Petition for Writ of Certiorari — Mayer v. Spanel International, Ltd., 116 S. Ct. 563 (1995) (No. 95-176)

Supreme Court, U.S.

PitL&# yp

95 176 Jul 24 19%

OFEICE OF THE CLERK

In the

Supreme Court of the United States

October Term, 1995

JOHN MAYER and DEBORAH MAYER,

Petitioners,

Vv.

SPANEL INTERNATIONAL, LTD., and BANK ONE

- ROCKFORD, N.A.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

Kenneth A. Michaels Jr.

53 W. Jackson Blvd.

Suite 520

Chicago, IL 60604

Office: (312) 427-9696

ttorney for Petitioners

an el

case

qaept

ee

Bankr

carve

UTS1

QUESTIONS PRESENTED

lL. Whether reasonable relic

ement of

to prove

a cre

non-di:

ince

or’s prima facie

Cchargeability of a

under §523(a)(2) (A) of the

uptcy Code.

” Whe

Out new

ther Ban

circums

neys’ fees in §5

rcumstan

eS may b

‘“ruptcy Courts may

‘ances for awardine

23 litigation

those Congressionally

ces wherein

e awarded.

LIST OF PARTIES

The parties are listed in the

s

TABLE OF CONTENTS

Questions Presented

List of Parties

Table of Contents

Table of Authorities

Petition for Writ of Certiorari

to the United States Court of Appea

for the Seventh Circuit

pinions Below

Jurisdicticn

Statutes Involved

Statement of the Case .... . 3

Reasons for Granting the Writ Pes

i # The decision of the court

of appeals conflicts with the

majority of other circuits in

eliminating "reasonable

reliance" as an element to the

prima facie case for proving

non-dischargeability of

under §523(a) (2) (a) of the

Bankruptcy Code

Il. Courts may not carve out

new bases upon which to award

attorneys’ fees under the

Bankruptcy Code where Congress

has expressly provided for such

relief in only certain limited

ee al a le a 22

}- -

i)

+

In re Allison,

960 F.2d 481 (5th Cir. 1992) au, #2

Carini v. Matera,

592 F.2d 378 (7th Cir. 1979)

13

In re Garman,

643 F.2d 1252 (7th Cir. 1980)

cert. denied, 450 U.S. 910, 101

S.Ct 1347, 67 L.Ed.2 333

(1981 19

In re Kimzey,

761 F.2d 42 7En Car 1985 2 16

In re Maurice,

21 F.3d 767 7th Cir 1994 13

In re Mayer

S51 F.3d 67C ttn & LY 1995

’

- KA TT ao + 11% oO rt yoy At

504 U.S. 1353, t44 8. Ot. £24464,

1a Tf 2) c-40 (7Q0% >) “

a oe iu Ed a Si ¥ PS p P- <

a

804 F.2d 930 (6th Cir. 1986) . 15-20

In re Scarlata,

979 F.2d 521 (7th Cir. 1992) .. 13

Union Bank v. Wolas,

502 U.S. 1853, 132 8. Ct. 827,

ane by. BG. 26 $36 (3993) . « « 2 22

United States v. Ron Pair Enterprises,

i.

489 U.S. 235

su) bb. BG. 2

, 209 &. Ce. 2088,

qd 290 (

Table of Statutes

Be Veoh Bees tes 1S) (A) 20's we passim

In the

Supreme Court of the United States

October Term, 1995

JOHN MAYER and DEBORAH MAYER,

Petitioners,

Ws

SPANEL INTERNATIONAL, LTD., and BANK ONE

- ROCKFORD, N.A.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

Petitioners John Mayer and Deborah

Mayer, respectfully pray that a writ of

certiorari issue to review the judgment

and opinion of the United States Court of

Appeals for the Seventh Circuit, entered

in the proceedings on March 31, 1995.’

In a footnote contained in the

Seventh Circuit’s opinion decided and

issued March 31, 1995, the Court of

Appeals informed the parties that it had

consolidated two appeals which had been

separately briefed and one of which had

been orally argued. Rule 12.2.

EEE

OPINIONS BELOW

The opinion of the Court of Appeals

is reprinted in the Appendix. This

Opinion is reported at 51 F.3d 670 (7th

Cir. 1995). The district court opinions

issued in these two appeals were reported

below at In re Mayer, 164 B.R. 83 (N.D.

Ill. 1994) (Spanel case) and In re Mayer,

173 B.R. 373 (N.D. Ill. 1994) (Bank One

case).

JURISDICTION

The judgment of the Court of Appeals

was entered on March 31, 1995. A timely

petition for rehearing, with suggestion

of rehearing en banc, was denied on April

24, 1995.

This petition is filed within 90

days of the denial of rehearing. Rule

13.4.

The jurisdiction of this Court is

conferred by 28 U.S.C. §§ 1254(1),

2101(c), and 2350(a).

STATUTES INVOLVED

§ 523. Exceptions to discharge.

(a) A discharge under section 727,

1141, 1228(a), 1228(b), or 1328(b) of the

title does not discharge an individual

debtor 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

insider’s financial condition;

Bankruptcy Code, 11 U.S.C. §523(a) (2) (A).

STATEMENT OF THE CASE

The Seventh Circuit panel hearing

Oral argument on one of the instant

appeals, sua sponte raised questions

concerning the prima facie case for a

§523 (a) (2) (A) non-dischargeability

action.

On January 16, 1992, John Mayer

filed a voluntary petition for bankruptcy

3

Ww

Spanel’s request for attorneys’ fees.

Judgment was entered in favor of Deborah

Mayer and against Spane

On cross-appeals to the district

court, the bankruptcy court’s decision

was affirmed in part and reversed in

part. The district court found that

although Mayer had not acted knowingly,

he had acted recklessly and affirmed non

Gdischargeability. The district court

also reversed the bankruptcy court and

awarded Spanel attorneys’ fees.

Bank One - Rockford, N.A. ("Bank

One") also filed an adversary proceeding

against the Mayers alleging that a

deficiency judgment in the amount of

$187,665.35, plus interest, obtained in

Winnebago County, Illinois, pursuant to

foreclosure proceedings was non-

dischargeable under the Bankruptcy Code.

