A primer on the elements of fraud

 

The James vs. West case, part eight: The Elements of Fraud

As a bankruptcy attorney in Mount Vernon, IL for over 20 years, I read through and analyze court rulings throughout the country. I was lucky to find this wonderful case from the Western District of Missouri (whence lay Kansas City, Independence, Branson, etc.). James v. West, 16-40358.

What a wonderful case this is: an excellently written opinion dealing with fraud, the means test and other topics important in bankruptcy.

This isn’t an opinion, this is a text book. It should be on the curriculum of anyone teaching bankruptcy law. It is that good!

Click on the links to read Part One, Two, Three, Four, Five, Six and Seven for a statement of the facts and other bankruptcy issues in this wonderfully written case!

 

Count I: Section 523(a)(2)(A)

Turning finally to the requirements of § 523(a)(2)(A), the plaintiff must show by a preponderance of the evidence the following five elements:

(1) The debtor [or agent] made a representation;

(2) The debtor [or agent] knew the representation was false at the time it was made;

(3) The representation was deliberately made for the purpose of deceiving the creditor;

(4) The creditor justifiably relied on the representation; [and]

(5) The creditor sustained the alleged loss as the proximate result of the representation having been made.

In re Freier, 604 F.3d 583, 587 (8th Cir. 2010) (citing In re Mauer, 256 B.R. 495, 500 (B.A.P. 8th Cir. 2000)).

First Element: Representation

The first requirement is that the debtor or her agent made a representation. Silence regarding a material fact may suffice for a representation. In re Moen, 238 B.R. 785, 791 (B.A.P. 8th Cir. 1999). Also, “representation” is not confined to spoken or written words, but also encompasses other conduct that amounts to an assertion inconsistent with the truth. Id. (citation omitted). A statement in a contract may constitute a representation for purposes of section 523(a)(2)(A). See, e.g., In re Smith, 281 B.R. 613 (Bankr. W.D. Penn. 2002).

Second Element: Knowledge of Falsity or Reckless Disregard of the Truth

As to the second requirement, that the debtor or her agent knew the representation was false when she made it, it is sufficient if the declarant made the statement not knowing of its falsity but with a reckless disregard for the truth of the statement. Moen, 238 B.R. at 791. In determining whether the declarant knew the representation was false when it was made, the court may consider the knowledge and experience of the declarant. Id.

Third Element: Intent to Deceive

The third requirement is intent to deceive. Because direct evidence of intent is rare, a court may accept surrounding circumstances that create an inference of an intent to deceive the creditor. In re Schnuelle, 441 B.R. 616, 622 (B.A.P. 8th Cir. 2011). When the creditor introduces this circumstantial evidence of intent, the declarant’s self-serving statement of honest intent is not enough to overcome the inference of intent. Id.

Fourth Element: Justifiable Reliance

The fourth requirement is justifiable reliance. In Field v. Mans, 516 US 59, 73–74 (1995), the Supreme Court held that § 523(a)(2)(A) requires justifiable reliance, but not necessarily the reasonable reliance required under (a)(2)(B). The Court noted that “reasonable reliance” is a more stringent standard than “justifiable reliance.” Id. at 77. Justifiable reliance is a subjective standard. In re Schmank, 535 B.R. 243, 258 (Bankr. E.D. Tenn. 2015) (citation omitted).

Justifiable reliance falls somewhere between actual reliance and reasonable reliance; even if an investigation would have revealed the falsity of the representation, reliance can still be justifiable. Schnuelle, 441 B.R. at 622–23. What is not justifiable is blind reliance where a cursory examination would have revealed the falsity of the representation. Id.

Fifth Element: Proximate Cause

The fifth requirement is proximate cause. Proximate cause requires that the creditor would not have suffered the loss at issue but for the debtor’s (or her agent’s) actions. In re Maier, 38 B.R. 231, 233 (Bankr. D. Minn. 1984). It also requires the creditors to prove that their loss was a foreseeable result of the misrepresentation. In re Smithson, 372 B.R. 913, 922 (Bankr. E.D. Mo. 2007) (citing In re Creta, 271 B.R. 214, 219 (B.A.P. 1st Cir. 2002)).

Addressing each alleged representation in turn:

The Debtor’s Alleged Representation No. 1 That She Intended to Purchase the Property

The Court assumes in the absence of any authority to the contrary that making an offer to purchase in a written contract is a representation that the Debtor intended to purchase the property – the first element of § 523(a)(2)(A). The question is whether the Debtor knew that the representation was false or had reckless disregard for its truth.

