Here’s how the debtor and creditor discover the facts in a dispute about whether a debt gets discharged in bankruptcy.
Here are the facts, briefly. Five years ago Marshall got a $35,000 loan from his aunt, Heather. But he wasn’t completely upfront with her at the time, neglecting to list in his loan application a $7,500 debt to another aunt. So now, after Marshall filed bankruptcy, Heather filed a formal complaint accusing him of fraud for this lying by omission. Specifically, she alleged that his omission about the other loan was “materially false,” Heather “reasonably relied” on that omission in making the loan, and Marshall made the omission “with intent to deceive” her. (There are other elements of fraud but these are the ones that are at issue in this example.)
Marshall filed an answer by denying that this omission was “materially false.” That’s because he thought that Heather would have made the $35,000 loan even if she had known about the $7,500 balance on the earlier loan. He also denied that Heather had “reasonably relied” on his omission because he didn’t think that she had relied on the application at all. Finally, Marshall denied that he’d excluded the prior $7,500 “with intent to deceive” Heather. He hadn’t thought she’d care one way or the other.
He felt he hadn’t set out to cheat her at all. Since he hadn’t, he understood the law gave him the right to legally write off the now-$21,000 debt in bankruptcy.
Burden of Proof
Debts like Marshall’s get discharged unless the creditor finds legally valid grounds for the bankruptcy court to deny discharge. The burden is on the creditor to find facts supporting those grounds.
Here in our example Heather has to bring evidence establishing ALL of the following:
- Marshall’s omission was “materially false.” That is, the omission not only made his application false. It was so false that Heather would not have made the loan had Marshall included the $7,500 debt.
- Heather had “reasonably relied” on the omission in making the loan. That is, Heather had at the time not only relied on the lack of a $7,500 loan. She had relied on that omission reasonably. Under all the circumstances it made sense for her to rely on the accuracy of Marshall’s application.
- Marshall acted with “intent to deceive” Heather. He had not included any reference in the loan application to the $7,500 he owed to the other aunt because he purposely wanted to fool Heather into giving him the loan.
“Discovery” is the formal procedure for discovering the relevant facts in a lawsuit. In our context it’s the way that Marshall and Heather get at the facts relevant to their discharge dispute.
The facts are “discovered” mostly through these four methods:
- Interrogatories: a list of written questions the other party must answer in writing. (Federal Rule of Bankruptcy Procedure 7033, Federal Rule of Civil Procedure 33)
- Document production: a formal request that certain documents be provided. (FRBP 7034, FRCP 34)
- Admissions: ask the other party to admit certain facts. (FRBP 7036, FRCP 36)
- Depositions: oral sworn testimony of the parties and witnesses. (FRBP 7030, FRCP 30)
“Discovery” in Our Example
The Louisville bankruptcy lawyers for Marshall and Heather wanted to try to keep litigation costs down for their clients. So they agreed to avoid depositions if they could get the facts they needed without them. Depositions can be time-consuming and expensive.
So both parties prepared and delivered Interrogatories.
Heather’s Interrogatories to Marshall
Here are some of the most important interrogatories that Heather presented to Marshall, along with his sworn answers:
1. Were you aware of the $7,500 balance you owed your other aunt at the time you completed Heather’s loan application?
2. If you were aware of this other loan balance, why did you not include it in the application?
I did not include it because I really didn’t think Heather would care one way or the other. I’d made payments on that personal loan perfectly, bringing it down from $20,000 to the $7,500 balance at the time. I figured that with this payment history that existing loan was more of a positive than a negative to Heather. It showed my creditworthiness on family loans. However, I’d heard that Heather was in an unpleasant dispute with the other aunt. Heather had a reputation for being unpredictable. So I was afraid of giving her any excuse to not give me the $35,000 business loan. I was pretty desperate to get it from her.
3. Did you intend to deceive Heather into making the loan by omitting the $7,500 debt you still owed to your other aunt?
No. I really didn’t think that Heather was basing her decision on the loan on financial and risk considerations. She seemed to be motivated mostly by family considerations. Aunt Heather expressed a desire to help, out of affection and family ties. She acted like the application was a formality.
Also, I thought Heather may well already know about that other debt. I had borrowed the $20,000 years earlier from the other aunt to get a 2-year community college degree. These two aunts were not very close, but that earlier loan wasn’t any big secret. I figured there was a good chance that Heather already knew about it.
I wasn’t trying to fool her into thinking I was debt-free so that she would make the loan.
Marshall’s Interrogatories to Heather
Here are some of the most important interrogatories that Marshall presented to Heather, along with her sworn answers:
1. Were you aware that Marshall had taken out a loan from his other aunt at the time you agreed to lend him the $35,000 for his new business?
No. I’d heard vaguely about it a few years before that. But it was not in my mind at the time I was considering whether to make the $35,000 loan. I did not know whether he’d paid it off, was making payments at the time, or any such details.
2. If you had been made aware of the $7,500 debt by Marshall including it on his application, would you have made the $35,000 loan to him?
I don’t know. Hard to tell now, more than five years later. It would have made it less likely, for sure. I WAS a little nervous about making the loan anyway. That could have pushed me to change my mind.
3. Did you review the application after Marshall had completed it?
I had my lawyer prepare the application form and I asked her to review it when he’d completed it. But no, I didn’t read it myself. I remember vaguely talking with my lawyer about it, but nothing specifically.
4. On what did you base your decision to make the loan to Marshall?
On whether he was worthy of getting the money. He’d always been a good guy. I don’t have any kids myself. I’d always liked him. He was always a hard worker, an honest young man. He had gotten some bad breaks earlier and I wanted to help. His business plan sounded sensible. He was family.
But now he needs to pay me back. Just because he can write off his other debts doesn’t mean he should write off this one. I was loyal to him. He should return the loyalty by paying back this debt to me.
Next, the Trial
With these facts on the table, this adversary proceeding is ready for trial. We’ll finish with that in our next blog post on Monday.