Bank One’s adversary proceeding was based

upon a theory of "no intent to pay" under

§523(a) (2) (A) of the Bankruptcy Code.

By virtue of the state court

foreclosure decision, the Mayers were

collaterally estopped from denying

execution of the note and mortgage. The

Mayers admitted never having an intent to

repay the loan, as they had consistently

denied ever entering into the loan to

purchase a hotel. The Mayers nevet

attended the loan closing or personally

met with anyone for Bank One (or its

predecessor). All the work in obtainin<

the loan was done by the Mayers’

relatives and friends, the Montis. The

loan officer admitted in her deposition

that she had received a power of attorney

from John Mayer to Donald Monti

authorizing Monti to sign the purchase

contract to buy the hotel and other

documents. The loan officer further

loan commitment because of this power of

attorney. Monti confirmed his role in

this transaction at his deposition and

acknowledged the existence of a certain

power of attorney from John Mayer to him

upon which he relied. The only power of

attorney ever produced by any party was

detail a contemplated transaction whereby

John Mayer would acquire the hotel and

immediately thereafter transfer title to

Rosemary Monti.

At trial the loan officer changed

her testimony to deny that she had ever

reviewed any power of attorney prior to

making the loan. The bankruptcy cour

did not allow the Mayers’ counsel to

cross-examine the loan officer on this

point because her deposition had been

admitted into evidence already.

rat the conclusion tr trial, the

bankruptcy court entered judgment for

Bank against both Mayers, but dé }

the award of attorneys’ fees

Subsequently, the bankruptcy court, on a

motion for reconsideration, reversed its

I jy and awarded attorneys’ fees f

listr irt affirmed the bankruptcy

REASONS FOR GRANTING THE WRIT

- THE DECISION OF THE COURT OF

APPEALS CONFLICTS WITH THE MAJORITY OF

OTHER CIRCUITS IN ELIMINATING “REASONABLE

RELIANCE" AS AN ELEMENT TO THE PRIMA

FACIE CASE FOR PROVING NON-

DISCHARGEABILITY OF A DEBT UNDER

§523 (a) (2) (A) OF THE BANKRUPTCY CODE.

The court of appeals, in the instant

.

iam

‘

minated the requirement

a

proving "reasonable reliance" t<

/

establish a prima facie case for

determining non-dischargeability of a

lebt under §523(a)(2) (A) of the

ee

Bankruptcy Code in conflict with the

majority of the other circuits. The

practical effect of this decision is to

dissuade lenders or investors from asking

questions or exercising any diligent

inquiry into any facts or statements

Surrounding the loan or investment.

Removing the element of "reasonable

reliance" from the prima facie case for

showing non-dischargeability of a debt

promotes a "don’t ask" policy for lenders

and investors because what a lender or

investor learns may bar a subsequent

claim for non-dischargeability if a loan

Or investment sours.

The several circuits of the court of

appeals universally consider that

§523 (a) (2) (A) of the Bankruptcy Code

requires a creditor to prove at least

that: (a) The debtor obtained the subject

money, property, services, or credit by

10

P . >

x

< ~

7 4 . 4 a4 4 Jd a4 4

+4 > 4 4 4

= —, - bate + 7 >

+ 4 ’ 4 7 ’ > > 4 i . 4 4 < |

~~ + - 7 = s dd . »

“ 4 4 4 . oa *

4 ~ + 4 a4 + ‘ + 4 + +

or “ 4 ” ~ P

4 4 ma > 4 4 > + 4 + P~4 4

_ j j x ‘ 4 4 4 ae

i > 4 > > 4 md + —

et 4 ’ 4 . — ry 4 4 4 5 i

re x ~ 4 4 a — _ a

er Jd - = ~ + 4 > r > J4 r

4 aan 4 . . -_ + ws

l = LY ) [x] ] ; oO 2 U4 { {

ean! 4 7+ - , — . 4 paw a - =.

| \ —~ ‘ eq . “~~ + +> ne r + rh

- - A ~~. 4 4 re ~ r

J 4 ~— + . _ tm 4 4a +- \ +

4 re r + a oan - ~ - 4 “

4 ve “ 4 + rbd + 7 moe 4

if r pan j ~~ j : “ =

4 Vi = > 4. mm ~ a dnd 4

j a . * 4 - “ ae 4 ~~ “ . _ .

4 4 4 ~~ ae 4 4 ~ ~ ~ r 4 _ 4

_ . " ~ “4 “ " 4 -

> —~ nt 4

Jd » 4 > — 4 \ 4 hs 4

rr . 4 , , nm

aa Jd 7 - ~~ —) ’ rq 4 4 + i

~ ‘ — . P 4 4 rr “ ‘ oo

4 , , . ¥ % 44 ~ + st +> ma 44 rt + ms

ry) 4 4 Tt 4 4 os r ~ + « rr -

se + 4 +4 4 J)

o ; : , ~ , : 4 - 4 2 S

— 4 a4 ban ~~ 4 4 Pe -

~~ ~ - 4 x —_ 4 4 _ “ .

| ; mo a . _ psa \ 7 7 Tt at ~ + ,

“ 4 “ “ ~ - =a ,

4

= 4 4 - +f + J - mM ~~ ¢

f j 4 " + . re - 4

\ + + 4 4 4 vl ta ~ \ -

- ‘ 4 ~ _ ‘ - « rr r e

“ <4 + > ~~ bd > —~ 44 r 4 ‘ 4 4

4 ~ ~ c ‘ ~ a rx a] r 4 ~

4 . a + 4 \ 4 ‘ . a

rx " n .

| ‘ + . ’ + ~« = - ~~ | = | i |

4 ‘ ) - wr~ “ .

