.D. Ind. 2001) (noting McClellan's "looser standard" for satisfying § 523(a)(2)(A) by showing any type of active fraud). "Reliance" is an element when the fraud involves misrepresentation but not when it involves actual fraud. See McClellan, 217 F.3d at 894.
The court considers the plaintiffs' allegations of the defendant's misrepresentations, material omissions and actual fraud in determining whether the debts he owes to the plaintiffs are excepted from his discharge under § 523(a)(2)(A).
A. False Pretenses and False Representations
(1) Misrepresentations, deliberately misleading omissions
The plaintiffs alleged that the defendant deliberately misled them by failing to disclose fully the nature of the investments being made and the means of generating funds to repay their investments. They further asserted that Boehm failed to disclose the risks involved in the investments and lulled them into a sense of security by promising to take good care of their money and by guaranteeing the investments. Boehm did not deny that he promised to care for the investors' money and to return it whenever they wanted it; that was his intention, he said. He insisted, however, that he explained to potential investors that M D used investors' money for short-term loans at premium interest rates and repaid the investors with interest when the loans were repaid.
This circuit has made clear that the "most common type of fraud involves deliberate misrepresentation or, what amounts to the same thing, a deliberately misleading omission." McClellan, 217 F.3d at 892. A finding of nondischargeability requires that the intentional falsehood or omission concern a material fact, "one touching upon the essence of the transaction." 4 Collier on Bankruptcy ¶ 523.08[1][d] at 523-43 (Alan N. Resnick Henry J. Sommer, eds-in-chief, 15th ed. rev'd, 2003); see Mayer v. Spanel Int'l Ltd. (In re Mayer), 51 F.3d 670, 676 (7th Cir.), cert. denied, 516 U.S. 1008 (1995). Bankruptcy courts in this circuit are among the vast majority of courts to hold that "a debtor's silence regarding a material fact can constitute a false representation actionable under section 523(a)(2)(A)." Caspers v. Van Home (In re Van Home), 823 F.2d 1285, 1288 (8th Cir. 1987), abrogated on other grounds, Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991) (finding that debtor's failure to disclose his intention to divorce before taking loan from mother-in-law constituted a material omission); see First of America Bank v. Bourdon (In re Bourdon), 160 B.R. 117, 120 (Bankr. N.D. Ind. 1993) (citing Caspers); see also Greater Illinois Title Co. v. Terranova (In re Terranova), 301 B.R. 509, 515-16 (Bankr. N.D. Ill. 2003) (finding that debtor's deliberate failure to disclose existence of a junior mortgage on sold real estate reflected debtor's intent to create false impression about a material fact).
"`The purpose of § 523(a)(2)(A) is not to punish a debtor who went wrong, even terribly wrong, but to protect creditors from debtors who knowingly misinform the creditor in such a way that induces the creditor to participate in the transaction.'" Hodgin v. Conlin (In re Conlin), 294 B.R. 88, 100 (Bankr. D. Minn. 2003) (quoting Minnesota Client Sec. Ed. v. Wyant (In re Wyant), 236 B.R. 684, 698 (Bankr. D. Minn. 1997)). In this case, there are stark factual disagreements about whether the defendant misinformed or failed to inform the plaintiffs before they invested with the defendant. The court turns to the evidence before it to determine whether the plaintiffs have shown, by a preponderance of the evidence, that the defendant deliberately misled them.
Concerning the defendant's failure to disclose the riskiness of the investments, all the witnesses testified that Boehm promised to care for their money and to return their investment whenever they felt insecure. The promissory notes presented a written guarantee of that return. The plaintiffs and their supporting witnesses stated that they therefore believed that their investments were risk-free. Boehm did not deny that he promised to watch over the investors' money; he said that he gave a personal guarantee to his investors because he believed in the ability of his borrowers to repay the loans. He explained that local banks had referred business owners to him. Rita and Markus Knipp, daughter and son-in-law of Gibler, financed their Windsor Park Conference Center with his help, he said. He testified that M D used the funds from investors to lend to businesses and other entities on short-term credit for specific purposes. When the loan was repaid, with interest, Boehm then repaid his investors, with interest. He stated that he would not have signed the promissory notes, guaranteeing the return of funds to the investors, if he had believed the investments were at risk. Nothing was said about risk because he fully intended to take good care of his investors' money — and he did so for many years, he insisted — and because he and Dorothea Bressler, as the partners of M D, could afford to guarantee the repayment.
