Heritage Pacific Financial, LLC (Heritage) filed a complaint alleging that the debtor's loan obligation was nondischargeable under § 523(a)(2).
On March 6, 2006, Oscar Trejo (the Debtor) applied for a loan from American Mortgage Express Financial dba Millennium Funding Group (Millennium). Millennium was a subprime lender; it lent to borrowers with lower credit scores who represented a greater credit risk than more qualified borrowers. The Debtor executed a promissory note in the amount of $88,802 in favor of Millennium (the Loan) on March 7, 2006. The Loan was secured by a second mortgage on the Debtor's real property in Merced, California (the Property). The Loan was subsequently assigned to Heritage.
In order to obtain the Loan, the Debtor completed and executed a Uniform Residential Loan Application form (Loan Application). On the Loan Application, Trejo stated his monthly income was $9,500. The Debtor stated that he was employed by Trejo Networks, a "consulting business" that operated from the Debtor's home. It was later revealed that this information about the Debtor's income and employment was not true even though the Debtor signed the Loan Application under penalty of perjury.
The Debtor provided the information about his income and employment in an interview in conjunction with completing the Loan Application. In addition, the Debtor executed a Borrower's Certification and Authorization form on March 8, 2006, which certified that the information the Debtor provided in the Loan Application was true and complete (Certification Form).
The Loan Application provided that: "Self Employed Borrower(s) may be required to provide additional documentation such as tax returns and financial statements." The Certification Form also authorized Millennium to review the Debtor's financial information with lenders and other third parties. However, Millennium did not request any additional documentation from the Debtor, such as tax returns, earnings statements, or bank records.
On August 24, 2010, the Debtor filed a voluntary chapter 7 petition. He was not represented by an attorney.
On November 23, 2010, Heritage filed a complaint (Complaint) against the Debtor alleging that the Debtor made misrepresentations in the Loan Application, which constituted fraud, making the Loan nondischargeable under both § 523(a)(2)(A) and (B).
Heritage served Requests for Admission on the Debtor in April 2011, which requested the Debtor to admit, among other things, that he misstated his monthly income and employer on the Loan Application, and obtained the Loan through false pretenses, false representations, and actual fraud. The Debtor did not respond to the Requests for Admission.
On May 27, 2011, Heritage filed a motion for summary judgment (MSJ). A hearing on the MSJ was held on August 25, 2011. The bankruptcy court subsequently denied the MSJ on September 8, 2011. According to the bankruptcy court, based on
A trial on the Complaint was held on September 21, 2011. In a written order entered on November 2, 2011 (Order After Trial), the bankruptcy court found that Heritage failed to establish that Millennium justifiably or reasonably relied on the representations made by the Debtor in the Loan Application. Therefore, the bankruptcy court determined that Heritage failed to prove its claims under § 523(a)(2)(A) and (B). It entered judgment in favor of the Debtor and discharged the Loan on November 3, 2011. Heritage timely appealed.
The bankruptcy court had jurisdiction pursuant to 28 U.S.C. §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. § 158.
Did the bankruptcy court err in determining that Heritage failed to prove that the Loan should be excepted from the Debtor's discharge under § 523(a)(2)?
In reviewing a bankruptcy court's discharge determination, we review its findings of fact for clear error and conclusions of law de novo.
We note that if the bankruptcy court's "account of the evidence is plausible in light of the record viewed in its entirety," we may not reverse even though we may be convinced that "had [we] been sitting as the trier of fact, [we] would have weighed the evidence differently."
The bankruptcy court's evidentiary rulings are reviewed for abuse of discretion.
Heritage argues that the Debtor committed fraud when he applied for and obtained the Loan, and that this fraud gave rise to a nondischargeable debt under § 523(a)(2). Section 523(a)(2) provides that a debtor is not entitled to a discharge of a debt to the extent that the debt was obtained by:
In order to prevail, Heritage was required to prove: (1) the Debtor made material representations; (2) that he knew at the time were false; (3) with the intention of deceiving the creditor; (4) who justifiably or reasonably relied on the representations; (5) which caused damage as a result.
Heritage argues that it established all the necessary elements because, when the Debtor failed to answer the Requests for Admission, the Debtor admitted that he: (1) "obtained the loan through false pretenses"; (2) "obtained the loan through false representations"; and (3) "obtained the loan through actual fraud."
Federal Rule of Civil Procedure 36(a)(3) provides that if a party does not answer a request for admission within thirty days of being served, it is deemed admitted. Fed. R. Civ. P. 36(a)(3) (incorporated by Rule 7036);
However, the bankruptcy court determined that the Requests for Admission sought an impermissible admission of a conclusion of law, which exceeded the scope of Fed. R. Civ. P. 36(a)(1)(A). We agree. Heritage's § 523(a)(2) claim requires that the bankruptcy court make the ultimate determination that the Debtor obtained the Loan fraudulently. That determination necessarily requires the bankruptcy court to find that there are sufficient facts to prove each element of § 523(a)(2)(A) or (B). While "requests for admission may relate to the application of law to fact," "opinions of law" are not contemplated by Fed. R. Civ. P. 36(a)(3). 8B CHARLES ALAN WRIGHT & ARTHUR R. MILLER, FEDERAL PRACTICE AND PROCEDURE § 2255 (3d ed. 2012);
Even to the extent the admissions were not conclusions of law, the admissions did not cover all of the elements that Heritage had to prove by a preponderance of the evidence in order to prevail on the Complaint. The "admitted" facts, at most, established that Heritage proved the first three elements of § 523(a)(2). Although the Loan was funded, Heritage did not establish through the "admitted" facts that Millennium justifiably or reasonably relied on the misrepresentations before disbursing the funds under the Loan.