~ =. a > 4 = we 4 ed + > i

4 4 4 ~~ 4 4 > — a] ~~ 44 e 4 on)

‘ ‘ ~ ~ “ — ~ ~ + 1

beng _— + > 4 — 4 4 > — r . ’ — 4

‘ . 4 ~~ . —~ anl > ~ “

’ cc ~~ ’ 4 4 4 , > ‘ > a

~~ ~~ ‘ 4 4 . me 4

4 f 4

> r — rs +> + + Ja ~~ 47 +

al ryt > “ _ < ~ ~

J > TS ‘ 4 4

4 4 . - 4 me 4 j 4

~ a4 — ~ 4 rt 4 4 —_ . i r 4 » = i +—

J ~ -+- + rr we .

x as 4 — ad 4 phy 4 4 oo ’ Ji 4 a

Also, some circuits have imposed

elements requiring creditors to also

prove proximate causation resulting in

damages to the creditor.

The first court of appeals to

actually announce all of the elements of

a §523(a) (2) (A) action after the

enactment of the Bankruptcy Code, in

1978, was the Seventh Circuit in In re

Kimzey, 761 F.2d 421 (7th Cir. 1985).

To succeed on a claim that a

debt is nondischargeable under

section 523(a) (2) (A), a

creditor must prove three

elements. First, the creditor

must prove that the debtor

obtained the money through

representations which the

debtor either knew to be false

or made with reckless disregard

for the truth as to constitute

willful misrepresentation.

Carini v. Matera, 592 F.2d 378,

380 (7th Cir. 1979). The

creditor also must prove that

the debtor possessed scienter,

i.€., an intent to deceive.

Gabellini v. Rega, 724 F.2d

579, 581 (7th Cir. 1984).

Finally, the creditor must show

that it actually relied on the

12

se

lse

eliance upon

e reasonable

hargeable

3 i Z of t

1S §523 (a) (2

Matera, 592

reasonable

xr cur

Kimzey decision has been

Subsequently f

Oo ¢

Oo ,

‘ 4

54

A het ohn

and n

representation, and that

reliance was reasonable.

592 F.2d at 381.

.20 at 423. In Carini, the

lt acknowledged that actual

by

a false statement must also

to hold a debt non-

he Bankruptcy Act, which

A)’s predecessor. Carini

F.2d 378 380-81 (7th Cir

/

Lam)

Ollowed by the Seventh

In re Maurice, 21 F.3d

‘ir. 1994); In re Scarlata,

[7m tar. 298e) . It was

the bankruptcy court and

below in these instant

O party challenged that

reliance" was or should be an

of the prima facie case.

13

‘ In the Court’s opinion issued in

these instant appeals, the Court

expressed doubts as to viability of the

"fraudulent intent" elements articulated

under Kimzey, but then deferred removing

scienter or fraudulent intent from the

prima facie case.

We hesitate, however, to strip

all intent components from

§523 (a) (2) (A). Other courts of

appeals recite that the 1978

Code has a mental state

ingredient. [cites omitted. ]

We do not create conflicts

among the circuits without

strong cause. A conflict here

would be gratuitous.

In re Mayer, 51 F.3d 670, 674-75 (7th

Cir. 1995). The Court’s opinion

continued its analysis, ultimately

Stripping reasonable reliance out of the

cause Of action under §523(a) (2) (A).

"Reasonable reliance" is a

different kettle of fish.

Language establishing a

reliance requirement not only

is missing from §523(a) (2) (A)

but also appears in

14

S523 (a 2)(B), wnere 1t i ised

/ : P ; ; ras +

t } 1etermine SS & a JiDYI 4 y | TI |

4

Z Z +} . } +

j1ischarge when the debtor e |

‘ ¢ >) ‘4 ] a . y

| | LD LT a | Lrlalc Ladi sta ement

the category carved out of

, "7 (%s + . .

3523\a 2) (A ngress

ippears; Kimzey did not explain

- parr leds

why a standard applicable unde!

§523 (a) (2) (B) should be applied

to cases under §523(a) (2 A),

inless the reason is that

Kimzey was not thinking about

was simply repea

hat had been developed unde:

I

the 1898 Act

May* if ] 7 ,0d ft r c

A 6 ; T ne ] | r) I Lt | |

el rea nabdDile¢ re il € ] il f nt

. j ; A iction ina Ié J] ed

lial relilal f i i Tieé é ary

nt t tne iusé Tf ictioO! In 1}

304 F.2d 93 6th Cir 1B

Wii Ll | : i Clille ii ) Lift - a

Kimzey, but adds other requirements,

namely proof that the misrepresentation

was material and that the creditor’s

reliance proximately caused the loss.

Phillips, 804 F.2d at 932.

After expressing the prima facie

case, the Sixth Circuit observed that the

"precise contours and meaning of

reasonable reliance under §523(a) (2) (A)"

has been less than clear and attributed

this fault to the legislative history of

§523(a) (2) which is quoted in relevant

(U]nder section 523(a) (2) (A) a

creditor must prove that the

debt was obtained by false

pretenses, a false ‘

representation , or actual

fraud, other than a statement

respecting the debtor’s or an

insider’s financial condition.

Subparagraph (A) is intended to

codify current case law e.g.,

Neal v. Clark, 95 U.S. [5 Otto]

704 [24 L.Ed. 586) (1887),

which interprets "fraud" to

mean actual or positive fraud

rather than fraud implied in

16

law. Subparagraph (A) is

subparagraph (B). Subparagraph

(B) pertains to the so-called

false financial statement. In

order for the debt to be

nondischargeable, the creditor

must prove that the debt was

obtained by the use of a

statement in writing (i) that

is materially false; (11)

respecting the debtor’s or an

insider’s financial condition;

(iii) on which the creditor to

whom the debtor is liable for

obtaining money, property,

services, or credit reasonably

relied; (iv) that the debtor

caused to be made or published

with intent to deceive.

Phillips, 804 F.2d at 932, quoting, 1978

,

> .

