Summary of a Recent
Judicial Development in
Secured Transactions

Exceptions from Discharge for Fraud and Willful and
Malicious Conversion of Collateral

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Bates, Bank. No. 05-07616, Adv. No. 05-30258-wle, 2007 WL 473732 (Bankr. S.D. Iowa Feb. 1, 2007), the United States Bankruptcy Court for the Southern District of Iowa held that a debtor's conduct did not constitute fraud because he did not knowingly make the false representation, and that his subsequent conversion of collateral was not malicious, and therefore dismissed his creditor's complaint.

Background

Debtor obtained an operating loan from Midstates Bank in 2001 using his crops, livestock, and farm equipment as collateral. Id. at *1. He had been a longtime customer of Pelgrow Petroleum Company, but Pelgrow refused to sell him any fertilizer on credit after he got into financial difficulty in 2002. Id. The Debtor subsequently misinformed Pelgrow about his ability to obtain financing for the 2003 crop year, so they again sold him fertilizer products on credit. Id. at *2. He claimed that he honestly believed that Midstates would finance the 2003 crops on the condition that he sold his farm and gave the Bank the proceeds from the sale, which he dId. Id. After he sold the farm, Midstates notified the Debtor that they would not provide him with financing, and when confronted by Pelgrow he admitted that that was the case. Id. at *3. Pelgrow had the Debtor sign a Certified Request and Waiver of Confidentiality so that it could obtain an agricultural supply dealer lien under Iowa Code Chapter 570A. Id. Pelgrow then filed a financing statement to perfect its lien. Id. at *4. After executing the certified request and waiver, the Debtor made six more purchases from Pelgrow. Id. Midstates later served the Debtor with notice of acceleration on his notes and demand for payment in full of all debt. Id. He harvested his crops in 2003 and told Pelgrow that he planned to pay it with the proceeds from the sale of the crops, but after Midstates filed a replevin action against him, he agreed to surrender the crops to Midstates. Id. at *5. The Debtor filed for bankruptcy shortly afterward, and Pelgrow brought this adversary proceeding, seeking to have its claim excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(A). Id. at *6.

Arguments

Pelgrow argued that the Debtor fraudulently obtained an extension of credit from it during the 2003 crop year, and that he willfully and maliciously converted its crop collateral. Id. at *6.

The Debtor claimed he made an honest mistake, and that he had actually believed that Midstates would finance the crops. Id. at *2.

Analysis and Holdings

A debtor's discharge of any debt for property or services or an extension of credit obtained by fraud is excepted by 11 U.S.C. § 523(a)(2)(A). Id. at *6. The court recognized that to recover under the theory of fraud, Pelgrow had to show that:

(1) [the Debtor] made a representation of a material fact; (2) at the time, [the Debtor] knew the representation was false; (3) [the Debtor] made the representation deliberately and intentionally with the intent to deceive Pelgrow; (4) Pelgrow justifiably relied on the representation; [and] (5) Pelgrow sustained damage as a proximate result of [the Debtor's] representation.
Id.

It was undisputed that the Debtor had made a representation of material fact that Pelgrow justifiably relied on to its detriment, but the issue was whether the Debtor honestly believed that Midstates would finance the 2003 crops. Id. at *6-7. The court found that he did believe that Midstates had agreed to lend him money on 2003 crop inputs on the condition that he would pay the Bank the proceeds from his land sale, and pointed to the payment of those proceeds as the strongest evidence that he believed what he told Pelgrow. Id. at *7. Midstates had no right to the proceeds by virtue of any lien, but the court found it likely that he paid them because he believed that if he did, it would keep a promise to help him financially through the 2003 season. Id.

Pelgrow also claimed that the Debtor converted its collateral and asked that its claim for conversion be excepted from discharge as a willful and malicious injury to Pelgrow's property interests pursuant to 11 U.S.C. § 523(a)(6). Id. The court found that the Debtor's conduct was not malicious, however, and that he had intended to pay Pelgrow but was simply unable. Id. at *8. The court therefore dismissed Pelgrow's complaint. Id.

The case was decided on February 1, 2007.