Shaw Steel, Inc v. Morris, Hewlett E. ( 2000 )


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  • In the
    United States Court of Appeals
    For the Seventh Circuit
    No. 99-3800
    In re:
    Hewlett E. Morris, Jr.,
    a/k/a H. Edward Morris,
    Debtor-Appellee.
    Appeal of:    Shaw Steel, Inc.
    Appeal from the United States District Court
    for the Northern District of Illinois, Eastern Division.
    No. 99 C 2327--Elaine Bucklo, Judge.
    Argued May 31, 2000--Decided August 11, 2000
    Before Flaum, Chief Judge, and Bauer and
    Harlington Wood, Jr., Circuit Judges.
    Flaum, Chief Judge. Plaintiff Shaw Steel, Inc.
    appeals the district court’s decision affirming
    a bankruptcy court’s determination that defendant
    Hewlett E. Morris, Jr.’s (a/k/a H. Edward Morris)
    debt to Shaw Steel was not exempt from discharge
    under 11 U.S.C. sec. 523(a)(2)(B) of the United
    States Bankruptcy Code. For the reasons stated
    herein, we affirm the decision of the district
    court.
    I.   Background
    In 1993, Shaw Steel filed suit in the United
    States District Court for the Northern District
    of Ohio against O.L. Anderson Co. and defendant
    Morris, the Chairman of the Board and Chief
    Executive Officer of O.L. Anderson. In its
    complaint, Shaw Steel alleged that O.L. Anderson
    owed it money for materials that Shaw Steel had
    previously shipped to O.L. Anderson. Shaw Steel
    also alleged that Morris, in his capacity as a
    corporate officer for the company, had
    fraudulently induced Shaw Steel to extend credit
    to O.L. Anderson for the purchase of those
    materials.
    On September 1, 1993, the United States
    District Court for the Northern District of Ohio
    entered judgment in favor of Shaw Steel and
    against O.L. Anderson in the amount of
    $215,836.69 plus 10% interest on that amount from
    November 17, 1992. At the time this judgment was
    entered, Shaw Steel’s complaint against Morris
    was dismissed without prejudice. Subsequent to
    the entry of judgment in favor of Shaw Steel, and
    prior to the satisfaction of O.L. Anderson’s
    judgment debt to Shaw Steel, O.L. Anderson was
    dissolved without any money being paid to Shaw
    Steel.
    When O.L. Anderson was dissolved prior to the
    payment of its judgment debt to Shaw Steel, Shaw
    Steel again filed suit against Morris in the
    United States District Court for the Northern
    District of Ohio alleging the same fraud that was
    the subject of its first complaint. On July 26,
    1994, Shaw Steel signed a stipulated entry
    dismissing its case against Morris with prejudice
    and, on August 22, 1994, Shaw Steel and Morris
    executed a "Settlement Agreement and Mutual
    General Release" ("Settlement Agreement" or
    "Agreement"). This Agreement provided for the
    payment of $35,000 by Morris to Shaw Steel, and
    it contained a variety of representations as to
    Morris’s financial condition./1 The Agreement
    also incorporated an Affidavit of Financial
    Condition previously given by Morris to MNC
    Financial Group, a major lender to O.L. Anderson.
    As part of the Settlement Agreement, Morris
    consented to Shaw Steel’s investigation of the
    representations he made in that Agreement.
    Under the terms of the Settlement Agreement,
    Shaw Steel had the right to challenge the
    statements made by Morris in the Settlement
    Agreement as to his financial condition by
    commencing an arbitration proceeding. If Shaw
    Steel decided to commence such a proceeding, the
    sole issue to be arbitrated was the material
    accuracy of Morris’s representations. The
    Settlement Agreement also provided that if the
    arbitration terminated in Shaw Steel’s favor, a
    previously-agreed consent judgment in the amount
    of $215,000 could be filed in the United States
    District Court for the Northern District of Ohio.
    On July 13, 1995, Shaw Steel commenced
    arbitration proceedings pursuant to the
    Settlement Agreement after an investigation led
    it to believe that Morris’s statements as to his
    financial condition were false. Morris then filed
    suit in Michigan state court seeking to enjoin
    Shaw Steel from proceeding with the arbitration.