Code Cong. & Admin. News 5787, 6453

rT

The Phillips court then addressed

arguments both for and against including

reasonable reliance as an element of a

ge

324

3$(a) (2) (A) action. Citing two

bankruptcy court decisions, the Phillips

court

the

noted the primary argument made by

creditors in that case against

reasonable reliance was because

oo

++

m4

rr

> 4

~

a

4 4

ro)

Jd +

ro

‘an nd

‘ ~

+ m4

oan rr

‘ Jd

; aal

4

aa J

m4

a 4)

>

4

a4 a4

pdt

+4

— 4

4 -™

‘

a

|

4

+

4

rt

‘ i a4

4

r m

4 oo)

~ +

4

L |

Ty 4 '

j +

4 / ’

- ~~ .

a4 ‘ 4

N Oy

rt a

> j

4

r- ° 4 .

m t— 4 .

4 4

j ~

9) d4 ’

~

r-4 4 4

ay r ‘am ow

) i

4 j

Ja J2 Ji 4

ore ~

>| Aa 4

+ rt 4

4 ,

rq 4 ~~

4 4 > .

/ 4

afl rt ~~

a4 4 7

land re

m4 J) 4

4 4

lant 1

1 _

a

4 4

TY 4

)

4 4 rm rw

4 4

4 .

i ; 4

rx ~ ~]

s

aan

dg

rt

ba

4

which the honest citizen may be relieved

from the burden of hopeless insolvency."

Phillips, 804 F.2d at 933 (emphasis in

Original), quoting, Neal, 95 U.S. at 709.

The Sixth Circuit noted that reasonable

reliance "cannot be said to be a rigorous

requirement, but rather is directed at

creditors acting in bad faith."

Phillips, 804 F.2d at 933, quoting, In re

Martin, 761 F.2d 1163, 1166 (6th Cir.

1985) (a §523(a) (2) (B) case). After

careful consideration of the question,

the Sixth Circuit decided to retain

reasonable reliance as an element.

The court of appeals in the instant

cases noted: "Two courts of appeal have

held that §523(a) (2) (A) does not contain

a reasonable-reliance requirement. In re

Allison, 960 F.2d 481, 484-85 (5th Cir.

1992); In re Ophaug, 827 F.2d 340, 343

(8th Cir. 1987)." In re Mayer, 51 F.3d

20

670, 675.

However, the Fifth Circuit nominally

joined the Eighth Circuit in rejecting

reasonable reliance as an element of a

§ 523(a) (2) (A) action. Having rejected

reasonable reliance as an element, the

Fifth Circuit continued holding that

reasonable reliance is strong

circumstantial evidence of actual

reliance. Allison, 960 F.2d at 485

So while the Fifth Circuit has

reasonable reliance as an element of the

« ge 5 > aa see 7 len kan he

iction, it has expressly also kept tne

question of reasonable reliance alive as

on tiara ee : } ’ si cts a

stronaq circumstantial evidence.

instant appeals, moves the Seventh

ircuit from the majority of circuits t

)

+ a ) ~ -

1 minority of one, possibly wo, L1rci S

) s

. ,amh hartra arr . 1 " Kh 7 soc it £ «

which have stripped "reasonableness I

DI

a a nee ee ee

reliance in proving a §523(a) (2) (A) case.

II. COURTS MAY NOT CARVE OUT NEW

BASES UPON WHICH TO AWARD ATTORNEYS’ FEES

UNDER THE BANKRUPTCY CODE WHERE CONGRESS

HAS EXPRESSLY PROVIDED FOR SUCH RELIEF IN

ONLY CERTAIN LIMITED CIRCUMSTANCES.

Nothing in the plain language in

§523 of the Bankruptcy Code provides for

an award of attorneys to a prevailing

creditor in a dischargeability adversary

proceeding. However, §523(d) does

provide for such an award of attorneys

fees to prevailing debtors where a

consumer debt is challenged.

The United States Supreme Court has

repeatedly directed the bankruptcy courts

not to depart from the plain language of

the Bankruptcy Code without substantial

justification. Patterson v. Shumate, 504

U.S. 753, 132 &. Ct. 22462. 2268;. 119

L.Ed.2d 519, 528 (1992); Union Bank v.

Wolas, 502 U.S. 151, 112 S. Ct. 527, 531,

116 L.Ed.2d 514, 522 (1991); United

oe

22

C + T D ’ i wrig Tne A4Q¢

Stat vy. Ron Pair Enterprises Inc., 489

TT , r Cc ,A , re “~ a] i ¢ ¢ 4 “ 4 )

J Ne x 5 dy ata, 10 y S . es . AV aU , i. 5 1 , A 5

L.Ed.2d 290, 299 (1989

7 tr 4 y > lan Crea kok alten, /

yJranting a prevailing creaitor attorn

BO” “—hala' ~ -+ho mor oa = 1 =, of a i | c + a: +

cecp Ais i \ l€ AUSD1¢ es Ol DE LNG pal Ji

r

eho tAc - tf rn ~ oO = ) id —aT= ide _+ } +

9 | — oO) 4 @ es arn LT1¢ epeli¢ elt Ddasis

f , tho ale, fle hi t YY a / a +r

ror tne award O} attorneys Lees iT

Z

x » “* la 7 + +7 + } h +

c : : - +r - fo [a :

i “a3 A aj A i a 4 jal LUii il Li Ls il

— <7 | ’ ‘ . y - Dan M1IMWFT OV ’

KJ JV ALAS A A 3 4 Lid ne Bankr a we . ALAS

I i

~aAT Ss rT] TC

‘ONCLUSION

ee Y at __ A he

G y + " t “alle taninal Yan C TY T 1

r I I1€ i rego1ing C€asO!ls, i Wd I

‘OY? } rari c hai) | qd 1a C11Q -r, alt ae “otal + +} ’

i LULAL IA mwllUUSL LsSouc LV ~Scvitcw Lit

1-rm + £ t- 1h T 1 + ry Cr at . oF it +

VA AM — + 4 & §) I 4 a - A — oe! cp / A hn = -

Anne ia thece CA SeS

PA b | . | | hi N Cap ©

Doc ~ rk + ler a hm - + im

rRespet +UA4 Yy mo ULI cu,

r 4

la

In the

United States Court of Appeals

For the Seventh Circutt

Nos. 94-1389 & 94-3870

IN THE MATTER OF:

Joun E. Mayer and DEBORAH MAYER,

. Debtors-Appellants,

SPANEL INTERNATIONAL LtTp. and BANK ONE-

ROCKFORD, N.A., .