The Court believes the Debtor’s credible testimony that she thought at the time she made the offer to purchase the Property that Knowles was going to procure the funds for the Contract, and therefore concludes this representation was not overtly false. That does not, however, end the inquiry; it is a closer question about whether signing the Contract in reliance on her boyfriend was made in reckless disregard of the truth. Certainly, with the benefit of hindsight, her reliance on her boyfriend – now known to be an untrustworthy person – to procure $1.0 million of funds from a rich brother and friend whom she had not met seems far-fetched. It is unclear to the Court whether there was ever valid interest by the brother to help with the funding, or whether Knowles invented the brother’s interest and lied to the Debtor from the inception.

But the Court believes that the Debtor honestly believed and trusted her boyfriend, and likewise believes it is unfair to judge her intent and reliance with the benefit of 20/20 hindsight.

The Court believes she would not have signed the Contract if she had known Knowles’ brother intended not to advance the funds to purchase the B&B. The Court thus finds that the Jameses have failed to meet their burden to prove that the Debtor knew when she signed the Contract that the representation that she was willing to close was made with reckless disregard of the truth.

The third element is whether the representation was deliberately made with the intent to deceive. Again, the Court does not believe that the Debtor engaged a buyer’s agent, looked at several houses, and then deliberately picked the Jameses, whom she did not know, to make an offer to buy their house with the intent not to perform. The Court believes her credible testimony that she would not have made the offer if she had known that Knowles could not procure the funds to close, and that she reasonably believed Strong when he said that if the earnest money was not paid timely the Contract was void in any event.

The fourth element is whether the creditor justifiably relied on the representation. The Court finds that the Jameses justifiably relied on an offer to buy their home. Strong, an otherwise reputable real estate agent, used a standard real estate contract and passed the offer to the Jameses’ own agent.

The fifth element is whether the creditor sustained the loss as the proximate cause of the representation being made. The Court confesses to some difficulty with the proximate cause element here. It is true that the default clause of the contract in Paragraph 14 states that: “Seller or Buyer will be in default under this contract if either fails to comply with any material covenant, agreement or obligation with any time limits required by this contract,” and that if the Buyer defaults, the Seller may either retain the earnest money or “pursue any other remedy and damages available at law or in equity.”

The effective date of the Contract according to its terms was April 9, 2013, when the Jameses signed it. Under the Contract’s plain terms, the Debtor defaulted on the Contract when she failed to comply with the first material obligation in Paragraph 7 “to provide written verification from a depository of funds on deposit within 5 calendar days which are sufficient to complete the closing the contract” – in other words, by April 14, 2013. Although the Jameses have argued that they relied on the Letter as the proof of funds, they admitted they relied on the Letter before they signed the Contract – meaning that the Letter could not have served as the “written verification from a depository of funds.”

More importantly, the Letter is not from a “depository of funds on deposit,” but from an entity evidencing an intent to make a loan. Even if the Letter could be stretched to constitute “written verification from a depository of funds on deposit,” the Contract also provided in Paragraph 19, “that upon acceptance of this Contract, unless otherwise agreed, any Earnest Money will be deposited within . . . 10 banking days (if MO property).” Here, ten banking days would have been April 23, 2013.

So, at the earliest, the Debtor was in default of the Contract as early as April 14 and no later than April 23. Although the Court is bound to accept the state court’s final judgment as to the amount of damages, the Court has exclusive jurisdiction over whether a debt is nondischargeable, and must therefore question how damages incurred after the April 14 default were proximately caused by any actual representations of the Debtor.

Had the Jameses met their burden of proof with respect to all five elements, the Court might have felt the need to apportion the damages proximately caused by the representation based on the evidence, but since the Court concludes that the Jameses failed to meet their burden of proof with respect to the second and third elements of § 523(a)(2)(A), there is no need to apportion. The Court denies judgment under § 523(a)(2)(A) with respect to the representation that the Debtor would close.

The Debtor’s Alleged Representation No. 2 That She Would Comply With the Entirety of the Contract

The Court believes that the same analysis and findings apply to this element. Debtor did make a representation that she would comply with all the terms of the Contract; the representation was not false or made with reckless disregard for the truth at the time it was made based on her credible testimony; she did not intend to deliberately deceive the Jameses; the Jameses justifiably relied on the representation she would comply; not all the damages were proximately caused by the reliance, but the Court need not apportion which damages were caused by the reliance since the Jameses did not meet their burden of proof on all five elements with respect to this representation.

