In the case of Sullivan v. Glenn (In re Glenn), No 14-3213 (7thCir. 2015), the Seventh Circuit Court of Appeals held that a debt which was incurred as a result of fraud perpetrated by the debtor’s agent is dischargeable, so long as the debtor was not complicit in the agent’s fraudulent conduct.  The facts involved a loan made by Brian Sullivan to the Glenns through the actions of a loan broker by the name of Karen Chung.  Chung and Sullivan knew each other.  In fact, Sullivan, an attorney, had represented Chung on more than one occasion.  In this transaction, however, Chung acted as the agent of the Glenns in seeking a bridge loan of $250,000 pending the closing of a bank loan for $1,000,000.  Chung convinced Sullivan to loan the Glenns $250,000 on a short-term basis at a high interest rate, representing to Sullivan that a bank had agreed to give the Glenns a loan of $1,000,000.  Chung represented to the Glenns that she had negotiated the bank loan and that it had been approved.  Based on Chung’s representations, Sullivan made the loan to the Glenns, and the Glenns signed promissory notes to Sullivan.  As it turned out, there was no bank loan at all.  After the Glenns filed bankruptcy, Sullivan filed an adversary proceeding seeking denial of the discharge of his loan based on fraud.

Sullivan raised two arguments to justify denial of the debtors’ discharge, both of which were rejected by the Seventh Circuit.  First, Sullivan argued that a debtor’s complete innocence in connection with the fraud should not be a defense to nondischargeability.  The court rejected this “debt not the debtor” theory for denying a discharge, even though it agreed the theory was consistent with the language of § 523, stating this argument “just illustrates the limitations of literal interpretation of statutory language.”  The court illustrated this limitation by taking Sullivan’s argument to its logical conclusion:  if Chung, who was jointly liable with the Glenns on the loan, had assigned the debt to an innocent third party who agreed to assume it, and that third party later filed bankruptcy, Sullivan under his theory could obtain a judgment denying the discharge of the debt in that innocent third party’s bankruptcy case.  The court concluded the intent of § 523 did not go that far, and rejected the “debt not the debtor” argument advanced by Sullivan.

The court then addressed Sullivan’s agency argument, contending that Chung’s fraud should be charged to the Glenns.  Sullivan contended that an agent’s fraudulent conduct must always be binding on his principal, even if the principal had not knowledge of the fraud.  The court rejected this argument, and agreed with the Eighth Circuit’s opinion in In re Walker, 726 F.2d 452, 454 (8th Cir. 1984) that denial of a discharge of a debt based on an agent’s fraudulent conduct requires “proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”  On the facts before it, the Seventh Circuit determined that, as between the Glenns and Sullivan, the Glenns were the more innocent party, and Sullivan was in the better position to protect himself.  As a result, the court affirmed the judgment in favor of the Glenns.