Opinion
Case No. 98-17405 Adversary No. 99-91179
November 6, 2000
WILLIAM A. STONE, ESQ., Attorney for the Debtors/Defendants.
Donna E. Wardlaw, Esq., WARDLAW ASSOCIATES, P.C., Attorney for Plaintiff.
MEMORANDUM-DECISION AND ORDER Jurisdiction
The 11 U.S.C. § 523(a)(2)(B) dischargeability causes of action before the court involve a core proceeding under 28 U.S.C. § 157(b)(2)(I). The court has jurisdiction over this proceeding pursuant to 28 U.S.C. § 157(a), 157(b)(1) and 1334(b).
The complaint also contains objection to discharge causes of action under section 727(a)(3), (a)(4)(A), (a)(5) and (a)(6)(A) and a request for the Chapter 7 Trustee to examine the Debtors to determine whether another ground exists for a denial of discharge pursuant to section 727(c)(2). As the Debtors accurately point out in their post-trial brief, the Plaintiff's post-trial brief deals exclusively with only one of the section 523(a)(2)(B) causes of action. (Defendant's [sic] Post-Trial Memorandum of Law p. 1.) Therefore, the court deems all of the Plaintiff's section 727 causes of action abandoned or withdrawn.
Facts
This adversary proceeding arises from the Plaintiff's lease agreement with the Debtors and two individuals named Eric B. Mattison ("Mattison") and Kevin Jenks ("Jenks"). The Plaintiff seeks a determination that the prepetition judgment it obtained from the Debtors is nondischargeable pursuant to 11 U.S.C. § 523 (a)(2)(B) of the Bankruptcy Code. It asserts two section 523(a)(2)(B) causes of action: one based on the financial statement of one of the Debtors and another based on a financial statement of a business partner of the other Debtor. The court finds the following relevant facts:
Debtor Michael W. Wykes ("Wykes") had a business partnership with Mattison involving certain real estate. Their business partnership existed prior to any lease negotiations with the Plaintiff. Debtor Joann Nemeyer/Wykes ("Nemeyer/Wykes") became acquainted with Mattison and Jenks sometime in June 1995, before she married Wykes. (Tr. 10.) Originally, Mattison and Jenks entered into negotiations with the Plaintiff to lease a commercial building it owned in Saratoga Springs for the purpose of operating a bar. Mattison and Jenks submitted the initial lease application to Tammy Emery ("Emery"), the property manager employed by the Plaintiff at that time. She reviewed the application and later discussed it with Plaintiff's managing partner, Donna E. Wardlaw ("Wardlaw"), who subsequently turned down their application. (Tr. 95, 101, 103.) On direct examination, Emery testified the Plaintiff declined the first lease application "because of the financial circumstances of the two gentlemen," while Wardlaw merely stated, "It wasn't a very substantial lease application, so we declined. . ." (Tr. 95, 101.)
After Wardlaw rejected the first lease application, Mattison and Jenks submitted a second one, adding Nemeyer/Wykes as a co- applicant. (P1. Ex. 2.) The three attachments to the second application contain little information regarding Nemeyer/Wykes's assets and liabilities. The one attachment containing information specific to her merely stated she was retired from N.Y. Telephone with monthly gross income of $1,800, rental income of $600 and a $5,000 checking account. (P1. Ex. 3, p. 3.)
Wardlaw testified she relied on Mattison's income and on Nemeyer/Wykes's assets as presented in a document separate from the second application. (Tr. 103, 114.) Mattison prepared this "financial statement" using information Nemeyer/Wykes provided to him; he sent it to Emery via letter dated June 6, 1995. (Tr. 65;P1. Ex. 2.) Wykes testified he provided accurate financial information to Mattison and both he and Nemeyer/Wykes testified they were unaware of Mattison's inaccurate depiction of her financial condition until recently. (Tr. 54-55, 65.)
Everyone agrees that Mattison was responsible for negotiating the lease and he did prepare the second application. (Tr. 17, 19, 78.) Although both Debtors knew about Mattison's lease negotiations with the Plaintiff, it was Nemeyer/Wykes's understanding that she was not a "business partner." (Tr. 16, 77- 78.) Furthermore, she believed "the corporation" was responsible for the lease. (Tr. 76-77, 79.) The record reflects the "corporation" she refers to is JKEM, a corporation owned by Mattison and Jenks, at least according to the Assignment Agreement discussed later in this opinion. (P1. Ex. 10.)