    This state court action was removed to federal
    district court and, after summary judgment was
    granted to Shaw Steel, the arbitration continued.
    On April 16, 1997, an arbitration panel ruled in
    Shaw Steel’s favor, finding that there were
    material inaccuracies in the representations made
    by Morris in the Settlement Agreement. This
    arbitration award was later confirmed by the
    United States District Court for the Northern
    District of Ohio and Shaw Steel’s consent
    judgment against Morris was entered.
    On December 23, 1997, Morris filed a voluntary
    bankruptcy petition under Chapter 7 of the
    Bankruptcy Code in the United States Bankruptcy
    Court for the Northern District of Illinois.
    Although Shaw Steel argued that the money owed to
    it by Morris pursuant to the arbitration award
    and consent judgment was not dischargeable in
    bankruptcy under 11 U.S.C. sec. 523(a)(2)(B), the
    bankruptcy court disagreed. The bankruptcy court
    held that Morris’s debt to Shaw Steel was
    dischargeable because Shaw Steel could not show
    that its reliance on Morris’s representations was
    reasonable. This determination was affirmed by
    the district court, and Shaw Steel now appeals.
    II.   Analysis
    "In the ordinary course of bankruptcy, the
    debtor’s assets are applied to the payment of his
    debts and, even though the assets will usually be
    insufficient to pay those debts in full, he will
    emerge from bankruptcy with the unpaid balance
    discharged . . . ." McClellan v. Cantrell, 
    2000 WL 876933
    , at *1 (7th Cir. July 5, 2000). In this
    case, however, Shaw Steel contends that Morris’s
    debt is exempt from a general discharge under
    Chapter 7. Specifically, Shaw Steel argues that
    because Morris’s debt stems from his fraudulent
    misrepresentations as to his financial condition,
    that debt is excepted from discharge under 11
    U.S.C. sec. 523(a)(2)(B). See, e.g., FDIC v.
    Meyer (In re Meyer), 
    120 F.3d 66
    , 68 (7th Cir.
    1997) (stating that "debts [that] can survive
    [bankruptcy] whole despite a general discharge"
    include "those that a debtor incurred with the
    aid of fraud and deceit"). In considering the
    bankruptcy court’s determination that Shaw Steel
    did not reasonably rely on Morris’s statements
    regarding his financial condition, we recognize
    that "’exceptions to discharge are to be
    constructed strictly against a creditor and
    liberally in favor of the debtor.’" Goldberg
    Securities, Inc. v. Scarlata (In re Scarlata),
    
    979 F.2d 521
    , 524 (7th Cir. 1992) (quoting In re
    Zarzynski, 
    771 F.2d 304
    , 306 (7th Cir. 1985)). We
    review the bankruptcy court’s legal conclusions
    de novo and its factual findings for clear error.
    See In re A-1 Paving & Contracting, Inc., 
    116 F.3d 242
    , 243 (7th Cir. 1997).
    The statutory provision at issue in this case,
    section 523(a)(2)(B) of the Bankruptcy Code,
    provides that:
    A discharge . . . does not discharge an
    individual debtor from any debt--for money,
    property, services, or an extension, renewal, or
    refinancing of credit, to the extent obtained by-
    -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 . . . .
    11 U.S.C. sec. 523(a)(2)(B); see also In re
    McFarland, 
    84 F.3d 943
    , 946 (7th Cir. 1996); In
    re Sheridan, 
    57 F.3d 627
    , 633 (7th Cir. 1995)
    ("In order to prevail on a claim under 11 U.S.C.
    sec. 523(a)(2)(B), a creditor must prove . . .
    that a debtor made, with an intent to deceive, a
    materially false written statement regarding his
    financial condition and that the creditor relied
    on that statement."). Under section 523(a)(2)(B),
    Morris’s debt to Shaw Steel is presumed to be
    dischargeable, see 
    McFarland, 84 F.3d at 946
    ,
    unless Shaw Steel can demonstrate by a
    preponderance of the evidence that the debt meets
    the requirements of the statutory exception, see
    Grogan v. Garner, 
    498 U.S. 279
    , 291 (1991); In re
    Thirtyacre, 
    36 F.3d 697
    , 700 (7th Cir. 1994).
