Georgia Bankruptcy Blog

By: Scott B. Riddle, Esq.

From Conglomerate (and now the Wall Street Journal) comes the recent decision in National City Bank v. Hill (In re Hill), Adv No. 07-4106, Ch. 7 Case No. 07-41137 (Bankr. C.D. Ca. May 23, 2008) (click here for .pdf of opinion).  Here, the debtors had previously submitted a materially false loan application to the Bank in order to obtain a secured residential loan.  The false representations at issue included fairly significant inflated income for both of the debtors.  However, the loan program was a "stated income" loan, or "liar loan," which was not subject to independent verification by the lender, as long as other conditions were met.  After default and foreclosure by a senior lender, the Bank filed a complaint to determine dischargeability, arguing that the debt was nondischargeable pursuant to §523(a)(2)(B)  based upon the false representations made by debtors in the loan applications.

Here are the basic facts:

• Debtors joint income was modest - at most, $65,000 combined.
• Debtors owned their home almost 20 years, frequently refinancing first and second mortgages  as the value increased.  As of the petition date, total secured debt was $683,000.
• For several years, Debtors had used the services of a mortgage broker.  In April 2006 the Broker assisted Debtors in getting a $200,000 equity line from the Bank.  The application signed by Debtors falsely indicated they had combined income of $145,716.  The Broker testified he obtained this information from Debtors to place in the application, and he sent the application for the Debtors to sign.  Debtor Mrs. Hill testified she did not provide the figures and that Debtors had never read this, or any other, loan application.
• In October 2006, Debtors needed more cash and contacted the Bank directly.  The new application signed by Debtors reflected a combined income of $190,800, or about triple the actual number.  Again, Debtors denied providing this number.
• The Loans made by the Bank were stated income loans, which  required verification of employment, but not income.  However, the guidelines entered as evidence did reveal that there should be an evaluation of the reasonableness of the stated income based on the type of job, tenure, location, etc.  There was no evidence of such a review by the Bank.  The last loan was also apparently supported by an inaccurate appraisal, but that was apparently conducted by, or on behalf of, the Bank.
• After foreclosure by the senior lender, the Bank filed the adversary proceeding against Debtors, arguing the debt should be determined nondichargeable based upon the materially false financial statements signed and submitted by Debtors.

 The Court ruled against the Bank, stating it had not met it burden under §523(a)(2)(B).

• For reasons more thoroughly discussed in the Opinion, the Court did find that Debtors knew that the representation concerning income was false when made, and that the Debtors made the representation with the intent to deceive the Bank.  Basically, the Court apparently did not find Debtors to be credible on any issue about which they testified.  This is something that should not be lost in the holding. 
• Conversely, the Court held that the Bank did not meet its burden of proving that it reasonably relied on the false representations when making the loan.  Its own guidelines were not followed as far as employment verification and self-employment verification, and it ignored a "red flag" as far as the disparity in stated income for the April and October 2006 loans. The appraisal performed on behalf of the Bank was apparently inflated, and thus the Bank's reliance was in part on its own vendor.

I do not find this opinion particularly remarkable.  The Court starts off by stating that the proceeding is "a poster child for some of the practices that have led to the current crisis in the housing market."   That is probably correct, and notably, the opinion does not distinguish which face is on that poster.  It appears that the Court simply applied the evidence to the statute in a rather straightforward manner, and aptly held that the Bank did not meet the burden of proof on one of the elements.   It certainly could be a big problem for lenders who choose to object to discharge when they have not followed their own guidelines and standards, or have otherwise acted "unreasonably."

Since drafting this, I have already seen a couple of other posts in other bankruptcy forums touting this as a "victory" for debtors over the lenders, or "restoring the balance to the equation."  It is not.  It is a loss for a lender that did not make its case, and should have lost.   The Debtors fortuitously escaped liability as the Court obviously thought they were inherently dishonest and had the intent to deceive the Bank. 

I have served as an "expert" (witness) to counsel in similar matters. We can expect to see a significant rise in these types of decisions. No loan file should be left without a borrower handwritten form 1003 application. The final application is computer generated but MUST match the application in the borrowers handwriting. Nothing handwritten equals lender liability, thats all!

This is not the time nor place to debate the training many "ethical" veterans of acceptance will recall as to maintaining a reasonable and common sense approach to earnings. God bless the union laborers, those employed at your local grocery store and public school system teachers. But lenders who rationalize a need to highly leverage debt to those in such occupations and at cost of funds twice in excess of what their income shows and can afford is wrong.

Quality Control and risk management entry level positions know earnings are verifiable through public and private data banks taken from industry and IRS reports. A published median earnings figure in a subjects area, for a postal worker or cop, will certify the integrity of a stated income loan (I assume what we are talking about). What other means of acceptance will otherwise allow these wage and W2 earners access to a million dollar note (or home). The notion is politically and socially unacceptable and has no basis for logic. The logic used by the bank to approve the loan and method for selling the loan to the secondary is however, more absurd. These are the rescission arguments we are using to help clients----right or wrong---where no lender handwritten 1003 application exists. (Note - Your article is obviously not a falsified tax returns and borrower instigated fraud matter related to a story, bank being duped and claims of "other" borrower sources of income. That is an entirely different matter with criminal implications). My advice to lenders is negotiate a settlement now with future claims or lose your security in a costly trial. And, next time try something like salaries.com

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