Daily Development for
Friday, August 23, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

BANKRUPTCY; DISCHARGE: If Borrower fails to disclose a change in Borrower's financial condition between the date of a former loan and a refinancing loan with the same lender, then the refinancing loan is not dischargeable in bankruptcy.

Matter of McFarland, 84 F.3d 943 (7th Cir. 1996).

Borrower made a loan in 1990 and regularly refinanced the loan. In the refinancings, Borrower paid off the existing loan and borrowed the amount of the paid off balance plus an additional loan advance. This was a typical method by which Lender extended additional credit while simultaneously refinancing the existing debt.

In 1993, borrower previous borrowing had been pursuant to a note with a maturity date of 1995. Borrower elected to increase the amount of her borrowing, and, pursuant to the practice, signed a new note for the old balance plus an additional amount, rather than just a new note for the new amount. In making the subject loan, Borrower furnished a financial statement that purported to list her assets and liabilities. Borrower, however, failed to include a liability as a cosigner on another note and also an amount she owed to the Internal Revenue Service. Had she included these, her payment ratios would have put her outside of the bank's lending limits.

Later that same year, Borrower filed a Chapter 7 bankruptcy and Lender filed an adversarial complaint seeking a determination that the entire balance was not dischargeable pursuant to the fraud exception under 11 U.S.C. § 523(a)(2)(B). Lender testified that it would not have made the latest loan had it known the financial condition of Borrower. Bankruptcy Court determined that only the additional sum disbursed to Borrower was nondischargeable and District Court agreed. The apparent rationale was that, as to the original loan amounts, Lender was no worse off than it would have been had it not refinanced the debt. Lender already had agreed to a loan with a 1995 due date for the original amounts.

The Seventh Circuit reversed, commenting that the premise of the lower court rulings implies the existence of a detriment requirement in the statute, which the statute does not contain.

Comment 1: The case is reported just as a reminder of "what can happen" when one cosigns a note. The court gives us no facts here, but it is not uncommon for cosignors to be accomodators for "real" borrowers, with an understanding that they have no direct responsibilities. Consumer borrower cosignors frequently neglect to report such items on their financing statements, just as they fail to view pending tax obligations as "real" debts. They are "real" though, to the bank. Although it is possible that bank would have worked things out anyway with the debtor had she made the disclosure, here the bank is able to dodge the bankruptcy bullet.

Comment 2: DIRT wants to know: Is the bank's practice of constantly rolling all debts into one note a common one, and, if so, is it done for reasons related to the result in this case, or for more prosaic reasons such as ease in bookkeeping?

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