The plaintiffs suggested at trial that each promissory note might be a separate agreement with the defendant. However, they did not pursue that position and did not assert it in their complaint, which treats each investment payment (the two $50,000 payments from Gibler and the $10,000 payment from the Jackowiaks) as the three specific investments on which they based their complaint. Indeed, they refer to Boehm's default "under the promissory note," not "notes." The court finds that the investments began when the monies first were given to Boehm, and they continued over time, with each note marking renewals of the same investment.
Concerning the defendant's failure to disclose material information, the witnesses gave different reports. Plaintiff Gibler testified that she was not told how Boehm intended to use or repay her investment. Plaintiff Mary Jackowiak, who invested with Boehm, did not testify. Plaintiff Robert Jackowiak testified that he had no contact with the defendant until Boehm stopped sending interest checks. For that reason, he was unable to testify whether the defendant made misrepresentations or misleading omissions to induce his wife to turn over monies to Boehm. The witnesses Liane Kable, Betty Morehead, and Florence Kopca testified that Boehm explained his business transactions to them before they chose to invest with him. Kopca had been skeptical that Boehm could offer such a high rate of interest, but invested after his explanation. Kable also questioned his ability to pay a 20% interest rate but said she liked his business philosophy.
The defendant testified that he explained to potential investors "how M D works" — by using the money of investors for short-term loans at premium interest rates and by repaying them, with interest, when the loans were repaid. He gave them sample promissory notes and answered their questions, he said. He assured them that their money was safe because the loans he made were collectible.
In dischargeability cases, particularly those alleging fraud, a determination often depends on the court's assessment of the credibility of the witnesses. See In re Snyder, 152 F.3d 596, 601 (7th Cir. 1998) (credibility of the witnesses is a matter for the court, as finder of fact, to assess). The court found that the demeanor of the plaintiffs and the four other plaintiffs' witnesses, while occasionally defensive, usually was candid and straightforward. Their testimony was generally credible. It also found the defendant's demeanor calm and remorseful, and his testimony believable and without evasion. Based on the testimony of all the witnesses, therefore, the court first finds that Boehm did not keep silent about his business plans and the use of the investments with the non-plaintiff investors. It also finds, from the testimony of Kable, Morehead, and Kopca, that Boehm adequately disclosed to them the nature of his business dealings. His business plan was not complicated; he lent money to businesses which, in his assessment, would pay back the loan. In the view of this court, the non-plaintiff investors decided to trust his judgment. However, they are not plaintiffs in this case. Gibler, the one plaintiff witness who dealt directly with Boehm, testified that he did not explain to her how he intended to use her money.
The court finds that there is conflicting evidence about a material fact: whether Boehm told Gibler how he planned to use and to pay back her money. However, resolution of this factual disagreement need not be found by deciding which party is telling the truth about the content of their first discussion. It appears to the court that Gibler, having admitted that she did not question Boehm about these matters, was not particularly interested in his business plans. The court finds significant the fact that Gibler's daughter and son-in-law had dealt with Boehm and had recommended him to Gibler. In the view of this court, Gibler learned about Boehm's business and their relationship with him when they recommended him. It seems reasonable, indeed likely, that Gibler invested with him and recommended him to her other daughter and son-in-law, the Jackowiaks, because she believed that Boehm helped and lent money to businesses like the one her daughter and son-in-law the Knipps had started. In any case, Gibler had background information on Boehm and his business from a trustworthy family source before she met him. In light of the underlying recommendation, the court finds that, if Boehm failed to discuss with Gibler the nature of the investments or his method of generating funds to repay the investors, it was not a deliberately misleading omission of material fact. See Mayer, 51 F.3d at 676 (stating that, when an investor has enough information to question a representation and does not ask, her failure to ask indicates that the representation was not material under the circumstances). The court concludes that the plaintiffs were not successful in demonstrating, by a preponderance of the evidence, that Boehm failed to disclose the nature of his business, the use of the investors' funds, and the methods for generating funds from borrowers to repay the investors.