Creditors-Appellees.

Appeals from the United States District Court

for the Northern District of Lllinois, Eastern Division.

No. 93 C 3931—Harry D. Leinenweber, Judge.

No. 94 C 3442—Milton I. Shadur, Judge.

ARGUED SEPTEMBER 14, 1994—SuBMITTED Marcu 10, 1995*—

DeciweD Marcu 31, 1995

Before Lay,** EASTERBROOK, and RIPPLE, Circuit

Judges.

EASTERBROOK, Circuit Judge. Two bankruptcy appeals

present a common question: whether a liar may obtain

* Appeal No. 94-1389 was argued on September 14, 1994. The

debtors’ later appeal, No. 94-3870, was submitted to the same

panel for decision under Operating Procedure 6(b). The panel de-

ferred disposition of No. 94-1389 until the briefing had been com-

pleted in No. 94-3870. The panel is unanimously of the view that

oral argument is unnecessary in No. 94-3870, which presents legal

issues already explored at the argument of No. 94-1398. We have

consolidated the two appeals for disposition in a single opinion.

** Hon. Donald P. Lay, of the Eighth Circuit, sitting by desig-

nation.

2a

bo

Nos. 94-1389 & 94-3870

a discharge in bankruptcy by showing that the victim did

not do enough to nose out the truth. Debts attributable

to fraud may not be discharged, 11 U.S.C. §523(a2\A),

and intentional deceit concerning a material proposition

is fraud whether or not a more-alert target would have

smelled a rat. Victims of intentional torts need not take

special precautions.

_ The first transaction occurred in December 1987. John

and Deborah Mayer jointly borrowed more than $135,000

to purchase the Bess Hotel, a residence for transients in

Rockford, Illinois. The Mayers presented financial state-

ments showing assets exceeding $800,000 and tax returns

showing annual income exceeding $150,000. John Mayer

promised to subsidize the hotel’s operations until it turned

a profit. Yet the Mayers had no intention of operating

the hotel, underwriting its losses, or paying off the loan.

They were serving as fronts for their friends Donald and

Rosemarie Monti. Donald Monti and John Mayer had en-

gaged in other real estate transactions; Rosemarie Monti

and Deborah Mayer are first cousins, “inseparable’’

friends who rode horses together daily. The Montis could

not have obtained the loan in their own names, because

Donald was in bankruptcy and Rosemarie had no income.

So the Mayers lent their name and financial statement;

John Mayer signed a power of attorney authorizing the

Montis to transfer the hotel to their own name by quit-

claim deed and adding: “I have agreed to help Rosemarie

K. Monti obtain a loan From the 1st Natl. Bank of Rock-

ford. I, Dr. John E. Mayer, have no legal interest in the

Bess Hotel.’’ Any correspondence the Mayers received

from the bank was passed, unopened, to the Montis.

The Montis could not make a go of the hotel and did

not pay off the loan. The Mayers refused to pay a cent.

A state court determined that the Mayers had taken out

a loan, had signed all the papers, and are liable. The court

ordered the hotel sold at foreclosure; a deficiency judg-

ment of $187,665.35 (including attorneys’ fees and accrued

interest) was entered against the Mayers on January 3,

1992. The Mayers sought to discharge that debt in their

ecicesiieaiaiiaiaiaaiaitaiaiaiii

Nos. 94-1389 & 94-3870 3

federal bankruptcy proceeding. The bankruptcy judge de-

nied discharge under §523(aX2XA) after concluding that

the Mayers had defrauded the bank. The state court’s

judgment conclusively determines that the Mayers bor-

rowed and owe the money. Grogan v. Garner, 498 U.S.

279 (1991). The Mayers concede that they never intended

to repay. As the bankruptcy court saw things, that left

only the question whether the bank reasonably relied on

the Mayers’ promise to pay. The Mayers said not, because

the bank either saw or should have tracked down the

power of attorney revealing that the Mayers were straw

purchasers. The bank’s loan officer testified that she had

not seen that power of attorney, and the bankruptcy

judge believed her. The bank had no obligation to search

out such papers, the judge concluded, and was entitled

to rely on the Mayers’ written and oral promises. The

district court affirmed. 173 B.R. 373 (N.D. Ill. 1994).

The other transaction occurred in September 1990. By

then John Mayer was in financial distress and unable to

borrow from banks. He located Spanel International, which

was willing to lend at substantially higher rates. A clinical

psychologist specializing in adolescents with drug prob-

lems, Mayer told Dennis King, Spanel’s owner, that he

was working on a manual that would help schools deal

with substance abuse among pupils. To add verisimilitude

to this claim (and to fortify his representation that he

would be able to pay back the 90-day loan of $100,000),

Mayer showed King a purchase order issued by the Chi-

cago Board of Education for 5,000 copies of the manual,

at a total price of $725,000. Spanel made the loan; Mayer

did not repay the debt; the purchase order turned out

to be a fake, with a forged signature. Mayer denied know-

ing that the purchase order was bogus and blamed his

literary agent. The bankruptcy judge found that Mayer

knew that the order was spurious and rejected his con-

tention that King should have investigated its validity

more thoroughly. (King had called the Board about the

subject, but Mayer told him to stop snooping.) On recon-

sideration the bankruptcy judge withdrew his finding that

——SeS——e____a_QaQaQLQLae

a

4a

4 Nos. 94-1389 & 94-3870

Mayer knew of the forgery but concluded that Mayer was

reckless in presenting the order to King. The bankrupt-

cy court concluded that the debt may not be discharged,

and the district court affirmed. 164 B.R. 83 (N.D. Ml.

1994).

Section 523(aX2\XA) forbids the discharge of any debt in-

curred by

false pretenses, a false representation, or actual

fraud, other than a statement respecting the debtor’s

or an insider’s financial condition(.]

Each of the district judges turned to Jn re Kimzey, 761

F.2d 421 (7th Cir. 1985), for an exegesis of this text.