    The issue in dispute between Morris and Shaw
    Steel centers on the reasonableness element of
    section 523(a) (2)(B)’s reliance requirement. See
    11 U.S.C. sec. 523(a)(2) (B)(iii); see also Field
    v. Mans, 
    516 U.S. 59
    , 68 (1995) (stating that, in
    contrast to the less-demanding justifiable
    reliance standard applied in section 523(a)(2)(A)
    cases, "[s]ection 523(a)(2)(B) expressly requires
    . . . reasonable reliance . . ."). The district
    court held that the bankruptcy court correctly
    found that Morris’s debt to Shaw Steel did not
    qualify for an exemption from discharge on the
    ground that Shaw Steel did not reasonably rely on
    the representations Morris made in the Settlement
    Agreement as to his financial condition. In
    reaching this conclusion, the district court
    found it significant that Melvin Morris, Vice
    President of Shaw Steel, testified that he had
    "reservations" about Morris’s honesty and that he
    did not know whether the statements made by
    Morris in his affidavit were true or false. The
    district court also noted that Howard Klein, Shaw
    Steel’s investigator, stated that both Melvin
    Morris and Harry Sulzer, the President of Shaw
    Steel, did not believe the representations in
    Morris’s affidavit. Moreover, as the district
    court recognized, Morris’s past dealings with
    Shaw Steel gave the company good reason to doubt
    his veracity. According to the district court,
    Shaw Steel could not have reasonably relied on
    Morris’s affidavit absent prior investigation in
    light of the legitimate doubts its officers
    admitted having as to the representations made by
    Morris in the Settlement Agreement.
    Although Shaw Steel acknowledges its burden to
    establish that it reasonably relied on Morris’s
    statements, it contends that the bankruptcy court
    applied too strict a standard of reasonableness.
    In support of this argument, Shaw Steel cites
    prior judicial interpretations of the
    reasonableness standard, including a decision of
    this Court in which we stated that
    "reasonableness is circumstantial evidence of
    actual reliance" and that a creditor should not
    be denied protection against discharge unless the
    "creditor’s claimed ’reliance’ on a ’financial
    statement’ would be so unreasonable as not to be
    actual reliance at all." Northern Trust Co. v.
    Garman (In re Garman), 
    643 F.2d 1252
    , 1256 (7th
    Cir. 1980)./2 Shaw Steel further notes that one
    of our sister circuits, relying in part on our
    decision in Garman, has stated that "[a] district
    court reviewing a bankruptcy court’s
    determination of reasonable reliance is not ’to
    undertake a subjective evaluation and judgment of
    a creditor’s lending policy and practices.’" Bank
    One, Lexington, N.A. v. Woolum (In re Woolum),
    
    979 F.2d 71
    , 76 (6th Cir. 1992) (quoting 
    Garman, 643 F.3d at 1256
    ). According to Shaw Steel, the
    bankruptcy court erred in its reasonableness
    determination because it failed to recognize that
    "the reasonableness requirement of sec. 523(a)
    (2)(B) ’cannot be said to be a rigorous
    requirement, but rather is directed at creditors
    acting in bad faith.’" 
    Woolum, 979 F.2d at 76
    (quoting Martin v. Bank of Germantown (In re
    Martin), 
    761 F.2d 1163
    , 1166 (6th Cir. 1985)).
    Although we agree with Shaw Steel’s analysis of
    the relevant precedent and its assertion that
    district courts are not to use the reasonable
    reliance requirement of section 523(a)(2)(B) to
    second-guess a creditor’s lending decisions, we
    cannot conclude that the district court clearly
    erred in finding that Shaw Steel did not
    reasonably rely on Morris’s representations as to
    his financial condition, see Fed.R.Bank.P. 8013
    (mandating a clearly erroneous standard of review
    for a bankruptcy judge’s findings of fact); In re
    Bonnett, 
    895 F.2d 1155
    , 1157 (7th Cir. 1989)
    ("[A] bankruptcy court’s determination of
    dischargeability is subject to a clearly
    erroneous standard of review.") (citing Prairie
    Prod. Credit Ass’n v. Suttles (In re Suttles),
    
    819 F.2d 764
    , 765 (7th Cir. 1987)). "The
    reasonableness of a creditor’s reliance should be
    determined on a case by case basis," 
    Bonnett, 895 F.2d at 1157
    (citation omitted), and the
    bankruptcy court should not be "overturned
    ’simply because [the appellate court] is
    convinced it would have decided the case differently.’"