The plaintiffs relied on Smith v. Price (In re Price), 124 B.R. 791 (Bankr. W.D. Mo. 1991), as a case remarkably similar, they claim, to this one. In it, the debtor Price (an insurance agent) convinced the plaintiff (a 79 year-old retired laborer with a fourth grade education and little financial experience) to invest in the debtor's insurance agency in exchange for 40% of the agency's profits. The debtor gave the plaintiff false written and oral reports. He failed to disclose the true nature of the accounts receivable and the risks inherent in the business. The court found that the omissions, made with the intent to deceive the plaintiff, rendered the debt nondischargeable under § 523(a)(2)(A).
This court finds Price distinguishable in two important respects. First, the plaintiffs and plaintiffs' witnesses herein are educated, professional individuals — a school teacher, a nurse, a shop owner, a businessman with a delivery service company — and they all have bank accounts, retirement accounts, and perhaps other investments, even if they have not ventured into the stock market. They knew how to compare interest rates and were attracted by the defendant's promise of a much higher return for their money than the banks and the retirement funds were offering. Second, Boehm carried out his announced business plan and used the funds from repaid loans to make interest payments to the investors until problems arose. The defendant Price, on the other hand, changed his business plan as soon as he received the plaintiff's first payment and continued his misrepresentations, in the form of oral and written "glowing" reports, to induce more funds from him. This court finds clear evidence of deception from the inception of the debt in Price but not in the facts before it in this case. See In re Sheridan, 57 F.3d 627, 635 (7th Cir. 1995) ("[W]hen a creditor entrusts the debtor with money to use for a specific purpose and the debtor has no intention of using it in that manner, a misrepresentation exists upon which a debt can be held non-dischargeable."). The court therefore finds Price inapposite.
The plaintiffs also asserted that Boehm failed to disclose the risks involved in the investments and deceptively lulled them into a sense of security by promising to take good care of their money and by guaranteeing the investments. Gibler stated that, because the promissory notes guaranteed that she could get her money back whenever she felt insecure, she assumed the investment was risk-free.
The court finds three difficulties with the plaintiffs' position that the defendant deceived them by promising the safety of their investment and the return of their money on demand. First, representations concerning the safety or risk-free nature of an investment are merely opinions, not facts. See In re Conlin, 294 B.R. at 100 (finding that a statement "that the transactions were safe or made good financial sense for the client . . . is an opinion, not a representation of past or present fact") (quoting In re Wyant, 236 B.R. at 697). As such, they cannot be false representations. "[A]n opinion cannot really be false at its moment of utterance because whether it is the right or wrong assessment of a situation may only be finally evaluated, if at all, at some later time." In re Wyant, 236 B.R. at 697-98; see also Loomas v. Evans (In re Evans), 181 B.R. 508, 512 (Bankr. S.D. Calif. 1995) (finding that a representation of property value is merely a statement of opinion and does not support a finding of fraud).
