As we have discussed in previous posts, if a debtor actively falsifies a financial statement to obtain a loan, such debt is not dischargeable in a subsequent bankruptcy proceeding under § 523(a)(2)(B) of the Bankruptcy Code. When a debtor is not directly responsible for preparing the false financial statement, but nonetheless “turns a blind eye” to the falsification, the debtor may still be found culpable for passive falsification.

A recent decision out of the First Circuit and a string of cases from the Middle District of Florida have extended § 523(a)(2)(B) to cover the preparation of false financial records by a third party.

In the First Circuit case of In re O’Donnell, a debtor had employed a commercial loan broker to arrange the financing of a loan to acquire certain apartment buildings. The debtor had provided tax returns, bank account statements and investment account statements to the broker, none of which contained any false information. Nonetheless, the financial statement that the broker prepared was materially false, and the lender relied on the statement when approving its loan.

Although the bankruptcy court acknowledged that the debtor did not actually review or sign the financial statement, the debtor “turned a blind eye to the falsification in reckless disregard to the truth or falsity of the propositions asserted in the financial statement.” Therefore, the debtor was culpable of passive falsification, and his debt was held to be non-dischargeable. The Middle District of Florida has found passive falsification even in situations where the false financial statements were simply “caused to be prepared” by the debtor.

The intent to deceive required under § 523(a)(2)(B) may be inferred from the totality of the circumstances surrounding the debtor’s acts, including the debtor’s “reckless indifference” to the accuracy of financial information submitted to a creditor. Put another way, a debtor cannot escape liability by “firmly putting his head in the sand and later claiming not to have known the falsity of representations made on his behalf while his head was covered.”