ROBERT E. NUGENT, Bankruptcy Judge.
Debt obtained by fraud is, upon appropriate proof, excepted from a debtor's discharge, even if the note evidencing the debt is canceled by the debtor executing a renewal and consolidation note. Here, Southwind Bank renewed a series of term loans it made to the debtor to finance a construction project by renewing and consolidating them into one note with monthly payments. The Bank responded to the debtor's chapter 13 filing by filing an adversary proceeding alleging that the underlying debts had been "obtained by" the debtor's fraudulent conduct and seeking to except those debts from his discharge. The debtor argues that the renewal and cancelation amount to a novation of the previous debts that cleanses them of their allegedly fraudulent nature. The fact that debtor's payment obligations have changed does not, in the absence of other proof in the summary judgment record, change the nature of the underlying debt itself. The debtor's motion for summary judgment is denied.
The final pretrial order includes a list of stipulated facts that, along with other uncontroverted facts established by the motion and response, may be summarized as follows. In February of 2013, Carl Denning applied for a loan to fund his proposed rebuilding and conversion of an old stone barn into a house. Under his agreement with the Bank, Denning granted the Bank a mortgage on the real estate and the barn and, pursuant to the parties' agreement, he was to submit loan draw requests to the Bank that itemized the labor and materials to be paid for with loan proceeds. He made a series of requests and, in September of 2013, asked for an increase in his line of credit. The Bank agreed. By March of 2014, he owed the Bank $194,786.25. After bank officers visited the site and viewed the progress of the work, the Bank asked Denning to execute a new promissory note that renewed and consolidated the previous construction notes into one loan to be repaid in monthly payments.
The additional uncontroverted facts are that, from the beginning of the construction loan transaction in 2013, Denning signed a series of notes. After the Bank's officers were prompted to inspect the premises in March of 2014, the Bank decided that the loan proceeds had not been applied to the project, prompting the Bank to consolidate the notes into one instrument. The parties dispute whether the Bank's March 2014 inspection was prompted by Denning's request for more money or by something an officer learned from a realtor's Facebook post. There is also a dispute about how the Bank may have benefitted from the consolidation: Denning says the renewal replaced the loans in good standing on the Bank's call list; the Bank says that substituting a consolidated monthly payment note for several term loans protected the Bank's financial interests. Neither dispute materially affects the legal issue posed by this motion.
To prevail on summary judgment, Denning must show that there are no disputed material facts and that he is entitled to judgment as a matter of law.
Denning argues that the consolidated renewal note was a novation that replaced his old debts with one new one. As the Bank doesn't suggest that this new debt was "obtained by" fraud, it cannot be an exception to Denning's discharge. The Bank responds that the consolidated note evidences the same debts that the debtor obtained through his bad conduct, just in a different form.
Section 523(a)(2)(A) of the Bankruptcy Code excepts a "debt" from a debtor's discharge if it was "obtained by" false pretenses, false representations, or actual fraud.
A novation occurs when a new debt is substituted for an existing one and the existing obligation is released, thereby extinguishing the old debt.
The manner or form that a debt takes does not change the nature of the debtor's previous dealings, at least for dischargeability purposes.
Years later, in Archer v. Warner, the Court again faced this issue, this time arising under § 523 of the current Bankruptcy Code.
The Supreme Court reversed, holding that even though the settlement agreement, releases, and promissory note "completely released each and every underlying state law claim," the debt remained one "for money obtained by fraud, within the terms of the nondischargeability statute."
Here, there has been no "prior proceeding." All the Bank did was renew and consolidate the old debts into one instead of calling and enforcing them. At best, the consolidated note recast the contractual terms of repayment. The fact that the original debt was renewed in this case as opposed to compromised as in Archer, is a distinction without a difference for the purpose of determining dischargeability. Brown and Archer teach that resolving the means of repaying a fraudulently obtained debt is not the same as determining that the fraud itself did not occur.
This matter remains set for trial on July 17, 2017.