The Debtor’s Alleged Representation No. 3 That She Had $999,500 in Cash to Purchase the Property

The first element is whether the Debtor made a representation that she had $999,500 in cash to purchase the Property. The Court finds no credible evidence that the Debtor made a representation to the Jameses that she had $999,500 in cash.

First, the Contract does not contain such a representation. The Contract states in Paragraph 7 that the sale is a cash sale and that the buyer must provide written verification from a depository of funds on deposit and that the purchase price must be paid in certified funds on or before closing. Neither of those clauses constitutes a representation that the Debtor had $999,500 in cash. The Jameses allege that she told Strong she had a large estate or fund, but that is the subject of a separate alleged misrepresentation and not a representation that she had $999,500 in cash when she signed the Contract. There is no other evidence that the Debtor herself or through Knowles or otherwise represented that she had $999,500 in cash.

Moreover, it is generally accepted that buyers may choose the cash sale option when buying real estate even though they intend to secure outside financing. The choice of the cash sale option simply means that the buyer does not have the out of a financing contingency. Cash buyers cannot be said to represent, at the moment of signing the contract, that they have cash equal to the purchase price. Instead, in those transactions, as is the case here, the buyers may be seeking outside financing, some type of gift, or another means of obtaining cash by the closing date. The closing date is the date that the buyer must have the funds available to close under the contract. The Contract at issue does not contain a provision that the Debtor must have cash on the date of signing, and establishes the closing date as the date she must pay the balance of the purchase price.

Furthermore, construing the Debtor’s signature on the Contract as a representation that she had $999,500 in cash would render superfluous the proof of funds provision in the Contract.

The proof of funds provision requires the Debtor to provide proof of funds for the contract price within five days of signing the Contract.

Alternatively, even assuming the Debtor represented that she had $999,500 in cash by signing the Contract, for the reasons already discussed, the Court does not find that the Debtor’s representation that she could procure the funds was false or was intended to deceive the Jameses.

Likewise, the Court cannot find justifiable reliance or proximate cause on the part of the Jameses. The purpose of the proof of funds provision was to ensure the Debtor had sufficient cash to close. Thus, the Jameses were not entitled to rely on the Contract as a representation that the Debtor had sufficient funds – that was the purpose of the proof of funds provision.

In conclusion, as to the representation that the Debtor had $999,500 in cash, the Jameses have failed to show that the Debtor made a representation, that the Jameses justifiably relied on the representation, and that the alleged representation was the proximate cause of their loss. The Court denies judgment under § 523(a)(2)(A) with respect to the alleged representation that the Debtor had $999,500 in cash.

The Debtor’s Alleged Representation No. 4: That the Debtor Would Close on the Dates in the Contract

The Court incorporates its findings with respect to the previous representations, and finds as follows. First, by signing the Contract, the Debtor represented that she would close. Second, the Debtor’s representation was not false or made with reckless disregard for the truth, because she reasonably relied on Knowles to provide the financing to close. Third, the Debtor did not make the representation with the deliberate intent to deceive the Jameses. In particular, the Debtor credibly testified that she believed based on what Strong told her that the Contract would be void if she did not pay the earnest money. Fourth, the Jameses justifiably relied on the Debtor’s representation in signing the Contract that she would close. But fifth, the intervening defaults for the failure to provide verification from a depository of funds and payment of the earnest money mean that the Jameses’ damages were not all proximately caused by the representation. The Court therefore need not apportion the damages caused by the representation since the Jameses failed to meet their burden of proof with respect to all five elements.

Debtor’s Alleged Representation No. 5: That She Would Take Possession of the Property on May 3, 2013

The Court incorporates its findings from the previous representations, and finds that the Jameses have failed to meet their burden of proof with respect to all but the reliance element.

Debtor’s Alleged Representation No. 6: That She Was Approved by the Letter for $999,500

The Letter representation is somewhat different from the other alleged representations. It was obviously (1) a representation; (2) that was false; and (3) that was deliberately made with the purpose of deceiving the Jameses. This representation could be a representation under §523(a)(2)(A) or a representation regarding financial condition under § 523(a)(2)(B). But since the first three elements of both sections are essentially the same, the Court will address those elements first before deciding which Count this representation falls under (and therefore which standard of reliance applies.) The first issue with this allegation is whether the Debtor made the representation or whether the representation should be imputed to her.