Second, a promise, like Boehm's, that he would return an investment in the future if the investor felt insecure cannot be a fraudulent representation. "[A] broken promise to repay a debt, without more, will not sustain a cause of action under § 523(a)(2)(A)." EDM Machine Sales, Inc. v. Harrison (In re Harrison), 301 B.R. 849, 854 (Bankr. N.D. Ohio 2003). Boehm's promise to repay the investors whenever they felt "insecure" does not, by itself, constitute a misrepresentation. See In re Conlin, 294 B.R. at 100 ("A debtor's promise related to a future action which does not purport to depict current or past fact [ ] cannot be defined as a false representation or a false pretense.") (quotations, citation omitted). A debtor's promise or statement of future intent is not necessarily a misrepresentation if intervening events cause the debtor to change his mind or to alter his future actions from his previously expressed intentions. See Palmacci v. Umpierrez, 121 F.3d 781, 787 (1st Cir. 1997); 4 Collier on Bankruptcy ¶ 523.08[1][d] at 523-44 (Alan N. Resnick and Henry J. Sommer, eds., 15th ed. rev'd, 2003) (citing In re Scarlata, 979 F.2d 521 (7th Cir. 1992)). In Conlin and in Wyant, as in this case, the debtor assured the investor that the investments were safe. The Wyant court found that, "[a]t best, any representations Wyant made by utterance, silence, or conduct, either statement of present fact or opinion, were merely wrong." See In re Wyant, 236 B.R. at 698. The Conlin court concluded that, on hindsight, it was plain that Conlin's statement concerning the safety of the investments "proved to be aspirational conjecture, and indeed not very accurate speculation in the end." In re Conlin, 294 B.R. at 100. This court has come to the same conclusion in this case. It finds that the defendant's assurances of a safe, refundable investment were statements of belief, hope, opinion, or speculation, but were not fraudulent representations.
The third and most critical problem with the plaintiffs' claims is one of timing. To prove the fraudulent nature of the representation or promise, the plaintiffs must demonstrate that, at the time Boehm made it, he intended not to do that act or promise. The fraudulent conduct must have occurred "at the inception of the debt, i.e., the debtor committed a fraudulent act to induce the creditor to part with his money or property." McClellan v. Cantrell, 217 F.3d 890, 896 (7th Cir. 2000) (Ripple, J., concurring); see also McCoun v. Rea (In re Rea), 245 B.R. 77, 85 (Bankr. N.D. Tex. 2000) (requiring the plaintiffs to establish "that, either in the inducement or in the actual transaction, [the debtor] made false representations, with the intent and purpose of deceiving the [investors]"). In the present case, the court finds that Boehm testified credibly that, when the plaintiffs decided to invest, he believed their investments were safe because he made loans that could be collected and because he and his partner had enough net worth to cover problems. See Palmacci, 121 F.3d at 792 ( concluding that "statements or actions which were neither false nor fraudulent when made will not be made so by the happening of subsequent events"). He also credibly stated that he had trouble making the interest payments after problems developed with three loans in 1999. See id. (finding that "failure to carry out one's intentions [does not] constitute a basis for finding a debt nondischargeable under § 523(a)(2)(A) absent a showing that the claimed fraud existed at the inception of the debt.").
The court examined Boehm's conduct after he received the plaintiffs' investments to determine whether he carried out his promise to keep their funds safe and to return their investments with interest.
While as a general proposition the alleged fraud must exist at the inception of the debt, and statements or actions which were neither false nor fraudulent when made will not be made so by the happening of subsequent events, a promisor's subsequent conduct may reflect his state of mind at the time he made the promise and thus be considered in determining whether he possessed the requisite fraudulent intent.
Miller v. Krause (In re Krause), 114 B.R. 582, 606 (Bankr. N.D. Ind. 1988). The record shows that the plaintiffs did receive payments for years before the loans stopped being repaid. For example, Robert Jackowiak, whose wife invested $10,000 with Boehm on September 30, 1999, admitted that he probably received interest payments of $833.34 in 1999, $2,056.90 in 2000, and $873.34 in 2001. All the witnesses testified that they received interest payments for some period of time. Betty Morehead first invested with Boehm in 1994; her recommendation of Boehm to Liane Kable in 1998 is indicative of a successful four-year financial relationship. The court finds that, in the light of such evidence, the plaintiffs were unable to prove, by a preponderance of the evidence, that Boehm did not intend to carry out his promise, at the time he made it, to pay back the investments.
