Innocence is Required to Discharge a Debt Created by Agent’s Fraud

By: Arielle Cummings

St. John’s Law Student

American Bankruptcy Institute Law Review Staff           

            With certain limited exceptions, an individual debtor may have his debts discharged in bankruptcy.[1] Debts resulting from a debtor’s fraud, however, are generally not dischargeable. In In re Glenn,[2] the United States Court of Appeals Seventh Circuit affirmed the lower court’s holding that if a debt is the result of fraud, the court can discharge the debt in bankruptcy if the debtor was not complicit in the fraud and that the court can still discharge the debt even if the fraud was created by the debtor’s agent, provided, again, that the debtor was not complicit in it.[3] In Glenn, the defendants, the Glenns, asked a loan broker, Karen Chung to get them a short-term “bridge” loan of $250,000.[4] Chung told the Glenns that a bank had agreed to give the Glenns a $1 million line of credit, but that the line for credit would not be available for a few weeks—hence the need for the “bridge” loan.[5] Brian Sullivan, a lawyer and friend of Chung, agreed to lend the Glenns the $250,000.[6][7] The loan was never repaid and the $1 million line of credit was never approved because Chung never applied for it in the first place.[8] The Glenns declared bankruptcy and the lower court found that neither of the Glenns had committed fraud and refused to impute Chung’s fraud to either of them under an agency theory.[9] The court granted the Glenn’s discharge.[10] The court reasoned that “[p]roof that a debtor’s agent obtains money by fraud does not justify the denial of discharge to the debtor, unless it is accompanied by proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”[11]

            It is well established that if you hire someone to negotiate a deal for you, that person is your agent.[12] Typically, a principal is liable for every action performed by the agent during the course of their duties.[13]  In particular, a principal is liable for a misrepresentation made by its agent if the person to whom the representation was made would have no reason to doubt that it was a true statement, authorized by the principal.[14] In Glenn, Sullivan argued that bankruptcy courts should impute liability through agents regardless of whether fraud was used to obtain the debt.[15] According to Sullivan, guilt or innocence should be irrelevant when imputing liability to principals through the fraud of their agents.[16] The court disagreed and instead turned to Section 523(a)(2)(A) of the Bankruptcy Code.[17] Section 523(a)(2)(A) provides that a debtors debt will not be discharged if it is obtained through fraud.[18] In certain instances, courts have imputed the agent’s fraud to the principal in a number of situations. In In re Walker, the court held that actual participation in the fraud by the principal is not always required.[19] The court reasoned that when the principal is recklessly indifferent to his agent’s acts, it can be inferred that the principal should have known of the fraud.[20] The debtor who abstains from all responsibility for his affairs cannot be held innocent for the fraud of his agent if, had he paid minimal attention, he would have been alerted to the fraud.[21] Glenn creates a divide between the agent and the principal in cases of fraud. Before Glenn, principals were liable for all the fraudulent acts committed by their agents in the course of securing a loan. Following Glenn, in the Seventh Circuit, agent-principal liability is limited to situations in which the principal should have known of the fraud, or when they were complicit in it.[22]

           The immediate implication of the decision in Glenn is that debtors are further insulated from the bad acts of their agents under the Seventh Circuit’s jurisdiction. Previously, principals and agents were considered complicit in regards to acts because the agent acted on the principal’s behalf. This decision has separated the agent and principal when the principal was deemed innocent by law. The process of determining innocence could cause bankruptcy courts to look into the intent and actions of the agent in regards to the fraud. Adding a determination of innocence to dischargeability proceedings could complicate and lengthen the course of litigation. However, the public policy implications of this decision far outweigh the negative effects on litigation. As a result of this decision, innocent debtors do not have to pay for the bad acts of another and are entitled to a fresh start in bankruptcy proceedings.

[1] See generally Sullivan v. Glenn, 782 F.3d 378, 383 (7th Cir. 2015).

[2] See Id.

[3] See Id. at 379.

[4] See Id.

[5] See Id.

[6] See Id. at 380.

[7] See Id.

[8] See Id.

[9] See Id. at 380.

[10] See Id. at 381 (citing In re Walker, 726 F.2d 452, 454 (8th Cir. 1984)).

[11]See Id. at 380–81.

[12] See Id.

[13] See Id. at 556.

[14] See Sullivan v. Glenn, 782 F.3d at 380.

[15] See Id.

[16] See Id. at 380.

[17] See 11 U.S.C. § 523(a)(2)(A).

[18] See Id.

[19] See also In re Walker, 726 F.2d 452, 454 (8th Cir. 1984).

[20] See Id. at 454.

[21] See Id.

[22] See Sullivan v. Glenn, 782 F.3d at 380.