Debtors entitled to discharge where they were not complicit in the fraud committed by their agent on their behalf, according to the Seventh Circuit

Sullivan v. Glenn, No. 14-3213 (7th Cir. Apr. 2, 2015) presented two questions of bankruptcy law: whether, if a debt is the result of fraud, the debtor can discharge the debt in bankruptcy if he was not complicit in the fraud; and whether he can discharge the debt even if the fraud was created by his agent. Defendants were real estate developers who asked a loan broker to arrange a short term loan. The broker brought in a lawyer to lend the money repayable in a few weeks with interest of $5,000 per week. Defendants needed the money for more than a few weeks, but the broker told them and the lawyer that a bank had agreed to give Defendants a $1 million line of credit in a few weeks. At the closing, the lawyer asked about the status of the bank loan and the broker told the lawyer and the Defendants that the bank had approved the line of credit. In fact, the line of credit had not even been applied for. The loan, of course, was never repaid. Defendants declared bankruptcy and the lawyer filed adversary complaints arguing that Defendants were not entitled to discharge the debt because it was the broker’s fraudulent assurance that had induced him to make the loan. The bankruptcy judge found that Defendants had not committed fraud and he refused to impute the broker’s fraud to them under an agency theory. He also rejected the alternative argument that if a debt is a product of fraud even the debtor’s complete innocence is no defense to nondischargeability. The bankruptcy court’s ruling was affirmed on appeal. The Appeals court was quick to point out that the debt not the debtor theory makes no sense. It would be a form of attainder: an innocent person punished for the misdeed of an ancestor, or in this case an assignor. Although it found that the lawyer’s agency theory had greater promise it too was ultimately rejected. The issue is not one of a principal’s liability for an agent’s misrepresentation, but whether the agent’s fraud is grounds for denying a discharge in bankruptcy. The lawyer simply had no proof Defendants knew or should have known of the fraud. The court had some particularly harsh words to say about the lawyer’s conduct and motives observing that he was in as good a position as Defendants to have detected the fraud. All he would have had to do – and should have done anyway, as a matter of elementary precaution – before making a $2000 loan was to call the bank for verification that the [Defendants’] line of credit – the sine qua non of his being assured of repayment of his bridge loan – had been approved. Instead, the lawyer was only too eager to make the loan because it constituted a very lucrative opportunity (carrying an annual interest rate of 104%). And in agreeing to make the loan the lawyer was relying not only on the broker’s being the borrowers’ agent but also on his friendship with her. He may have been trusting her more as a friend than as the [Defendants’] agent.

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