One other allegation remains to be considered. The plaintiffs claimed that Boehm could not have repaid the investors as he promised because his net worth was far less than the amounts owed to his investors. However, the Trustee testified that, at the time Boehm filed bankruptcy, his assets were approximately equivalent to his liabilities. In his view, if the accounts receivable had been collectible, Boehm's creditors would have been paid. The court finds this veteran Trustee with twenty-five years of experience to be careful, diligent and reliable. It is confident that the Trustee would have objected to the defendant's discharge if his investigations had brought forth evidence to warrant the charges. The court concludes that Boehm's financial difficulties lay in the uncollectibility of certain loans rather than in his intent to defraud the investors.
In sum, the court finds that Boehm truly believed that the plaintiffs' investments were safe and would be repaid, even upon demand. The plaintiffs have not met their burden of showing, by a preponderance of the evidence, that Boehm deliberately misled them by failing to disclose material facts concerning their investments and by failing to disclose the riskiness of the investments. It concludes, therefore, that the plaintiffs failed to establish that the defendant obtained their investments through false representations or deliberately misleading omissions.
Having determined that the plaintiffs were unable to meet their burden of proof with respect to the element of fraudulent representation, the court need not consider whether the other criteria of § 523(a)(2)(A) were met. However, it turns briefly to the other two factors (intent and reliance) related to false pretenses and false representation, and then to actual fraud, to underscore the court's conclusion that the debts owed by the defendant to the plaintiffs are dischargeable in his bankruptcy under § 523(a)(2)(A).
(2) Scienter — intent to deceive
The plaintiffs contended, and the defendant denied, that the defendant intended to deceive them when he took their investments. To prove scienter under § 523(a)(2)(A), the plaintiffs were required to show that, "at the time the debt was incurred, there existed no intent on the part of the debtor to repay the loan." EDM Machine Sales, Inc. v. Harrison (In re Harrison), 301 B.R. 849, 854 (Bankr. N.D. Ohio 2003). "Proof of intent to deceive is measured by the Debtor's subjective intention at the time the representation was made." Bletnitsky v. Jairath (In re Jairath), 259 B.R. 308, 315 (Bankr. N.D. Ill. 2001). An intent to deceive may be inferred when "a person knowingly or recklessly makes false representations which the person knows or should know will induce another to act." Id.
The court found, supra at page 22, that Boehm credibly testified that, when he received the investments, he honestly believed he could repay the investors. The court now finds, based on the defendant's belief and conduct, that Boehm truly intended to repay them. See In re Conlin, 294 B.R. 88, 103 (Bankr. D. Minn. 2003) ("[B]ecause [debtor] believed his representations at the time he made them to be truthful, . . . they were not false representations for purposes of § 523(a)(2)(A), and therefore the Court cannot reasonably conclude that any such representations were made by [debtor] with an intent to deceive or mislead [creditor] into making the investments"). The fact that the investors received interest payments for a period of time until 2001 or 2002 is evidence that his representations were truthful at the time he made them. No evidence was presented that the defendant received the funds for his personal benefit.
The plaintiffs have not proffered sufficient evidence to demonstrate that, at the time Boehm made his promises to the plaintiffs, he had the present intent to renege on his promise by not paying back their investments with interest. The court determines that Boehm's later action of failing to refund monies to the investors, "as opposed to being fraudulent, was simply done in an honest, albeit unsuccessful effort to save his company from financial ruin." In re Harrison, 301 B.R. at 855. It concludes, therefore, that the defendant did not intend to defraud the plaintiffs at the time he accepted their investments.
(3) Justifiable reliance
The plaintiffs contended that they, as unsophisticated investors, justifiably believed that their money was safe and that they could recover the entire amount of their investment at any time just by asking the defendant for it. They relied on the language in the promissory notes and Boehm's oral assurances.