Of course, inaccurate information found its way into the financial statement. Like Wardlaw testified, the financial statement claims Nemeyer/Wykes had a home worth $140,000 with a $36,000 mortgage, a boat worth $21,000 with no liens, a bank account of almost $7,000 and no credit card debt. (Tr. 102- 103; P1. Ex. 2, p. 3.) Accurate information would have looked different. At the time of the second application, Nemeyer/Wykes had outstanding balances on a few credit cards, the assessed value of her house was $99,500 and she owed about $10,000 on the boat that was really only worth approximately $10,400. (Tr. 63- 65, 67.)
The financial statement also shows a car worth $6,500. (P1. Ex. 2, p. 3.) Because there was no testimony from anyone regarding that particular asset, the court presumes that value was accurate.
Although Wardlaw testified she relied on Nemeyer/Wykes's financial statement, she and Emery never said that the Plaintiff would not have entered into the commercial lease with Mattison, Jenks and the Debtors if that document had contained the latter set of numbers. (Tr. 102-103.) In fact, the Plaintiff did not produce any evidence to show what equity levels it usually requires potential lessees to demonstrate. Wardlaw also testified she did not perform any credit or background checks on any of the applicants. (Tr. 118-119.)
Another document separate from the second lease application package was a written statement by Mattison which reads, "Please find enclosed my last 2 tax returns-my bottom line is not much as I am self-employed, and hide much income. I assure you my gross income is considerably more. If any further information is needed, please contact me." (P1. Ex. 2, p. 2.) During her testimony at trial, Wardlaw indicated she relied on Mattison's income, but later, when the court questioned her reliance on such a document, she offered this explanation: "I think the way I could explain it is the following: Eric was fairly young, and I thought it was just a pretty foolish thing of him to say —." (Tr. 103, 118.)
The execution of documents in June 1995 also provided interesting testimony. According to both Debtors, they did not sign Plaintiff's Exhibit 8, the document entitled "Lease Agreement." (Tr. 24, 73-74.) In an attempt to impeach Wykes, Plaintiff's counsel handed him a transcript of his examination before trial which showed he had testified that he did sign "a lease." (P1. Ex. 52, p. 45.) It is not clear that the Debtor meant the lease that is Plaintiff's Exhibit 8.
The numbering and lettering of the exhibits filed in this adversary proceeding lend themselves to confusion. Plaintiff's Exhibit 8 is referred to as "Exhibit D" in some of the state court papers filed in its lawsuit against JKEM. On the other hand, JKEM's "Exhibit D" in the state court action is an allegedly forged assignment agreement.
Plaintiff's counsel also attempted to show that during her examination before trial, Nemeyer/Wykes stated that she also entered into a lease, however, he did not have that exhibit on his Exhibit List pursuant to the court's scheduling order nor did he offer that transcript into evidence at trial. (Tr. 90-91.) The only deposition document in this court's record is the transcript of Wykes's examination before trial (i.e., Plaintiff's Exhibit 52).
Wardlaw recalled that the only document the Debtors signed in her presence was the Assignment Agreement, Plaintiff's Exhibit 10. (Tr. 106-107.) Emery did not witness the execution of any document. (Tr. 97, 99.) The Debtors' signatures on their petition do not look anything like the signatures on the Lease Agreement and the Option to Renew. Their petition signatures do look like the signatures on the Guarantee and the Assignment Agreement. The only notarized document is the Guarantee.
The Option to Renew is attached to the Assignment Agreement, thus, it is part of Plaintiff's Exhibit 10.
When Nemeyer/Wykes signed the Guarantee and the Option to Renew she was not married to Wykes so she signed it as "Joanne Nemeyer." However, she wrote the name "Joanne" in the same handwriting style as the one on the petition on both the Guarantee and the Option to Renew.
As for the documents themselves, the Lease Agreement covers terms typical of a commercial lease, e.g., premises, rent, deposit, trash removal, etc. The Assignment Agreement provided for the transfer of the lease from the four individuals to JKEM. (P1. Ex. 10.) Wardlaw testified she drafted the Assignment Agreement because the Plaintiff customarily required personal signatures and guarantees and would "never allow a lease to be simply in a corporate name." (Tr. 106.) The Assignment Agreement required the tenants to personally guarantee the lease. For that reason, Wardlaw also drafted the Guarantee, a document by which Jenks, Mattison and both Debtors unconditionally guaranteed the terms, covenants and conditions of the Lease Agreement. (Tr. 106; Plaintiff's Ex. 9.)