The bankruptcy court ultimately held that Heritage failed to prove the reliance element of its § 523(a)(2) claim for relief.
Section 523(a)(2)(A) requires a finding that a creditor justifiably rely on a debtor's false statements or misrepresentations, whereas § 523(a)(2)(B) requires that the reliance is reasonable.
Therefore, the inquiry regarding the justifiable standard focuses on "whether the falsity of the representation was or should have been readily apparent to the individual to whom it was made."
The justifiable reliance standard generally does not entail a duty to investigate and a person may be justified in relying on a representation of fact even if he might have ascertained the falsity of the representation had he made an investigation.
At the trial, a representative for Millennium (Judith Dunham) testified that Millennium routinely relied on borrowers' information provided in their loan applications. Ms. Dunham testified that although she had no recollection of the Debtor's Loan, there were general underwriting standards for subprime loans on the secondary market. She testified that pursuant to those standards, Millennium did not independently verify a borrower's stated income unless it "didn't make sense," for example, if an otherwise low earning professional stated a high monthly income, or if "something look[ed] unusual." Under such circumstances, Ms. Dunham testified that Millennium would undertake further investigation to verify the information provided in the loan application.
Ms. Dunham testified that with respect to self-employed borrowers, Millennium typically verified employment. Indeed, the Loan Application and the Certification Form permitted Millennium to request further information to document the representations made in the Loan Application, particularly when borrowers were self-employed. Ms. Dunham testified, however, that there was no additional documentation in the Loan records, and that it did not appear that Millennium verified any of the information provided by the Debtor on the Loan Application.
As a result, the bankruptcy court found that "[a]s a business experienced in subprime lending, Millennium should have known" that the Debtor's claim that he earned a "$9,500 monthly salary as the owner of an ambiguous `consulting' company" did not make sense and warranted further documentation. Order After Trial at 8. Accordingly, it found that Millennium did not justifiably rely on the Debtor's income and employment information as provided in the Loan Application.
Heritage argues on appeal that the bankruptcy court's assumption that a home business should have triggered further investigation of the Debtor's financial information was erroneous because "the converse is also true that home-based businesses are no less credible than ones conducted in a more traditional business setting." Appellant's Opening Br. at 15. However, Ms. Dunham testified that with respect to borrowers who were self-employed, Millennium's practice was typically to verify employment. We also reiterate that a factfinder's choice between two permissible views of the evidence cannot be clearly erroneous.
Given Ms. Dunham's testimony that Millennium's practice was to require further investigation or documentation when an application contained unusual financial information or self-employment, the bankruptcy court did not make an erroneous finding that Millennium should have conducted further investigation into the representations made by the Debtor on the Loan Application, and without doing so, it could not have justifiably relied on the Debtor's representations.
Reasonable reliance under § 523(a)(2)(B) focuses on whether reliance would have been reasonable to the hypothetical average person.
Again, a creditor is under no duty to investigate in order for its reliance to be reasonable. Furthermore, a creditor's reliance may be reasonable if it adhered to its normal business practices.
The bankruptcy court found that there were red flags that objectively warranted, even under a community standard, some minor investigation into the representations made by the Debtor on the Loan Application. Order After Trial at 8. It found that "Millennium should reasonably have understood that [the Debtor] was a greater risk for default than a better qualified borrower," and therefore should have required additional information to verify the Debtor's income and employment. Consequently, the bankruptcy court found that Millennium did not reasonably rely on the Debtor's representations in the Loan Application. After reviewing the evidence in the record, we conclude that the bankruptcy court's findings were not clearly erroneous.
Two separate representatives from Heritage (Ben Ganter and Mark Scheurman
Ms. Dunham also testified that there were general underwriting standards for subprime loans, which include verifying income if something appears "unusual," and, for self-employed applicants, verifying employment. These standards do not appear to have been applied with respect to the Debtor's Loan.
We reject Heritage's assertion that the industry practice is to rely solely on the representations in a loan application. The generalized forms that were used indicate there is an industry standard that requires borrowers to verify self-employment or other representations made in connection with a loan. Thus, the language used in the general forms signals that an ordinary prudent creditor does not, in every instance, rely solely on the information that the borrower provides on his application without ever conducting further investigation into the veracity of those representations.
As discussed above, the bankruptcy court found that red flags existed, which required an ordinary creditor to conduct further investigation. We perceive no error in that finding and accordingly, we also perceive no error in the bankruptcy court's finding that Heritage failed to prove the reasonable reliance element of § 523(a)(2)(B).
The Debtor made other arguments in his appellate brief: (1) the representations were not material; (2) Heritage's claims are barred by the California anti-deficiency statute, Cal. Code Civ. Proc. § 580(b);
Although standing is usually a jurisdictional issue that may not be waived, the Debtor's argument here regarding standing relates only to issues of prudential standing. Prudential standing requires the plaintiff to assert its own claims rather than the claims of another.
Because we conclude that the bankruptcy court did not err when it determined that Heritage failed to prove the Loan should be excepted from discharge under § 523(a)(2)(A) or (B), we AFFIRM.
The Bankruptcy Appellate Panel has indicated that an assignee's reliance, under certain circumstances and when not contested, may support a finding of reliance under § 523(a)(2)(B)(iii).
