Appeal from the United States District Court for the Eastern District of Pennsylvania. (D.C. No. 91-cv-06073).
Before: Stapleton, Greenberg and Cowen, Circuit Judges.
Insurance Company of North America ("INA") objects to the discharge in bankruptcy of a debt owed to it by David Cohn. This appeal turns on the proper interpretation of 11 U.S.C. § 523(a)(2)(B). The bankruptcy court concluded, and the district court affirmed, that INA did not meet its burden of proving that it reasonably relied upon a materially false statement contained in an investor bond application submitted by Cohn, and the debt was therefore dischargeable. Because the bankruptcy court based its decision upon facts that were not in the record, and because the district court acted beyond its authority in making its own factual findings, we will remand the case to the district court with instructions to remand to the bankruptcy court for further fact-finding.
Between September 1984 and September 1985, David Cohn was involved in a business relationship with a financial consultant, Christopher Scutto, an employee of Cigna Individual Financial Services Company ("Cigna Financial Services"). Cohn became interested in a limited partnership known as The Village Apartments Associates Ltd. ("Village Apartments"). In order to become a limited partner, Cohn was required to sign a promissory note for his share, and to obtain a surety for the note. On September 12, 1985, Cohn submitted an investor bond application ("the application") to INA, requesting INA to act as a surety on a promissory note in the principal amount of $47,500 which was to be executed between Cohn, as obligor, and the Bank of New York, as obligee.
Cohn relied upon Scutto and his staff to fill out the application and related documentation based upon financial and other information that Cohn had provided to Scutto over the previous year. After Scutto completed the application, Cohn reviewed it (though he contends that he did not read each page of the various documents), and signed it.
At the top of the application, the first paragraph read:
FOR THE PURPOSE OF PROCURING CREDIT OR GUARANTEE OF CREDIT FROM INSURANCE COMPANY OF NORTH AMERICA (SURETY), THE UNDERSIGNED FURNISH THIS APPLICATION AND THE INFORMATION CONTAINED THEREIN INCLUDING A TRUE AND ACCURATE STATEMENT OF THE UNDERSIGNED'S FINANCIAL CONDITION AS OF THE DATE OF THIS APPLICATION.
Item 9 on the second page of the application requested that the applicant list "Real Estate Registered in own name," and instructed, "See Sched. No. 5." Scutto indicated in Item 9 that Cohn had real estate valued at $110,000. Schedule No. 5 required as follows: "The legal and equitable title to all the real estate listed in this statement is solely in the name of the undersigned, except as follows: . . . ." Two blank lines were then provided for entries by the applicant. Also in Schedule No. 5, immediately below the two blank lines, the application provided a table for the applicant to fill out, requesting information regarding, inter alia, the description, dimensions, improvements, mortgages or liens, and assessed value of each property. It is not clear from the application whether this information was requested only regarding real estate not solely in applicant's name, or all real estate to which the applicant holds legal and equitable title. Neither the two blank lines nor the table were filled in on Cohn's application.*fn1
Cohn admits that at the time that he signed the application, he did not own real estate valued at $110,000 registered in his own name. Cohn testified that before he signed the application, he was assured by Scutto that using the ultimate value of the asset he was seeking to purchase as part of his present net worth, when applying for credit to purchase that very same asset, was "an accepted procedure." Scutto testified that such a practice was followed by other individuals in his office.
Scutto submitted the application to INA in October 1985, and it was accepted later that month. In the interim, INA made no inquiry of Cohn or his financial consultant regarding any aspect of the real estate questions in the application, including the listing of real estate registered in Cohn's own name and the absence of any mortgages, liens or other indebtedness as reflected in Schedule No. 5. INA did obtain information from a credit report that indicated that Cohn had no mortgage, real estate payments, or other indebtedness.
INA became the surety for the promissory note and Cohn became a limited partner in the Village Apartments. Scutto was compensated for the sale by Village Apartments. Cohn executed an indemnification agreement under which Cohn agreed to indemnify INA against any loss INA might incur in the event that Cohn defaulted on the promissory note. Thereafter, Cohn defaulted on the note and a claim was made against INA based upon the investor bond. Cohn later filed a Chapter 7 proceeding under the provisions of the Bankruptcy Code, and listed INA in his schedule of creditors whose debts were to be discharged. INA filed a complaint with the bankruptcy court seeking an exception to Cohn's discharge for the indebtedness arising from this transaction.