Arguments
The Plaintiff believes the requirements of section 523(a)(2)(B) have been met. It argues that it relied on Nemeyer/Wykes's financial statement which showed she had minimal debt, excellent credit and a net worth of approximately $138,000; the Debtors do not deny the information in that statement was inaccurate when it was submitted. After receiving the inaccurate financial information, it reviewed it and then prepared a lease, an assignment and personal guarantees for the Debtors, Jenks and Mattison to sign.
The Plaintiff does not find the fact that both Debtors deny their awareness of the untruthful financial statement when Mattison submitted it troubling. It cites to pages 16 and 78 of the transcript to show the Debtors admit Mattison had the authority to act on their behalf when negotiating a lease with the Plaintiff. In addition to many cites to cases discussing section 523(a)(2)(B), particularly controlling Second Circuit decisions, the Plaintiff also cites cases regarding agency law.
In its post-trial brief, the Plaintiff did not develop its second 523(a)(2)(B) cause of action, the one based on Mattison's allegedly false financial statement. Accordingly, the court also deems that cause of action abandoned or withdrawn.
The Debtors do not cite to any cases in their post-trial memorandum of law. Focusing on a key element of section 523(a)(2)(B), the Debtors challenge the Plaintiff's "reasonable" reliance. They center on the financial information package Mattison put together with the second lease application, particularly his written statement that he "hide[s] much income," and on the Plaintiff's failure to take precautions and determine the accuracy of the financial information eventually submitted to it. The Debtors assert they provided accurate financial information to Mattison, who, for whatever reason, turned around and inaccurately depicted it to Emery and Wardlaw. According to the Debtors, the Plaintiff's reliance on any information provided by Mattison could hardly be considered "reasonable."
The Debtors deal with the Plaintiff's remaining causes of action very briefly in their post-trial memorandum of law. However, the court has already deemed those causes of action abandoned or withdrawn, therefore, it need not consider them.
Discussion
I. Section 523(a)(2)(B)
The provision of the Bankruptcy Code dealing with the nondischargeability of a debt based on a debtor's false financial statement is governed by section 523(a)(2)(B), which provides, in pertinent part:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not charge an individual debtor from any debt — . . .
(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, by — . . .
(B) use of a statement in writing —
(i) that is materially false;
(ii) respecting the debtor's or an insider's financial condition;
(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and
(iv) that the debtor caused to be made or published with intent to deceive;. . .
Like all exceptions to discharge, the Plaintiff must prove all parts of section 523(a)(2)(B) by a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 286-288 (1991).
Clearly, someone used a written statement ("statement in writing") regarding Nemeyer/Wykes's financial condition ("respecting the debtor's. . . financial condition") to obtain the commercial lease ("for. . .property"). But the Plaintiff must also prove the written financial statement was " materially false," that it " reasonably relied" on the statement and that the Debtors " caused [the statement] to be made or published with intent to deceive." The court finds the Plaintiff has failed to carry its burden on at least two of section 523(a)(2)(B)'s parts.
II. Section 523(a)(2)(B)(i): "Materially false"
According to the Second Circuit, a materially false statement "`paints a substantially untruthful picture of a financial condition by misrepresenting information of the type which would normally affect the decision to grant credit."' In re Furio, 77 F.3d 622, 625 (2d Cir. 1996) (quoting In re Nance, 70 B.R. 318, 321 (Bankr. N.D. Tex. 1987)). Substantially inaccurate information alone will not suffice; it must also be information which would have affected the creditor's decision-making process. In re Furio, 77 F.3d at 625 (citing In re Boice, 149 B.R. 40, 45 (Bankr. S.D.N Y 1992)). In other words, a statement is materially false when a creditor would not have made the loan had the debtor's true financial condition been known. In re Furio, 77 F.3d at 625 (citing In re Bogstad, 779 F.2d 370, 375 (7th Cir. 1985)).