The Court does not believe that the Debtor was responsible for creating and sending the Letter. She testified credibly that she had no knowledge of the Letter at the time it was provided to Strong, who provided it to the Jameses through their real estate agent. Her testimony was buttressed by Strong’s and by Knowles.’ Strong ultimately admitted he had no knowledge of who sent him the Letter. Knowles testified he created the Letter with Strong’s knowledge and that the Debtor had no knowledge of the Letter. The Court concludes that the Debtor herself did not represent through the Letter that she had the funds to close the loan. But that leaves the question about whether the misrepresentation evidenced by the Letter should be imputed to her.

To recapitulate, to impute Knowles’ or Strong’s misrepresentation to the Debtor, the Court must find both agency and actual or constructive knowledge of the fraud. Having found agency on the part of Knowles and limited agency on the part of Strong, the Court turns to the Debtor’s actual or constructive knowledge of the fraud.

The Court finds that the evidence does not show that the Debtor had actual or constructive knowledge of Knowles’ fraud through the Letter. The Court again believes her credible testimony that she was in good faith and based on a long-time relationship of trust and love reasonably relying on her boyfriend to procure the funding for the purchase of the Jameses’ home.

But what about Strong? Knowles testified that Strong assisted him in creating the fraudulent Letter. The Court tends to believe that was true, notwithstanding Knowles’ otherwise untrustworthy nature, given that Knowles appeared to lack the knowledge or sophistication for creating such a letter. (Knowles admittedly had computer and internet sophistication, but there was no evidence he was financially sophisticated.) But whether Knowles acting alone or Strong and Knowles together created the Letter, the bottom line is that there is no evidence the Debtor had actual or constructive knowledge of the Letter. The third element is thus not met.

With respect to the fourth element, justifiable reliance, the Court again is faced with a difficult question. The Jameses each credibly testified that they had no reason to question the validity of the Letter as providing proof that the Debtor had funds sufficient to close the contract, which they assert is what caused them to accept her offer and to sign the Contract to begin with.

Although the Court does not doubt their sincere belief, the Court must still question whether their belief was, in some respects, as naive and unrealistic as the Debtor’s was.

First, the Letter is not, as the Court has already mentioned, a letter from a depository institution of proof of available funds as the Contract required. It is also not from a standard or recognized funder of residential mortgages. Second, it was not accompanied with the earnest money deposit. Third, it bears no logo or professional letterhead such as would typically be seen of letters of commitment or letters of intent from reputable and well-known funding entities.

Fourth, the Letter does not contain any of the standard terms a reasonable person would expect to see, such as conditions, interest rates, date of closing, expiration, requirements of title, a deed of trust or mortgage, etc. Fifth, assuming the Debtor had represented to the Jameses that she had a fund or estate to finance the purchase, the Letter does not even state it is written on behalf of a fund or estate. Finally, the last sentence discussing terms of a loan are expressly contradictory to the nature of a cash deal.

In short, the fact that the Letter did not comply with the requirements of the Contract and contained no objective indicia of a proof of funds letter should have raised concerns not only from the real estate agents but from a seller who also happened to be an experienced lawyer.

That being said, it is not difficult for the Court to believe that real estate agents on both sides – with motivation to close a deal with a lucrative commission – did not have the incentive to fly-speck the Letter or to raise concerns about its patent red flags. That being said, it is also not difficult for the Court to believe that the Jameses – who were separated, trying to down-size, and who faced the ongoing upkeep of a very expensive home – likewise had no incentive to flyspeck the Letter or raise concerns. The Property had been on the market for several months, and the Jameses were presumably as anxious, as are all home sellers, to find a buyer and to close.

So, given that the standard under § 523(a)(2)(A) is “justifiable” and not reasonable, as under § (a)(2)(B), to the extent the Letter constitutes a representation under § (a)(2)(A), the Court concludes that the Jameses’ reliance on the Letter was justifiable.

With respect to the fifth element, proximate cause, the Court again incorporates its findings that not all of the damages were proximately caused by the representation but that since the Jameses did not meet their burden of proof with respect to all of the elements, the Court need not apportion the damages.

Alleged Representation No. 7: That The Debtor had $989,500 available from Banner Bank to purchase the Property

The evidence is undisputed that an image of a check from Banner Bank in the amount of $989,500 was sent to the Jameses through their agent by someone at Chartwell Realty. The Court finds and concludes that the Check was a representation; that the representation was false; and that the representation was made with intent to deceive. The issues with this representation are whether the Debtor made the representation or whether it should be imputed to her; whether the Jameses relied on it; and whether the representation proximately caused their loss.