To determine whether their reliance on Boehm's assurances was justifiable, the court must look at the plaintiffs' characteristics and the circumstances of the case; there is no objective "community standard of conduct" that applies. Field v. Mans, 516 U.S. at 70-71, 116 S.Ct. at 444 (citing Restatement (Second) of Torts § 545A cmt. b (1976)). The Supreme Court pointed out certain limits to a finding of justifiable reliance:
A person is required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation. Thus, if one induces another to buy a horse by representing it to be sound, the purchaser cannot recover even though the horse has but one eye, if the horse is shown to the purchaser before he buys it and the slightest inspection would have disclosed the defect. On the other hand, the rule stated in this Section applies only when the recipient of the misrepresentation is capable of appreciating its falsity at the time by the use of his senses. Thus a defect that any experienced horseman would at once recognize at first glance may not be patent to a person who had no experience with horses.
Id. (citing Restatement (Second) of Torts § 541, cmt. a). The Court added its own comment to the horse analogy: "A missing eye in a `sound' horse is one thing; long teeth in a `young' one, perhaps, another." Id. It also relied upon the explication of torts law set forth by Prosser, the eminent torts scholar: "It is only where, under the circumstances, the facts should be apparent to one of his knowledge and intelligence from a cursory glance, or he has discovered something which should serve as a warning that he is being deceived, that he is required to make an investigation of his own." Id. (quoting W. Prosser, Law of Torts § 108, p. 718 (7th ed. 1971)).
In determining whether the plaintiffs justifiably relied on the defendant's representations, the court conducted a fact-sensitive inquiry into the plaintiffs' individual characteristics and into the unique circumstances of this case. See Dobek v. Dobek (In re Dobek), 278 B.R. 496, 508 (Bankr. N.D. Ill. 2002). As it noted above, the court found the two testifying plaintiffs to be educated, professional individuals — a school teacher and a man in the delivery service business. They have bank accounts, retirement accounts, and CDs. Although they might not be experienced financial experts, they knew that they would make more money with a 20% return on the Boehm investments than they would make at the bank. Gibler met with Boehm because her daughter and son-in-law, who had worked with him in the past, praised him. Gibler in turn encouraged her other daughter and son-in-law, the Jackowiaks, to invest with him. The court finds that the plaintiffs, backed by family recommendations and enticed by the high return offered, did not question Boehm's use of their investments and therefore did not need financial sophistication to read balance sheets or make investment judgments along with the defendant. Indeed, to the extent that they relied mainly or exclusively on the statements of family rather than on the defendant's representation, the plaintiffs have failed to establish any reliance on Boehm's representations. See Marin v. McIntyre (In re McIntyre), 64 B.R. 27, 29-30 (D.N.H. 1986) (affirming that wife who acted on husband's representations rather than on the defendant's failed to establish reasonable reliance); Myers v. Ostling (In re Ostling), 266 B.R. 661, 666 (Bankr. E.D. Mich. 2001) (plaintiffs who relied on misrepresentations of defendant's wife, rather than of defendant himself, failed to show justifiable reliance), aff'd, 284 B.R. 614 (E.D. Mich 2002); Minnesota Client Sec. Ed. v. Wyant (In re Wyant), 236 B.R. 684, 699-700 (Bankr. D. Minn. 1999) (plaintiffs' reliance on friend's misrepresentations, rather than on defendant's, was not justifiable).
The court focused first on the promissory notes upon which the plaintiffs claimed justifiable reliance. In particular, they said, they felt confident that their investments were risk-free because they could demand payment if they felt "insecure for any reason whatsoever."
The language at issue is a boilerplate contract provision often found in notes of financial institutions. Such documents set a date certain, on which the note is to become due, and add a demand clause, allowing acceleration of the note if the holder should find itself "insecure" in connection with the loan. Promissory notes long have contained such constructions, see, e.g., Manson v. Dayton, 153 F. 258, 266 (8th Cir. 1907), and continue to incorporate them today, see, e.g., SunTrust Bank v. Brandon (In re Brandon), 291 B.R. 308, 313 n. 4 (Bankr. S.D. Ga. 2002). The defendant, trained as a bank loan officer, used that standard provision (and other boilerplate) in the promissory notes he issued to the plaintiffs. The plaintiffs, however, took that language to be an "ordinary language" promise that gave them a personal sense of security.
