National Union v. Scott Philo CV-94-554-L 07/20/95

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

In Re National Union Fire Insurance Company of Pittsburgh Pa.

v. #C-94-554-L

Scott Philo Defendant.

ORDER ON BANKRUPTCY APPEAL

This matter is on appeal from the United States Bankruptcy

Court for the District of New Hampshire. The appeal is from a

final judgment (Yacos, J.) entered in favor of the debtor on

September 2, 1994.

The underlying case is an adversary proceeding brought in

accordance with Bankruptcy Rules 4007(e) and 7001(6).

conferred jurisdiction and the matter was a core

proceeding pursuant to

(b)(2)(I).

Plaintiff appeals pursuant to Bankruptcy Court Rule 801 (a) .

Plaintiff is appealing from the court's order granting defend­

ant's motion for a directed verdict. This appeal was timely

filed by the plaintiff on October 3, 1994 in accordance with the

Bankruptcy's Court's order granting an extension of time within

which to do so.

Both parties agree on the statement of appellate issues

presented for review and the standard of review which are incorporated in this order.

The first issue presented for consideration is whether the

trial judge erred in ruling that plaintiff National Union failed

to prove actual reliance on the fraudulent financial statements

submitted by Scott Philo in bonding his obligations under the

Barrick Westwood Limited Partnership and the Barrick Atlanta I

Limited Partnership. In reviewing this issue, the bankruptcy

court's findings of fact will not be set aside unless clearly

erroneous. Bankruptcy Rule 8013; In re Earls ,

(W.D.

Mo. 1987). The bankruptcy court's rulings of law are subject to

de novo review.

The second issue is whether the trial judge erred in ruling,

in the alternative, that any reliance on said financial

statements was not reasonable. Again the standard of review is

that the bankruptcy court's findings of fact will not be set

aside unless clearly erroneous, and the court's rulings of law

are subject to de novo review. Bankruptcy Rule 8013; In re

Earls,

.

Finally for consideration is whether the plaintiff is

entitled to a ruling that Philo's debt to it is non-dischargeable

pursuant to

(a) (2) (B) . The standard of review is

that the bankruptcy court's findings of fact will not be set

aside unless clearly erroneous, and the court's rulings of law

2 are subject to de novo review. Bankruptcy Rule 8013; In re

Earls,

.

STATEMENT OF THE CASE

The plaintiff has appealed from a final judgment of the

United States Bankruptcy Court for the District of New Hampshire,

in which the court granted the defendant debtor's motion for a

directed verdict after the close of plaintiff's case.

Scott L. Philo and his wife Bonnie M. Philo (Philo) filed a

Chapter 11 bankruptcy petition on January 28, 1992. The case was

converted to Chapter 7 on August 19, 1992.

The underlying adversary proceeding was originally filed

against Philo on May 11, 1992 with a First Amended Complaint

filed on June 16, 1992. National Union sought a ruling that

pursuant to

(a)(2)(B) Philo's debt to it in the

amount of $174,212.98, secured by a judgment entered in the

United States District Court for the Southern District of New

York on December 21, 1991, was non-dischargeable.

Philo's obligations to plaintiff National Union arose out of

his investment in two limited partnerships known as the Barrick

Limited Partnership (Barrick Westwood) and the Barrick Atlanta I

Limited Partnership (Barrick Atlanta).

Philo's investments in these limited partnerships came about

3 after he reviewed a prospectus and then filled out a confidential

form (financial statement). These documents were provided by a

broker, named Margaret, employed by Buttonwood Securities in

Salem, New Hampshire.

The first limited partnership that Philo invested in was

Barrick Westwood. Philo signed the financial statement

pertaining to Barrick Westwood on September 9, 1983.

On November 8, 1983 Philo signed the financial statement

pertaining to Barrick Atlanta.

Philo's ownership interest in the two limited partnerships

was purchased for the sums of $108,000.00 and $118,000.00

respectively.

Philo executed promissory notes obligating him to pay his

obligations thereunder. To obtain additional security for

payment of these notes, Barrick Westwood and Barrick Atlanta

obtained bonds guaranteeing payment. The bond endorsement was

signed on November 29, 1983 by the plaintiff. Philo's name was

added by National Union to the two financial guaranty bonds at

issue by endorsement following Philo's execution of two separate

indemnification and pledge agreements promising to reimburse

National Union for any amounts that it paid as a result of

default by the defendant.

Philo defaulted in his payments on the two promissory notes.

4 and National Union did, as required, make payments as guaranteed

by its agreement.

During the trial before Judge Yacos plaintiff's position,

simply stated, was that the bonds were issued by it in reliance

upon Philo's financial statements which turned out to be

fraudulent.

Plaintiff's counsel called Philo to the stand and he

testified that he signed the financial statements in blank. He

claimed he was too busy to complete the form. Philo also stated

that he instructed Margaret, the broker, to meet with his

accountant by agreement to obtain the information to complete the

form. The accountant was not called by plaintiff's counsel as a

witness which is understandable. As defendant's motion for

directed verdict was granted, defendant had no need to produce

any witnesses.