    
    Id. (quoting Anderson
    v. City of Bessemer City,
    
    470 U.S. 564
    , 573 (1985)). Rather, "’[w]here
    there are two permissible views of the evidence,
    the [bankruptcy court’s] choice between them
    cannot be clearly erroneous.’" EEOC v. Sears,
    Roebuck & Co., 
    839 F.3d 302
    , 309 (7th Cir. 1988)
    (quoting 
    Anderson, 470 U.S. at 575
    ). "Under the
    ’abuse of discretion’ standard of review, the
    relevant inquiry is . . . whether any reasonable
    person could agree with the [bankruptcy] court."
    Deitchman v. E.R. Squibb & Sons, Inc, 
    740 F.2d 556
    , 563 (7th Cir. 1984).
    In this case, the bankruptcy court determined
    that both the President and Vice-President of
    Shaw Steel had serious doubts about the truth of
    Morris’s statement of his financial condition, a
    conclusion that was based largely on the
    bankruptcy court’s observation of the witnesses
    and their testimony. See 
    Bonnett, 895 F.2d at 1157
    (stating that appellate courts should give
    particular deference to the bankruptcy court’s
    evaluation of witness testimony). The bankruptcy
    court further found that Shaw Steel’s concerns
    about Morris’s veracity were justified by the
    company’s past dealings with Morris. In spite of
    its questions as to Morris’s truthfulness,
    however, Shaw Steel entered into a Settlement
    Agreement with Morris without engaging in any
    attempt to ascertain Morris’s true financial
    condition. While we understand that the concept
    of reasonable reliance does not generally require
    creditors to conduct an investigation prior to
    entering into agreements with prospective
    debtors, such a precaution could be the
    ordinarily prudent choice in circumstances where
    the creditor admits that it does not believe the
    representations made by the prospective debtor.
    See Coston v. Bank of Malvern (In re Coston), 
    991 F.2d 257
    , 261 (5th Cir. 1993) (stating that when
    determining reasonable reliance, "[t]he
    bankruptcy court may consider, among other
    things: whether there had been previous business
    dealings with the debtor that gave rise to a
    relationship of trust; whether there were any
    ’red flags’ that would have alerted an ordinarily
    prudent lender to the possibility that the
    representations relied upon were not accurate;
    and whether even minimal investigation would have
    revealed the inaccuracy of the debtor’s
    representations"). Under these circumstances, the
    bankruptcy court’s determination was a
    permissible one, and we cannot conclude that the
    court clearly erred in finding Shaw Steel’s
    reliance unreasonable.
    III.   Conclusion
    Because we determine that the bankruptcy court
    did not clearly err in finding that Shaw Steel’s
    reliance on Morris’s representations was not
    reasonable, we AFFIRM the decision of the district
    court.
    /1 Paragraph 4 of the Settlement Agreement stated
    that:
    The parties acknowledge that this Agreement has
    been entered into, in part, based upon the
    following representations, only:
    a. Those contained in the Affidavit of Financial
    Condition attached hereto and incorporated herein
    as Exhibit B; and
    b. That Defendant’s personal financial condition
    has not materially changed since his execution of
    the Affidavit of Financial Condition;
    c. That to the best of Defendant’s knowledge,
    there are no trust agreements in existence in
    which Defendant, his wife, nor any member of his
    immediate family has any present or future
    interest; and
    d. That Defendant has not been released of any
    liability he has to MNC related to its loans to
    O.L. Anderson Company, a Delaware corporation.
    /2 Although Garman involves the interpretation of
    section 17(a)(2), the predecessor statute to
    section 523(a)(2)(B)(iii), that case’s
    interpretation of reasonable reliance applies
    with equal force to section 523(a)(2)(B)(iii)
    because "Congress clearly indicated that section
    523(a)(2)(B)(iii) is merely a codification of the
    cases construing section 17(a)(2)." First Nat’l
    Bank of Lansing v. Kreps (In re Kreps), 
    700 F.2d 372
    , 376 (7th Cir. 1983).