The promissory notes also provided a personal guarantee of payment by the defendant and promised an interest rate of 20%. Courts have labeled rates of return as being "too good to be true," see, e.g., Brodie v. Schmutz (In re Venture Mortgage Fund, L.P.), 282 F.3d 185, 189 n. 2 (2d Cir. 2002) (affirming bankruptcy court's expunging of investors' claims, finding that investments returning 27% interest were "too good to be true" and violated New York's usury statute), or "not too good to be true," see, e.g., Berman v. Hollinger (In re Berman), 248 B.R. 441, 445 (Bankr. M.D. Fla. 2000) (finding that plaintiff reasonably relied on defendant's representation promising a rate of return of 8.25%, which was "not too good to be true"). The court finds that the plaintiffs in this case were sufficiently aware of general financial practices to know that banks were not paying a 20% return and to recognize that there was a risk involved in ventures that gave a 20% return. Like Florence Kopca, the retired nurse who testified that she would not want to pay 40% on a short-term loan but looked forward to getting the 20% interest payment when such loans were repaid, the plaintiffs themselves either were aware or should have been aware of the riskiness of transactions returning 20% interest and assuring a full, personally guaranteed repayment upon demand. See Mayer v. Spanel Int'l Ltd., 51 F.3d 670, 676 (7th Cir. 1995) ("If the investor possesses information sufficient to call the representation into question, he cannot claim later that he relied on or was deceived by the lie."). In the view of this court, this combination of promises was sufficiently unrealistic that it should have led the plaintiffs to question the accuracy of such assurances. New Hampshire Bankruptcy Judge Yacos described the risk in a similar investment used to purchase real estate:
There is nothing wrong of course in our economy with negotiating — if you can get it — a 45 percent return on an investment. But a 45 percent, or even 15 percent, return in profits of a real estate project does not come without some risk. And here the risk came home to roost with the collapse of the real estate boom in New Hampshire at the end of the 1980's. Both the plaintiffs and the defendant were caught in that crunch and the project failed. That being so I do not believe that Congress intended by § 523(a)(2)(A) of the Code to allow shifting of the entire risk to a debtor . . . once bankruptcy ensues.
Wingate v. Attalla (In re Attalla), 176 B.R. 650, 665 n. 9 (Bankr. D.N.H. 1994).
According to plaintiff Gibler, the defendant also made verbal assurances that her investment was safe and was personally guaranteed by him and his partner. Gibler was the only plaintiff who testified about her direct relationship with Boehm before and after making investments with him. She testified that she was convinced, by his oral promises as well as the language in the promissory notes, that her investment was risk-free. The court finds, however, that she should have seen both the oral and written assurances as warning signs prompting her to ask questions about risk. See In re Conlin, 294 B.R. at 103 (stating that "if there are any warning signs . . . either in the documents, in the nature of the transaction, or in the debtor's conduct or statements, the creditor has not justifiably relied on his representation") (quoting Guste v. Guste (In re Guste), 243 B.R. 359, 363-64 (8th Cir. B.A.P. 2000)). It does not take a financial degree to realize that investments bearing a 20% return are not "no-risk" and that such an investment was apparently "too good to be true." The witnesses testified to their skepticism of Boehm's promises; indeed, Kable and Kopca did question him and called his references. See Mayer v. Spanel Int'l Ltd., 51 F.3d 670, 675-76 (7th Cir. 1995) ("[A]n investor cannot close his eyes to a known risk.") In the view of this court, a cursory glance at these representations should cause a seasoned school teacher of Gibler's knowledge and intelligence to investigate. See Field v. Mans, 516 U.S. at 71, 116 S.Ct. at 444. The court is well aware that the "justifiable standard imposes no duty to investigate unless the likely falsity of the representation is apparent." Greater Illinois Title Co. v. Terranova (In re Terranova), 301 B.R. 509, 517 (Bankr. N.D. Ill. 2003) (citing Field, 516 U.S. at 71). In this case, the court believes that Gibler was capable of appreciating the likely falsity of Boehm's representations of a safe, refundable investment with a 20% return.