In his September 9, 1983 financial statement, Philo

represented his adjusted gross income to be as follows:

1981 $75,000.00

1982 $75,000.00

1983 (projected) $150,000.00.

Defendant's federal income tax returns filed jointly with

his wife, Bonnie Philo, represented the Philo's joint gross and

adjusted gross income for 1981, 1982 and 1983 as follows.

5 1981 gross income $474.00

1981 adjusted gross income $474.00

1982 gross income $27,543.00 adjusted gross income the

same.

1983 gross income $86,305.00

1983 adjusted gross income $86,105.00

Variance between the 1981 financial statement and gross

income evidenced by the tax return is $74,526.00.

Variance between the 1982 financial statement and gross

income evidenced by the tax return is $47,457.00.

Variance between projected 1983 financial statement and

gross income evidenced by the tax return is $78,695.00. Philo,

in his September 9, 1983 balance sheet listed total liabilities

of $133,000.00, net worth $1,942.00.

One of the difficulties plaintiff had in presenting its case

was its inability to produce a witness from the company in the

year 1983 when these transactions took place. Israel Silverman,

an underwriter for National Union, testified relative to making

underwriting decisions concerning bonding investors in limited

partnerships from 1984 through 1987. He testified in essence

that in underwriting each individual investor. National Union

would make sure that each limited partner was capable of repaying

his or her obligation in the event of default. Underwriters

6 would have to rely upon the accuracy of the financial statements

submitted by the investors. He further testified that Philo

would not have been bondable at the levels of his income as

evidenced by federal income tax returns for the years in

question.

Defendant's counsel ably brought forth the fact that

Silverman did not know what documentation if any, the National

Union underwriter had in his or her possession at the time the

decision was made to add Philo's name to the list of limited

partners whose notes were guaranteed by National Union's bond.

There was also a hiatus in the evidence as to the manner or dates

on which the completed financial statements were transmitted by

the Salem stockbroker to the limited partnerships in Atlanta,

Georgia. Judge Yacos was concerned about the fact that National

Union had no system to date stamp or otherwise record the date on

which the questionnaire forms were received by National Union.

Further, National Union did not have the original applications in

its files.

DISCUSSION

Judge Yacos orally granted defendant's motion for a directed

verdict from the bench.

The judge stated that § 523(a)(2) requires actual reliance

upon the financial statement in question.

7 "The bankruptcy court's findings of fact will not be

disturbed unless 'clearly erroneous.1" In re Earls,

(citing In re Martin,

, 474 (8th Cir. 1985).

The judge conceded for the present motion, or at least the

court would assume, that on a full trial the debtor would be

shown to have provided a financial statement that was materially

false and that the debtor caused it to be made or published with

intent to deceive.

The court went on to state that the exhibits dated Septembe

9, 1983 and November 8, 1983 were both dated prior to the actual

action by the plaintiff indicating that this particular investor

on these investments could be added to the list of bonded

investors under their transaction and agreement with the

partnership. The court added.

The exhibits, however, do not show any receipt date by the plaintiff itself, and the normal inference that they would have received them prior to the--prior to the action that they took is not in this case and these particular facts justifiable in my judgment, inasmuch as the evidence indicates first that these had to be routed through the broker and the partnership; and, secondly, that by the plaintiff's own testimony, the plaintiff engaging in--engaged in this process and had thousands and thousands of such transactions going through its offices to the point which it could-- couldn't check each and every application for any inconsistencies and so forth because of the sheer volume of investors that it was dealing with at a given time. While, as I say the seguence would normally infer that the document was received before the action was taken by the financial institution, that inference here on a preponderance of evidence basis I do not think is established, and that is the burden that the plaintiff has to meet in establishing nondischarge­ ability of a debt. That being the case, the motion for directed verdict should be granted and will be granted on that ground alone.

The court went on to add that the document was received

before the approval of adding his name to the bonded investor

list was done, the plaintiff had it in his possession and relied

on it. The reliance was not reasonable in view of the various

discrepancies in the financial statements. The bond endorsement

was signed on November 29, 1983.

The plaintiff must prove by a preponderance of the evidence

that the following elements under §523(a)(2)(B) justified a

ruling of non-dischargeability:

(1) A debt for money, or an extension, renewal or

refinancing of credit, obtained by (2) Defendant's use of a

statement in writing, (3) that is materially false, (4)

respecting debtor's or an insider's financial condition, (5) on

which statement plaintiff reasonably relied, and (6) which

statement debtor caused to be made or published with intent to

deceive.

