The Bankruptcy Code protects lenders which reasonably rely upon a debtor’s financial statements when approving a loan. The Eleventh Circuit was recently faced with an “enterprising” debtor who attempted to challenge the reasonableness of a bank’s reliance on his falsified financial statements. Ultimately the court rejected the debtor’s arguments that the bank should have more thoroughly investigated his specious financial statements.

The debtor did not dispute that the financial reports, which he submitted to obtain a three million dollar loan, were materially false. He admitted failing to disclose significant tax liabilities and outstanding debt that he owed to an Austrian bank. Nevertheless, he argued that the bank was unreasonable in relying upon his falsified financial statements, and therefore could not avail itself of the relief under § 523(a)(2)(b) of the Bankruptcy Code.

The Eleventh Circuit was not persuaded.

Instead, the court held that whether a lender’s reliance is reasonable should be evaluated on a case by case basis. The court set out three “pertinent” questions that supported a lender’s claim that its reliance was reasonable:

First, did the debtor have a previous business relationship with the creditor which gave rise to a relationship of trust? Second, were there any “red flags” that should have alerted an “ordinarily prudent lender” to the possibility that the representations were not accurate? Finally, would even a minimal investigation have revealed the inaccuracy of the debtor’s representation?

The court noted that its standard of reasonableness is set low, but in so holding, the circuit affirmed previous case law that protects even the most naïve creditors from debtors who use fraudulent financial statements to obtain a loan.

The court’s decision in Davenport further illustrates the Eleventh Circuit’s strict enforcement of § 523(a)(2)(b) that has been touched upon in previous posts. Nonetheless, lenders should not rest on the laurels of Davenport. Although the courts within the Eleventh Circuit may ultimately find for the lender in such situations, initial due diligence will pay dividends compared to the costs of litigation.