To succeed on a claim that a debt is nondischargeable

under section 523(aX2XA), a creditor must prove three

elements. First, the creditor must prove that the

debtor obtained the money through representations

which the debtor either knew to be false or made

with such reckless disregard for the truth as to con-

stitute willful misrepresentation. Carini v. Matera,

592 F.2d 378, 380 (7th Cir. 1979). The creditor also

must prove that the debtor possessed scienter, 1.¢.,

an intent to deceive. Gabdellini v. Rega, 724 F.2d 579,

581 (7th Cir. 1984). Finally, the creditor must show

that it actually relied on the false representation, and

that its reliance was reasonable. Carini, 592 F.2d at

381. The party objecting to discharge must prove the

facts establishing each element by clear and convin-

cing evidence.

761 F.2d at 423-24. The Mayers insist that their creditors

did not “reasonably’”’ rely on their false statements—a

term understood by both district judges (and by bankrupt-

cy judges in some other cases) to entail proof that the

creditor conducted an investigation reasonably designed

to discover whether the would-be borrower is telling the

truth. E.g., In re laquinta, 98 B.R. 919 (Bankr. N.D. Ill.

1989); In re Smigel, 90 B.R. 935 (Bankr. N.D. Ill. 1988).

John Mayer adds that he did not intend to deceive Spanel.

Sa

Nos. 94-1389 & 94-3870 5

We confess to some doubt that Kimzey is an accurate

guide to §523(aX2XA). Kimzey’s fourth requirement—that

the creditor prove the statutory elements by clear and

convincing evidence—has been disapproved by the Su-

preme Court, which thought Aimzey unduly influenced by

the goal of providing debtors with fresh starts. Grogan

y. Garner, 498 U.S. 279, 283 n.7 (1991). Only the “honest

but unfortunate” debtor can start anew, the Court ob-

served, id. at 287, and the process of classification should

be conducted without a thumb.on the scales. The rest of

Kimzey’s list likewise seems designed to stack the deck

in debtors’ favor, even to the point of doubling up on in-

tent requirements (factors one and two require proof of

different forms of intent to defraud). The exclusions in

§523 serve vital functions. Congress concluded that pre-

venting fraud is more important than letting defrauders

start over with a clean slate, and we must respect that

judgment. See Thomas H. Jackson, The Logic and Limits

of Bankruptcy Law 273-79 (1986) (identifying other restric-

tions on the fresh start policy).

Kimzey finds three ingredients in §523(aX2XA): falsity,

fraudulent intent, and reasonable reliance. The statute

itself specifies only the first of these, speaking of “false

pretenses, a false representation, or actual fraud”. The

word “fraud” implies a requirement of intent to deceive,

see Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976);

Neal v. Clark, 95 U.S. 704, 709 (1877), but “fraud” is only

one of three elements in the statutory list. By including

“false pretenses [and] false representation” Congress may

have done away with an obligation to show intent to de-

fraud; otherwise what function do these words serve? Re-

dundancy is common in statutes; we do not subscribe to

the view that every enacted word must carry indepen-

dent force. Neither, however, should one in a list of

related but not identical terms be treated as if it were

the whole shebang—not, at least, without strong evidence

that at the time of enactment the words were understood

as equivalents.

Kimzey took the intent requirement from Carini v. Ma-

tera, which interprets the Bankruptcy Act of 1898. Section

6a

tS) Nos. 94-1389 & 94-3870

17(aX2) of that Act, 11 U.S.C. §3&aX2), the portion closest

in spirit and effect to §523(aX2\A), forbade discharge of

“(liabilities for obtaining money or property by false

pretenses or false representations,’ language that to

modern ears differs from “fraud” in lacking an intent com-

ponent. It turns out that cases interpreting the 1898 Act

got the intent ingredient from the Bankruptcy Act of

- 1867, which disallowed the discharge of debts “created

by fraud.” This was the language understood in Neal to

require proof of intent to defraud. All reference to “fraud”

disappeared from the Act in 1903, but courts of appeals

paid no heed and the Supreme Court did not return to

the subject. See generally 1A Collier on Bankruptcy

§§ 17.01, 17.16[3] (14th ed. 1978) (tracing this history).

Then the 1978 Code included both fraud and the more

capacious “false pretenses [or] false representation” lan-

guage, and again courts have acted as if nothing has

changed.

Are we to treat the evolution of statutory language as

meaningless? Patterson v. Shumate, 504 U.S. 753, 112 S.

Ct. 2242, 2248 (1992); Union Bank v. Wolas, 502 U.S. 151,

158 (1991); and United States v. Ron Pair Enterprises,

Inc., 489 U.S. 235, 242 (1989), are a few among many re-

cent cases telling us to take the 1978 Code on its own

terms rather than as a restatement of earlier bankruptcy

statutes. See also Meyer v. Rigdon, 36 F.3d 1375, 1378-82

(7th Cir. 1994), adopting a plain-language understanding

of §523(aX11). We hesitate, however, to strip all intent

components from §523(aX2XA). Other courts of appeals

recite that the 1978 Code has a mental state ingredient.

See In re Philip G. Menna Century 21 Balfour Real Es-

tate, 16 F.3d 7 (1st Cir. 1994); In re Foreman, 906 F.2d

123, 127 (5th Cir. 1990); In re Phillips, 804 F.2d 930 (6th

Cir. 1986); In re Kirsh, 973 F.2d 1454 (9th Cir. 1992); In

re Mullet, 817 F.2d 677 (10th Cir. 1987); In re Miller, 39

F.3d 301, 306-07 (11th Cir. 1994). We do not create con-

flicts among the circuits without strong cause. A conflict

here would be gratuitous. Kimzey itself suggests that

reckless disregard of the truth is a form of intent to de-

ee |

7a

Nos. 94-1389 & 94-3870 7

fraud. See also Sundstrand Corp. v. Sun Chemical Corp.,

553 F.2d 1033, 1044 (7th Cir. 1977); Birmingham Trust

National Bank v. Case, 755 F.2d 1474, 1476 (11th Cir.