The Plaintiff has not shown, by a preponderance of the evidence, that it would not have entered into the lease with the Debtors if a true statement of Nemeyer/Wykes's assets and liabilities had been part of the second lease application. Neither Emery nor Wardlaw testified that had Nemeyer/Wykes's financial statement reflected her true financial condition of $68,900 in equity (i.e., $99,500 — $36,000 house + $10,400 — $10,000 boat + $5,000 bank account), the Plaintiff would not have executed the commercial lease with Mattison, Jenks and the Debtors. Also, the record does not even suggest that the Plaintiff routinely required its lease applicants to demonstrate equity cushions substantially above $68,900, let alone $132,000, that number being the amount of equity shown in the false financial statement (i.e., $140,000 — $36,000 house + $21,000 boat + $7,000 bank account). In fact, the only information the Plaintiff has provided regarding its commercial rental business is that Emery showed locations to potential applicants, gathered application information and then presented a completed application to Wardlaw. Wardlaw would then consider the application and ultimately decide whether the Plaintiff should enter into the proposed lease. Having failed to show any of its lease application review guidelines, particularly the asset to debt ratio it looks for, the court concludes the Plaintiff failed to prove Nemeyer/Wykes' s financial statement was a "materially false" one.
The court has used the "assessed value" Nemeyer/Wykes testified to in this "worst case scenario" calculation although an assessed value is often less than fair market value. (Tr. 63.)
For purposes of this calculation, the court has used the $5,000 figure shown in the attachment to the second lease application. (P1. Ex. 3, p. 3.)
The court has used the $7,000 bank account figure in this calculation, even though the attachment to the second lease application shows the lesser $5,000 figure.
III. Section 523(a)(2)(B)(iii): "Reasonably relied"
The Second Circuit has also decided that the reasonableness requirement of section 523(a)(2)(B) is not a rigorous requirement, rather, it is directed at creditors acting in bad faith. In re Bonnanzio, 91 F.3d 296, 305 (2d Cir. 1996) (quoting In re Woolum, 979 F.2d 71, 76 (6th Cir. 1992), cert. denied, 507 U.S. 1005 (1993) and In re Martin, 761 F.2d 1163, 1166 (6th Cir. 1985)). However, that is premised on the creditor proving the debtor provided a materially false financial statement. Id. Having failed to meet its burden of proving section 523(a)(2)(B)(i), the Plaintiff should not have such a seemingly low hurdle to overcome. Regardless of the hurdle's proper height in this case, focusing on the Second Circuit's direction that the trier of fact consider the totality of circumstances when determining the reasonableness of the creditor's reliance under section 523(a)(2)(B), the court finds the Plaintiff did not meet its burden on this part either. In re Bonnanzio, 91 F.3d at 305.
Having rejected the first lease application due to Mattison and Jenks's questionable income stream and their apparent lack of assets, Mattison submitted a second application, together with a letter, Nemeyer/Wykes' financial statement and his own financial statement. In his financial statement, he admits he does not report accurate income on his federal income tax returns. Wardlaw reviewed both financial statements and although she admits she considered Mattison's admission that he hides his income, she merely dismisses it as "foolish."
The two applicants on the first application clearly had insufficient income and assets. When they reapplied, they brought Nemeyer/Wykes's assets to the table, but with an unsigned financial statement that was inconsistent with a lease application she did not sign (e.g., Lease Application showed a bank account of $5,000 but the financial statement showed almost $7,000). Neither Emery nor Wardlaw questioned this information or verified its veracity. Furthermore, when she met the Debtors for the execution of the Assignment Agreement, Wardlaw did not even ask if the financial statement reflected Nemeyer/Wykes's true financial condition.
Given the first application's thinness, the "hidden income" disclosure on Mattison's financial statement and the fact that all of the applicants were basically unknown to the Plaintiff when both applications were submitted, it seems the Plaintiff would have taken at least one step toward verifying the accuracy of the financial information it, without a doubt, heavily relied upon in deciding to grant the commercial lease. The court is not suggesting that a creditor must show it verified all of the information in a financial statement in order to succeed in a section 523(a)(2)(B) adversary proceeding. The totality of the circumstances in this case, however, indicate this particular creditor easily could have, and should have, done more than what it did. See In re Bonnanzio, 91 F.3d at 301 (citing In re Reisman, 149 B.R. 31, 39 (Bankr. S.D.N.Y. 1993)). For the court, Mattison's disclosure about his less than truthful income reporting raised a red flag the Plaintiff should have followed up on. One simple question of "Is this financial statement accurate?" or "Did you prepare this?" might have prevented the lease altogether had Nemeyer/Wykes answered "No." of course, had she answered "Yes," the Plaintiff would have proven "reasonable reliance" under section 523(a)(2)(B)(iii). Although it appears that the Plaintiff might have had a section 523(a)(2)(B) cause of action against a debtor, the totality of the circumstances indicates it was neither Wykes nor Nemeyer/Wykes.