The bankruptcy court found that INA did not meet its burden of proof to demonstrate that it reasonably relied on a materially false statement when it accepted Cohn's application and refused to exempt Cohn's indebtedness to INA from discharge. Insurance Company of North America v. Cohn (In re Cohn), 131 Bankr. 19 (Bankr. E.D. Pa. 1991). While finding that Cohn's application contained a materially false statement regarding his financial condition, the bankruptcy court based its ultimate Conclusion on its finding that Cigna Financial Services is the parent company of INA. The court found "troublesome" that INA was "attempting to have a debt declared nondischargeable based upon the fraud masterminded by an employee of its own parent company." Id. at 21. The bankruptcy court held that "any reliance placed upon the application by INA was done at its own risk and must be found unreasonable." Id. Further, the court concluded that INA must be estopped from having the debt found nondischargeable because it had "unclean hands" in that an "employee of INA's parent company" was the ultimate source of the wrongdoing. Id. at 21-22.
The district court affirmed the order of the bankruptcy court, but on different grounds. It found that INA did not reasonably rely on the statement in Item 9:
in that the most reasonable reading of [Schedule No. 5] is that it provides blank lined spaces for the applicant to note which scheduled properties are not held solely in his name but otherwise requires the applicant to specify, inter alia, the location, dimensions, liens against and assessed value of each property and indeed it being illogical to assume that a lender or guarantor would require such information only for collateral not solely registered to an applicant, in that the failure of the debtor to identify any property on schedule 5 was sufficient to trigger further inquiry by a reasonable lender or guarantor, see In re Martz, 88 Bankr. 663, 674 (E.D. Pa. 1988), and in that a simple request of the debtor to identify the property listed on line 9 would have revealed that this was the value of the property the debtor proposed to acquire by investment of the borrowed funds.
Insurance Company of North America v. Cohn (In re Cohn), No. 91-6073 (E.D. Pa. June 28, 1994) (order denying appeal and dismissing action). This appeal followed.
The district court had jurisdiction to hear this case pursuant to 28 U.S.C. § 158(a). Our jurisdiction rests on 28 U.S.C. § 1291 and 28 U.S.C. § 158(d).
As a proceeding tried initially before the Bankruptcy Court for the Eastern District of Pennsylvania, the standard of review for the district court is governed by Rule 8013 of the Bankruptcy Rules, which provides:
On an appeal the district court or bankruptcy appellate panel may affirm, modify, or reverse a bankruptcy Judge's judgment, order, or decree or remand with instructions for further proceedings. Findings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to Judge the credibility of the witnesses.
Our review of the district court's order is plenary because in bankruptcy cases the district court sits as an appellate court. Brown v. Pennsylvania State Employees Credit Union, 851 F.2d 81, 84 (3d Cir. 1988) (citing Universal Minerals, Inc. v. C.A. Hughes & Co., 669 F.2d 98, 101-02 (3d Cir. 1981)). We review the findings of fact of the bankruptcy court only for clear error. Id. (citing In re Morrissey, 717 F.2d 100, 104 (3d Cir. 1983)). Findings of fact by a trial court are clearly erroneous when, after reviewing the evidence, the appellate court is "left with the definite and firm conviction that a mistake has been committed." Anderson v. City of Bessemer City, N.C., 470 U.S. 564, 573, 105 S. Ct. 1504, 1511, 84 L. Ed. 2d 518 (1985) (citation omitted). We have plenary review over questions of law. Epstein Family Partnership v. Kmart Corp., 13 F.3d 762, 765-66 (3d Cir. 1994). It is error for a district court, when acting in the capacity of a court of appeals, to make its own factual findings. Universal Minerals, 669 F.2d at 104.
The overriding purpose of the Bankruptcy Code is to relieve debtors from the weight of oppressive indebtedness and provide them with a fresh start. Exceptions to discharge are strictly construed against creditors and liberally construed in favor of debtors. See, e.g., United States v. Stelweck, 108 Bankr. 488, 495 (Bankr. E.D. Pa. 1989). Title 11, section 523(a)(2) of the United States Code provides for exceptions to discharge as follows:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual from any debt --
(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by --
(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an ...