In In re Martz,

(Bankr. E.D.Pa. 1988), the

Debtors argued that "they did not 'cause' the Statement 'to be made or published' within the meaning of § 523(a)(2)(B)(iv),

since the Statement was prepared by some person other than the

Debtors." However, the court generally recognized that a writing

is "published" under § 523(a)(2)(B)(iv) if it is either written

by the debtor, signed by the debtor, or used and adopted by the

debtor. Id.

"A financial statement is materially false if it contains an

important or substantial untruth." National Union Fire Ins. Co.

v. Main (In re Main),

(Bankr. W.D.Pa. 1991).

"A relevant factor in determining materiality is whether the

creditor would have agreed to the transaction had it been aware

of the debtor's true financial situation." JCd. (citing Matter of

Boqstad,

(7th Cir. 1985)).

An incorrect or erroneous financial statement is not

necessarily materially false. L. King, Collier on Bankruptcy,

Par. 523-09 at 523-52 45th ed. Supp. 1962. A materially false

statement is one which paints a substantially untruthful picture

of a financial condition by misrepresenting information of the

type which would normally affect the decision to grant credit.

In re Hunt,

(M.D.Tenn. 1983). "A financial

statement which markedly overstates the value of a person's

assets, so as to distort his financial picture must be considered

materially false." In re Denenberq,

(Bankr. D.

).

The objecting creditor has the burden of proof, pursuant to

Bankruptcy Rule 4005 and must prove each element of § 523(a) (2),

by a showing of clear and convincing evidence (note law has been

changed to a preponderance of the evidence) before its debt will

be excepted from discharge. In re Brown,

(Bankr. E.D.N.Y. 1986).

An intent to deceive will be inferred where a person

knowingly or recklessly makes a false representation which a

person knows or should have known will induce another to make a

loan.

.

"Direct proof of actual reliance is difficult to obtain. As

a result, courts customarily have found that actual reliance may

be proven by circumstantial evidence." In re Myers,

(Bankr. S.D.Ohio 1991). "[PJartial reliance on a false

representation in connection with an extension of credit is

sufficient to prevent the discharge of the underlying debt." In

re

.

"A directed verdict should not be granted for a defendant

'if there is evidence reasonably tending to support the recovery

by plaintiff as to any of its theories of liability.1" Flynn v.

Bass Brothers Enters.,

, 983 (3d Cir. 1984) (citing

Dougherty v. Hooker Chemical,

, 178 (3d Cir. 1976)).

11 In determining whether a directed verdict is appropriate, a

court must construe the evidence and all inferences therefrom in

the light most favorable to the non-moving party. TK-7

Corporation v. Estate of Barbouti,

, 723 (10th Cir.

1993) .

In the case at hand, the plaintiff did not have to prove its

case by clear and convincing evidence. Rather, the standard is a

preponderance of the evidence and Judge Yacos astutely applied

the not so onerous standard.

This court opines that a directed verdict should not have

been granted in this case. Defendant's argument that he signed

the financial statement in blank does not militate for a verdict

in his favor. See In re

The debtor was instrumental in providing the information

through his accountant and cannot disclaim at the time of trial

that he had no knowledge of what his accountant provided to the

plaintiff's underwriters. The debtor had to be the primary

source of the financial information disclosed to his accountant.

The debtor was not a neophyte in the business world. He was

running his own business at the time. It stretches credibility,

busy or not, to assume that he never reviewed or had the

opportunity to review the completed financial statement

especially where he had incurred an initial obligation of

12 $226,000.00.

On the other side of the coin, the plaintiff had the

untoward situation, which is understandable over a period of

eleven years, of not being able to present at trial an

underwriter conversant with the procedures. Silverman was hired

in 1984 and could testify as to the custom or habit of his

employer for the prior year.

I also disagree with my learned colleague's opinion that

sufficient time did not transpire from November 8, 1983 until

November 29, 1983 for the documents to wend their way from Salem,

New Hampshire to Atlanta, Georgia and then on to plaintiff's

underwriting office in Pittsburgh, Pennsylvania a total of

twenty-one days.

While it is conceded by the plaintiff that a plethora of

transactions went through its offices in 1983, this transaction

involved almost a guarter of a million dollars and good business

practice would not assume that it was rubber stamped without

examining debtor's financial statement. Another consideration as

heretofore stated is the eleven years which have transpired from

the date of the original bond and the trial in bankruptcy court,

and the difficulty over the period of time to have accurate

records as date stamping, etc..

It is pristine to this court that the plaintiff reasonably

13 relied on the financial reports in making its decision to bond

the debtor. There was a negative differential on the combined

1981, 1982 income tax returns filed by the debtor and the

projected 1983 income of $86,305.00 of $185,678.00. The

differential in debtor's total liabilities and not his

worth is an astronomical $1,809,000.00.

The case is remanded for further proceedings consistent with

the opinion of this court to allow the debtor an opportunity to

present his case.

July 20, 1995

Martin F. Loughlin Senior Judge Charla Bizios Labbe, Esg. Jeffrey A. Schreiber, Esg. George Vannah, U.S. Bankruptcy Court

14