1985). As we explain later, John Mayer was at least reck-

less in presenting the bogus book order to Spanel.

‘Reasonable reliance” is a different kettle of fish. Lan-

guage establishing a reliance requirement not only is miss-

ing from §523(aX2XA) but also appears in §523(aX2\B),

where it is used to determine eligibility for a discharge

when the debtor tells a fib in a financial statement—the

category carved out of §523(aX2XA). Congress deliberately

distinguished the criteria for discharge according to the

kind of document in which the falsehood appears; Kimzey

did not explain why a standard applicable under §523(aX2XB)

should be applied to cases under §523(aX2XA), unless the

reason is that Kimzey was not thinking about the 1978

Code at all, and (as the panel’s citations imply) was simply

repeating criteria that had been developed under the 1898

Act. The “reasonable reliance” requirement has given us

some headaches. E.g., In re Scarlata, 979 F.2d 521 (7th

Cir. 1992). And it has not found a wholly favorable recep-

tion in other circuits. Two courts of appeals have held

that §523(aX2XA) does not contain a reasonable-reliance

requirement. In re Allison, 960 F.2d 481, 484-85 (5th Cir.

1992); In re Ophaug, 827 F.2d 340, 343 (8th Cir. 1987).

Cf. In re Phillips, 804 F.2d 930, 933 (6th Cir. 1986) (a

creditor who relies “in bad faith” cannot block a dis-

charge, but the creditor need not investigate). Several

other courts have recited “reasonable reliance” or “justi-

fiable reliance” as part of the inquiry under §523(aX2XA),

but only one of these has explored the question whether

this standard is appropriate. See In re Burgess, 955 F.2d

134 (1st Cir. 1992); In re Kirsh, 973 F.2d 1454, 1457-61

(9th Cir. 1992) (discussing the subject; but this portion

of the opinion ry to speak for only one judge); /n

re Murlett, 817 F.2d 677 (10th Cir. 1987); In re Hunter,

730 F.2d 1577 (11th Cir. 1986). Like Kimzey itself, most

of these decisions proclaim a “reasonable reliance’’ stan-

dard as if the rationale for, and limits of, that phrase were

8a

- Nos. 94-1389 & 94-3870

obvious. The list in Kimzey was dictum to boot; nothing

in that case turned on the reasonableness of the creditor’s

reliance.

Support for Kimzey’s pronouncement is hard to come

by—at least if reliance, to be “reasonable” or “justifiable,”

includes an element of investigation. The common law of

fraud has a mental-state requirement; it does not have

any reasonable-investigation requirement. Indeed, it is

‘precisely because fraud has a mental-state requirement

that it lacks a reasonable-investigation requirement. Fraud

is an intentional tort, and victims need not take precau-

tions against such torts in order to preserve their rights.

Tolerating fraud by excusing deceit when the victim is

too easily gulled increases both the volume of fraud and

expenditures on self-defense. Society is better off with less

fraud and fewer precautions against it, and-the common

law has tailored the doctrine accordingly. In the standard

formulation, contributory negligence is not a defense to

an intentional tort. Prosser & Keeton on Torts 462 (5th

ed. 1984); Restatement (2d) of Torts §§ 481, 482 (1965). We

observed in AMPAT/Midwest, Inc. v. Illinois Tool Works

Inc., 896 F.2d 1035 (7th Cir. 1990), that Illinois departs

from this norm in fraud cases to some extent, using varia-

tions on the “reasonable reliance” or “justifiable reliance’”’

formula. Federal law has not followed suit—and since 1970

the propriety of discharge in bankruptcy has been a ques-

tion of federal law for reasons Grogan explains. For ex-

ample, Teamsters Local 282 Pension Trust Fund v. Angelos,

762 F.2d 522, 527-30 (7th Cir. 1985), considers at length

the question whether securities law requires an investor

to investigate representations made to it; we held that

it does not. See also Sundstrand, 553 F.2d at 1040. Ac-

cord, Restatement §540; Prosser & Keeton at 749. “Reli-

ance” is an element of fraud, but reliance in fact does

not lose its status in law just because the victim is care-

less. A “reliance” requirement plays a different role. It

excludes recovery if the investor knows or suspects the

truth. Reliance means the conjunction of a material mis-

representation with causation in fact. 762 F.2d at 530; see

9a

Nos. 94-1389 & 94-3870 9

also Flamm v. Eberstadt, 814 F.2d 1169, 1173 (7th Cir.

1987). AMPAT/Midwest concludes that Illinois follows a

similar path, that buyers (or lenders) do not have a duty

of reasonable care, but that a buyer who ignores a known

or obvious risk may not recover. 896 F.2d at 1042. See

also Astor Chauffeured Limousine Co. v. Runnfeldt In-

vestment Corp., 910 F.2d 1540, 1546-47, 1549-50 (7th Cir.

1990) (comparing the federal understanding of reliance

with the one Illinois employs); Dexter Corp. v. Whittaker

Corp., 926 F.2d 617 (7th Cirv 1991).

Angelos, this court’s most éxtensive examination of a

person’s obligation (if any) to protect himself from being

snookered, concluded that an intentional falsehood is not

always enough. The lie must concern a material fact. Even

a material lie may be disregarded when the victim is not

actually taken in. For example, the victim may know the

truth, having been given documents containing full infor-

mation. Compare Zobrist v. Coal-X, Inc., 708 F.2d 1511

(10th Cir. 1983), and Jackvony v. RIHT Financial Corp.,

873 F.2d 411, 416 (1st Cir. 1989) (Breyer, J.), with Acme

Propane, Inc. v. Tenexco, Inc., 844 F.2d 1317 (7th Cir.

1988). More generally, an investor cannot close his eyes

to a known nisk. If the investor possesses information suf-

ficient to call the representation into question, he cannot

claim later that he relied on or was deceived by the lie.

This is not because he has a duty to investigate lies or

prevent intentional torts, though; it is, rather, because the

false statement is not material under the circumstances.

Similarly, if the falsehood concerns things known to the

listener equally or better than to the speaker, the lie is

not material and in all likelihood cannot play a causal role.

