Most creditors recognize that it’s difficult to fully insulate a financing transaction from the risk of fraud. Representations, warranties and covenants can only go so far. Even diligence and structural protections have their limitations. It is therefore reassuring to know that §523(a) of the U.S. Bankruptcy Code limits in certain circumstances the ability of a debtor to discharge the claim of a victimized creditor. But that protection only goes so far. What many creditors may not know is that they don’t get a free pass when faced with fraud, no matter how blatant it is or rather, particularly when it is blatant.
A recent decision of a U.S. Court of Appeals highlights these issues for practitioners. In May of this year, the Eighth Circuit in Excellent Home Props. v. Kinard (In re Kinard), 998 F.3d 352 (8th Cir. 2021), on appeal from the U.S. District Court of the Western District of Missouri, ruled that an individual debtor could be discharged from its debt to a creditor, even though the debtor had clearly defrauded that creditor. Why? Because the creditor had not “justifiably” relied on the fraudulent conduct. In so doing, the court clearly hammered home the message that diligence is required not only at the initial stages of a transaction, but in exercise of rights and remedies as well.