Creditors' Failure To View Red Flags Not The Fault Of Bankruptcy Debtors

As we expected at the start of this recession, many creditors are becoming more desperate to challenge debtors’ bankruptcy discharge. A matter of fact, some creditors are becoming so desperate that they are presenting nonsensical arguments for denying a debtor’s bankruptcy discharge. In the recent Chapter 7 bankruptcy filing of a group of debtors who filed bankruptcy after the collapse of the real estate industry, a creditor challenged their discharge.  The creditors claimed that the debt should not be discharged in bankruptcy because the debtors pretended to be well-off when they weren’t and that they gave false values of the properties they were financing.

In addition, T2 asserts that the Debtors misrepresented in the Omnibus Closing Certificate & Affidavit that they and New Lineage were good credit risks. T2 asserts that the Debtors made this misrepresentation in order to deceive T2. T2 asserts that it relied on the Debtors’ misrepresentations by entering into the Note and accepting their guarantees and, therefore, the Debtors’ obligations on their guarantees are nondischargeable under § 523(a)(2)(A).

T2 has failed to establish by a preponderance of the evidence that it justifiably relied on the representations that the Debtors and New Lineage were in good financial condition in the Omnibus Closing Certificate & Affidavit. Mr. Thompson, the owner of T2, had in his possession contradictory information showing New Lineage to be insolvent. A person may not justifiably rely on a representation if “there are `red flags’ indicating such reliance is unwarranted.” In re Mercer, 246 F.3d 391, 418 (5th Cir. 2001).

The bankruptcy court definitely got it right this time.  Even if the debtors in this case made the claim that they were good credit risks when they weren’t, it is the responsibility of the creditors to look into the debtors’ finances to find the truth. It is not as if the debtor produced falsified financial records such as a fake bank account and credit report. They simply filed an affidavit saying they were in good financial condition and it is reasonable for the bankruptcy court to believe that they signed that affidavit believing that they were telling the truth. As for the “false” values giving for properties that were financed by the creditor-we are still in the middle of a recession with housing values halving in some parts of this country.  There is no way a creditor can win a denial of discharge during bankruptcy simply because a debtor’s home lost value.