The Plaintiff would also have met the "publication" requirement under section 523(a)(2)(B)(iv) that is discussed later in this decision.
The court takes judicial notice that Eric Mattison filed two bankruptcy petitions in the Northern District of New York: a Chapter 7 petition on November 16, 1994 and a Chapter 13 petition on October 13, 1998. He received a Chapter 7 discharge on March 8, 1995 and his Chapter 13 case was dismissed on September 23, 1999.
IV. Section 523(a)(2)(B)(iv): Caused to be made or published; intent to deceive
Having determined the Plaintiff has not proven the financial statement was a materially false statement that it reasonably relied upon, the court can conclude the burden under section 523(a)(2)(B) has not been met. In the interest of completely addressing the Plaintiff's argument and providing further guidance on how this court views section 523(a)(2)(B)'s remaining parts, the court will briefly discuss both parts of section 523(a)(2)(B)(iv).
The Debtors did not "publish" the inaccurate financial statement. The court finds both Debtors credible and believes their combined testimony that Mattison received accurate information about Nemeyer/Wykes's financial condition yet portrayed an inaccurate financial picture to the Plaintiff. The only way the Plaintiff can meet the first part of section 523(a)(2)(B)(iv) is by proving the Debtors "caused (the financial statement) to be made."
The Plaintiff argues both Debtors knew Mattison made representations regarding Nemeyer/Wykes's financial condition in order to obtain the commercial lease; it asserts he was their agent. While he might have been their agent for the purpose of obtaining the lease, the Plaintiff has not convinced this court that Nemeyer/Wykes knew or should have known about Mattison's fraudulent actions. In re Bonnanzio, 91 F.3d at 303. After all, she was never a "business partner" of Mattison's and the Plaintiff provided no evidence suggesting he was anything other than an acquaintance of hers.
The preponderance of the evidence also does not support a conclusion that Wykes "knew or should have known" about the false financial statement. Unlike his wife, Wykes was more than a mere acquaintance of Mattison; he had quite a number of business dealings with him prior to the commercial lease. However, at best, the Plaintiff showed it was a 50-50 toss-up over whether Wykes "should have known" about the false financial statement. Under the Supreme Court's analysis, ties go to the debtor. See Grogan v. Garner, 498 U.S. at 286-288.
As for proving "intent to deceive," courts in the Second Circuit may consider the totality of circumstances, including a debtor's reckless disregard of the consequences of her/his acts. In re Bonnanzio, 91 F.3d at 301. For all of the reasons discussed above, the court finds the totality of the circumstances weigh in favor of the Debtors.
Both Debors testified independently that they knew Mattison was compiling financial information in order to submit a second lease application, but the Plaintiff has not convinced this court that they also knew the information he actually presented showed the three applicants had the magic number of sufficient financial assets to induce it into entering into the commercial lease. While the Plaintiff accurately points out that the Debtors cooperated by supplying Mattison with income tax returns and information regarding Nemeyer/Wykes's assets, it mistakenly believes that what it describes as the Debtors' "singular lack of curiosity" in verifying Mattison provided the same information to the Plaintiff is sufficient proof of their constructive intent to deceive. (Plaintiff's Post-trial Memorandum of Law 13.) To the court, it is the Plaintiff who displayed a lack of curiosity.
The biggest hurdle the Plaintiff faced in this proceeding was overcoming the fact that it entered into negotiations with an individual unknown to the Plaintiff and who blatantly informed it that he does not report all of his income on his income tax returns. That individual then brought another unknown individual to the lease negotiation table. Despite this scenario, the Plaintiff summarily accepted the asset/liability information this alleged tax cheat had compiled and provided as an inducement for the lease. The court concludes it did not surmount this hurdle.
Accordingly, it is
ORDERED that the Debtors' personal liabilities on the Plaintiff's judgment are discharged.