Kimzey was handed down almost simultaneously with

Angelos and was written by a member of the Angelos

panel. We think that the best understanding of the pass-

ing references in Kimzey to reliance is that this term

means the same in the definition of fraud under bankrupt-

cy law as in the definition of fraud under securities law:

it denotes the combination of materiality and causation.

See also In re Garman, 625 F.2d 755, 761 (7th Cir. 1980)

ee a

l0a

10 Nos. 94-1389 & 94-3870

(“The creditor need establish only its reliance in fact,

although its claim to reliance cannot be so unreasonable

as to defeat a finding of reliance in fact.’’); In re Kreps,

700 F.2d 372, 375-76 (7th Cir. 1983). A victim who lacks

access to the truth, and has not been alerted to facts that

would alert him to the truth, is not to be denied recovery

under the securities laws—or be blocked by a discharge

under the bankruptcy laws—just because he did not con-

~ duct a more thorough investigation.

So understood, the reliance element of §523(aX2\A) of-

fers the Mayers no comfort. The bank’s loan officer testi-

fied that she had not seen the power of attorney by which

John Mayer disclaimed any interest in the Bess Hotel:

the bankruptcy judge believed that testimony, and his

finding is not clearly erroneous. The bank therefore had

neither actual knowledge of the fraud nor any strong

reason to suspect one. Whether the bank should have

done more to protect itself is a subject of sound banking

practice. A lender wants a borrower willing and able to

pay, rather than a claim in bankruptcy, but the fact that

the lender ended up with a chose in action rather than

cash in hand does not disqualify its claim. It relied on

the Mayers’ material misrepresentations. As the Mayers

concede that they never intended to pay, §523(aX2XA) for-

bids discharge.

John Mayer’s attempt to shake off his debt to Spanel

fares no better. King testified that he relied on the pur-

ported purchase order, which was unquestionably material

to the transaction. The documentation for the loan so

recited. King inquired of the Board of Education; when

the person to whom King spoke could not verify that the

Board had agreed to purchase Mayer’s manual, Mayer

wrote King that he had spoken with the wrong person

and warned him off from making further inquiries:

Because of your call and fax to the Chicago public

school system we are on the verge of losing our con-

tact there. If you needed verification of our work I

wish you could have had me put you in contact with

the correct persons. You know how businesses work.

lla

Nos. 94-1389 & 94-3870 ll

Your call was a very costly one. If anyone contacts

you from CPS on this, please just let them know you

are satisfied with the origin of any documents. Any

questions, call me directly.

Thus although King had doubts about the purchase order,

Mayer specifically assured him that the doubts were un-

warranted. Mayer does not contend that the size of the

order (5,000 drug manuals for a district with 77 high

schools and 476 elementary schools) or the price ($145 per

manual) should have alerted Spanel that something was

fishy. In the end Spanel actually relied on the purported

purchase order, and it did not need to do more research

to protect its ability to collect.

Mayer’s letter also shows that he was at least reckless

in telling Spanel that he had a purchase order for the

drug manual. In the bankruptcy court, Mayer denied any

knowledge of the purchase order’s provenance; it was all

his agent’s doing, Mayer insisted, and how was he to

know that his agent had given him an ersatz order? Yet

Mayer told Spanel that he had actual knowledge of the

purchase order, and just who to call to verify it. A man

teetering on the brink of insolvency (as Mayer was) is un-

likely to be indifferent to a contract promising five times

his annual income. He cared enough about the subject to

offer the purchase order as collateral; it is hard to swallow

his later tale that he accepted this document from his

agent without inquiry. Mayer had more cause than King

to ask follow-up questions. Indeed, Mayer’s letter to King

suggests that Mayer well knew that the purchase order

was phony. One stratagem of a defrauder is to enlist the

aid of a confederate in “verifying” the truth of the repre-

sentation. Success depends on sending the victim to the

confederate; a call at random is likely to reach someone

who is not in on the scheme. The letter implies that

Mayer was worried that King’s call, to someone who had

not been enlisted, might set an inquiry in motion.

One final issue and we are done. John Mayer promised

Spanel, and both Mayers promised the bank, to reimburse

any attorneys’ fees that the lender incurred in the proc-

l2a

12 Nos. 94-1389 & 94-3870

ess of collection. Bankruptcy judge Wedoff, relying on

Klingman v. Levinson, 831 F.2d 1292 (7th Cir. 1987),

added the bank’s attorneys’ fees to the non-dischargeable

debt; district judge Shadur affirmed. Yet earlier judge

Wedoff, relying on Jn re King, 135 B.R. 734 (Bankr. W.D.

N.Y. 1992), had discharged Spanel’s claim to attorneys’

fees; district judge Leinenweber reversed. We agree with

judge Wedoff’s second thoughts. Attorneys’ fees provided

.. by contract are part of the debt, and if the principal and

(pre-bankruptcy) interest on the debt are non-discharge-

able, so are the other elements of the debt. Attorneys’

fees, no less than the principal and interest, are the result

of the fraud, and the perpetrator cannot escape the con-

sequences. Accord In re Luce, 960 F.2d 1277 (5th Cir.

1992); In re Martin, 761 F.2d 1163 (6th Cir. 1985); Tran-

south Financial Corp. v. Johnson, 931 F.2d 1505 (11th

Cir. 1991). But cf. In re Johnson, 756 F.2d 738, 741 (9th

Cir. 1985). Under the American Rule, attorneys’ fees

would not be added to a debt as of course. In re Fesco

Plastics Corp., 996 F.2d 152 (7th Cir. 1993). But if a

debtor agrees by contract to pay legal expenses, this is

no different in principle from agreeing to a higher rate

of interest, or a balloon payment, or any other contrac-

tual element of compensation to the lender. Cf. Security

Mortgage Co. v. Powers, 278 U.S. 149, 153-54 (1928).

AFFIRMED

A true Copy:

Teste:

Clerk of the United States Court of

Appeals for the Seventh Circuit

USCA AOTXXXC-92-001—Midwest Law Printing Co., Inc., Chicago—3-31-95

———ireeO |