The court also finds that, for Gibler, who did not know Boehm before their meeting at the Conference Center, the overriding reason for investing with Boehm was the recommendation of her daughter and son-in-law, the Knipps. They were satisfied customers of Boehm; the implication at trial was that Boehm supported their good business in the past and would choose to finance good businesses in the future. Because Gibler met with Boehm at their suggestion, she relied on their representations, rather than the defendant's, and did not ask him questions about his investment plans before giving him her money. See, e.g., In re Harrison, 301 B.R. at 857 (finding that relatively sophisticated creditor who took the defendant at his word instead of performing a cursory investigation — running a credit check or calling references — did not justifiably rely). There is nothing in the evidence to indicate that Gibler contacted the defendant's banker or other investors or questioned the defendant concerning his qualifications or investment strategy. In addition, there is no evidence that she requested secure, income-producing investments to supplement her retirement income. See, e.g., Owens v. Miller (In re Miller), 276 F.3d 424, 427 (8th Cir. 2002) (finding that plaintiffs requested secure investments to supplement their retirement income but received, through fraudulent conduct, high-risk investments that ultimately failed). Under these circumstances, the court finds first that the promises Boehm made to Gibler were not material representations to her, causing her to invest with him. The court also determines that the plaintiff relied primarily, if not exclusively, on the recommendation of her daughter and son-in-law. For that reason, the plaintiffs' reliance on the defendant's failure to describe his investment plans, if she relied at all, was not justified. The court concludes that the plaintiffs have failed to prove the element of justifiable reliance required under § 523(a)(2)(A).
B. Actual Fraud
The plaintiffs also allege that the defendant's conduct falls within the broad definition of "actual fraud" described in McClellan v. Cantrell, 217 F.3d 890 (7th Cir. 2000). As this court set forth supra at page 15, the Seventh Circuit described "actual fraud" as broader than misrepresentation: It includes "any unfair way by which another is cheated." Id. at 893. The actual fraud must be the "fraud that created the debt," and the debtor must intend, by taking the money, "to hinder his creditors." Id. at 894; see, e.g., Mellon Bank, N.A. v. Vitanovich (In re Vitanovich), 259 B.R. 873, 877-78 (6th Cir. B.A.P. 2001) (adopting McClellan, holding that check kiting scheme falls into definition of actual fraud); Greater Illinois Title Co. v. Terranova (In re Terranova), 301 B.R. 509, 518 (Bankr. N.D. 111. 2003) (finding that defendant committed actual fraud by withholding existence of junior mortgage with intent to gain financial advantage over purchaser plaintiff).
This court found in its prior analysis of scienter that Boehm did not intend to defraud the plaintiffs when they entered into their investment agreements and he took the plaintiffs' money. The plaintiffs have not demonstrated that the defendant's conduct reflected actual fraud — though tricks, cunning, or cheating actions, for example. They have presented no evidence of his intent to defraud or to gain an advantage over them which the court did not review in the previous section and find insufficient as proof of scienter. The court finds that the plaintiffs have failed in their burden of proving that the defendant committed actual fraud.
Conclusion
For the reasons stated above, the court finds that the investment debts owed to the plaintiffs Romayne Gibler and Robert and Mary Jackowiak are dischargeable debts pursuant to 11 U.S.C. § 523(a)(2)(A). The court determines that the plaintiffs were unable to meet their burden of proving by a preponderance of the evidence the elements of § 523(a)(2)(A). Accordingly, the losses sustained by the plaintiffs as a result of their investments with the defendant are not debts attributable to fraudulent conduct recognizable under § 523(a)(2)(A) and are not excepted from the defendant's discharge. The plaintiffs' Complaint to Determine Dischargeability of Debt is denied.
SO ORDERED.