The Court finds based on the credible testimony of the Debtor that she did not create or send the Banner Bank check. The Court’s finding is supported by Strong’s testimony that at this point in the transaction he was dealing with Knowles and had no personal knowledge that the Debtor sent the check, and Knowles’ testimony that he sent the check to Strong. With respect to whether knowledge of the false representation in the form of the check should be imputed to the Debtor either through Knowles or Strong, the Court incorporates its earlier findings. Knowles was in a joint venture with the Debtor to buy the home, but there is no evidence that she knew or had constructive knowledge of the false check either created by or found on the internet by Knowles, or that he was sending it to Strong and through Strong to the Jameses through their agent.

Strong testified he recognized immediately that the check was false since it had no routing numbers. He (or someone at Chartwell Realty acting on his behalf) therefore did not send it to the Jameses with the intent of deceiving them. Thus the Court concludes that the misrepresentation and intent to deceive of the false check should not be imputed to the Debtor.

More importantly, both the Jameses credibly testified that they immediately recognized the check as being false. It therefore cannot be said that they justifiably relied on the false check or that any of their damages were caused by it.

Alleged Representation No. 8: That the Debtor was married to Knowles

The first element is whether the Debtor made a representation that she was married. The evidence shows that the Debtor did not represent that she was married. The Court believes the Debtor’s credible testimony that she did not represent to Strong that she was married. More importantly, the Contract states on page 1 that “This contract is made between: PRINT Names and indicate marital status.” The Buyer’s name on the Contract is the Debtor’s, not the Debtor as a married person. There is likewise no other evidence that the Debtor represented to the Jameses that she was married.

Strong testified that the Debtor and Knowles represented to him that they were married, but the Court cannot believe that was true; if this experienced agent had believed so, he would have made sure that the Contract stated “Sharon West, a married person” – in the same way he testified that if he had known the purchase was for a B&B he would have made sure he checked the “other” box on his buyer’s agency form (indicating he was not merely representing her for the purchase of residential property).

More importantly, assuming the Debtor misrepresented to Strong her marital status, there is no evidence that the Jameses knew the Debtor was married or even relied on that representation. Plus, there is no evidence that the fact she was unmarried was the proximate cause of any of the Jameses’ damages.

Alleged Representation No. 9: That Debtor had a Large Estate or Fund Sufficient to Pay the Purchase Price

The final alleged representation is that the Debtor represented that she had a large estate or fund sufficient to pay for the purchase price of the Jameses’ home. The first element is whether the Debtor made this representation.

The Court believes the Debtor’s credible testimony that she did not represent she had a fund or estate worth $1.0 million. The next issue is whether Knowles or Strong as her agent made the representation such that the representation should be imputed to her. The Court need not reach that issue, however, since there is no evidence that anyone: (1) told the Jameses that the Debtor had access to $1.0 million through an estate or fund or (2) that the Jameses relied on that representation in accepting her offer to buy the Property. Rather, the Jameses’ testimony was that they relied on the Letter in accepting the Debtor’s offer, not on any representation of the Debtor that she had $1.0 million from an estate or fund.

Conclusion as to Count I

In sum, assuming all nine representations fall within § 523(a)(2)(A), the Court concludes that the Jameses have failed to meet their burden of proving by a preponderance of the evidence that their debt should be nondischargeable under § 523(a)(2)A) based on any of the nine alleged representations. Judgment will be entered against the Jameses on Count I of their complaint.

 

About the blogger:

Michael Curry of Curry Law Office in Mount Vernon, Illinois (http://michaelcurrylawoffice.com/) has helped thousands of individuals, family and small businesses in southern Illinois find protection under the Bankruptcy Code for almost twenty-five years. He is also available to help individuals and families with their estate planning (wills, power-of-attorney) and real estate and other sales transactions.

He is also the author of books on finance and bankruptcy available on Kindle through Amazon!

Whether you live in Mount Vernon, Nashville, Fairfield, Cisne and throughout Southern Illinois call Curry Law Office today at (618) 246-0993 and Finally Be Financially Free!

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2 thoughts on “A primer on the elements of fraud

  1. Pingback: The James vs. West case, part nine: More analysis on the Elements of Fraud | Curry Law Office

  2. Pingback: A primer on Willfull and Malicious: the final review of the James vs. West case | Curry Law Office

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