First American Title Insurance Company (First American) contended that an individual debtor should not receive a discharge for several mortgage loans based on false statements he made in connection with obtaining the loans. Its right to pursue the issue was based on an assignment of 75% of the lenders' interests in the applicable mortgage notes, which it obtained as part of a settlement involving claims under related title insurance policies. The debtor countered that any fraud claims could not be assigned, so First American could not pursue the exception from discharge. The bankruptcy court agreed and granted summary judgment to the debtor. After the district court reversed, the debtor appealed to the 6th Circuit.
The debtor did security work at a night club and other work for a consulting company, including scouting for commercial properties. The night club, consulting company and a title agency (Patrick Title Agency) were all owned by the same individual (Saylor).
In late 2007 the debtor applied for and obtained mortgage loans totaling ~$1 million to purchase 4 car washes. The loan closings were handled by Patrick Title Agency, which issued title commitments as agent for First American. Patrick Title Agency also issued closing protection letters (CPLs) to the lenders – which obligated First American to indemnify the lenders for certain types of losses that might arise from fraud of Patriot Title Agency in connection with the closings.
At some point the debtor defaulted on the loans. The assignee of the notes and mortgages (Bayview Financial) discovered that the debtor did not hold title to any of the mortgaged properties. So, it submitted claims to First American under the mortgagee title policies and CPLs, which the parties settled. The settlement included an assignment of 75% of Bayview Financial's interest in the debtor notes to First American.
As a related matter, in conducting its own investigations First American also discovered that Patriot Title Agency had been involved in a number of questionable transactions resulting in dozens of claims. It sued Patriot Title Agency and Saylor (its owner) for damages caused by Saylor's fraud, and obtained a default judgment against Saylor for ~$10 million.
After the debtor filed bankruptcy, First American filed an adversary proceeding seeking a determination that the ~ $764,000 owed to First American (75% of ~$1 million) was non-dischargeable under Section 523(a)(2)(B) of the Bankruptcy Code. (See Non-Dischargeable Debts: Some Lies Matter More Than Others.)
In addition to raising factual disputes, the debtor moved for summary judgment arguing that First American was just an assignee, and under applicable state law claims for fraud cannot be assigned. The bankruptcy court agreed and granted summary judgment to the debtor. First American sought reconsideration based upon a subrogation theory (i.e., it should be allowed to pursue the rights and remedies of its insured), which was also rejected by the bankruptcy court. The district court reversed on the basis that First American's claim arose from unpaid promissory notes, so it could assert its assignor's reliance on misrepresentations.
On appeal, a central part of the debtor's argument was that no misrepresentations were made to First American and it did not rely on any misrepresentations: its role was to insure title, not to evaluate the debtor's creditworthiness. First American responded by arguing that it was not asserting a fraud claim, but rather enforcing promissory notes. According to it, the underlying fraud made the notes non-dischargeable as soon as the debt was incurred, without regard to later assignments.
The 6th Circuit began by noting that there was a distinction under applicable state law between "naked claims of fraud and claims of fraud that are grounded in tangible property rights," quoting a state supreme court decision:
It is true, as a general proposition, that a distinct right of action for fraud is not assignable, but where the right to enforce a claim which is in itself assignable depends upon showing fraud incidentally the rule has no application. The assignment of the claim carries with it the right to employ any remedy which is open to the assignor.
The 6th Circuit concluded that the First American interest in the notes was a tangible property interest; and its claim was based on the notes, not a "naked claim of fraud."
The court next addressed the argument that First American's loss related to misrepresentations regarding title, not the misrepresentations that caused the loss to the lenders regarding the debtor's creditworthiness. Section 523(a)(2)(B) of the Bankruptcy Code sets forth an exception from the discharge of an individual debtor:
(B) use of a statement in writing –
(i) that is materially false
(ii) respecting the debtor's or an insider's financial condition
(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and
(iv) that the debtor caused to be made or published with intent to deceive;
The key question was whether "the creditor to whom the debtor is liable" meant the creditor holding the claim at the time of bankruptcy or at the time the debtor obtained the money. The 6th Circuit joined the 7th and 9th Circuits in deciding that the relevant question was whether the debtor made misrepresentations in connection with the original loan.
Consequently, the 6th Circuit affirmed the district court determination that First America could seek non-dischargeability under Section 523(a)(2), while expressing no opinion on the substance of its claims. (It also declined to address First American's subrogation argument.)
Sometimes we can be too quick to assume that an assignee steps into the shoes of the assignor in all respects. The outcome in this case bears out that expectation; however, it is worth remembering that this was not a foregone conclusion – as evidenced by the initial bankruptcy court decision.
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