Factual Summary: To finance a hotel development, the applicant applied for a standby LC. In issuing the standby, the bank required a second mortgage on applicant's home (the first mortgage for which it also held). Contrary to its normal procedure and because the applicant was a long-standing customer, the issuer failed to conduct a title search. Unbeknownst to the issuer, the applicant had transferred his interest in the property to his spouse and forged his spouse's name on the application, note, and mortgage.

Subsequent to paying the beneficiary, the issuer obtained a default judgement against the applicant for reimbursement. In the meantime, the applicant had filed for bankruptcy and sought discharge of the now unsecured obligation. The issuer brought this action to determine whether the applicant was entitled to discharge the debt under federal bankruptcy law in view of alleged fraudulent misrepresentations made to obtain the LC. The bankruptcy court ruled the debt was discharged since the issuer's reliance on the fraudulent misrepresentations was insufficient in character to attain the required status of justifiable reliance. The Bankruptcy Appellate Court affirmed. On appeal to the U.S. Circuit Court, reversed.

Legal Analysis:

1. The Justifiable Reliance Standard: The trial court concluded that the issuer, being a sophisticated business, was obliged to conduct a cursory observation in the form of a title search. The bankruptcy appeals panel concurred. In its opinion, having failed to conduct a title search or ascertian the spouse's identity, the issuer violated "its own as well as pro-fessional custom and put itself in harm's way", thus assuming the risk that its security would be worthless.

The appellate court, however, disagreed. Relying on the U.S. Supreme Court ruling in Field v Mans,516 U.S. 59, 116 S.Ct 437 (1995) and theRestatement (Second) of Torts --537, 540, 541, and 545A, it stated that there must be justifiable reliance by the creditor on these representations. Justification is "a matter of the qualities and characteristics of the particular plaintiff and the circumstances of the particular case, rather than of the application of a community standard of conduct to all cases."

Additionally, the appellate court disagreed that the issuer assumed the concordant risk by failing to witness the beneficiary's wife's signature (which the beneficiary forged on the papers). The appellate court distinguished between reasonable reliance and the more subjective standard of justifiable reliance. This approach was not to be taken to mean that the "[creditor] never has a duty to investigate; the [creditor] may not turn a blind eye if the falsity is obvious." Whether the falsity is obvious depends on the creditor's experience and knowledge."

The court stated that the issuer was entitled to rely on the debtor's statements absent warning signs of their falsity. Given the debtor's standing with the issuer and deliberate misrepresentation, the issuer was "not required to take the investigative step of obtaining a title search to confirm those statements." Additionally, the issuer's possible negligence in not conducting an investigation did not exculpate the debtor's fraud and dishonesty, nor did it relieve him of his "continued responsibility for his intentional tort."



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.