In Heritage Pacific Financial LLC v. Machuca, 2012 DJDAR 16803 (2012), the US Bankruptcy Appellate Panel for the Ninth Circuit decided an interesting attorney fee case arising in the commercial litigation context. The fee award was given to the debtor arising from adversary proceedings initiated by a creditor, a commercial bank.

The debtor sought and was granted a loan from a bank. The debtor’s loan application allegedly contained inaccurate information relating to the debtor’s income. The bank approved the loan without verifying the debtor’s income and before the debtor signed the loan application.

The debtor later defaulted on the loan and initiated bankruptcy proceedings. Heritage Pacific Financial LLC (HPF), which was the successor in interest to the original lender, filed an adversary proceeding against the debtor. The complaint alleged that the loan was nondischargeable under Bankruptcy Code Section 523(a) due to the bank’s reliance on the alleged inaccurate information provided by the debtor in the loan application. Section 523 of the Bankruptcy Code governs the grounds under which a debt is not dischargeable. That statute provides for the award of attorney fees under special circumstances.

The debtor filed a motion for summary judgment, asserting a lack of reasonable reliance on the income information contained in the loan application. The motion was granted and the debtor recovered his attorney fees under Section 523(d). 

In response, HPF argued that its filing of the adversary proceeding was “substantially justified.” The court had difficulty with this argument, noting that the record demonstrated income discrepancies in the paperwork, the implausible amount of stated employment income by the debtor, the lack of follow-up investigation by the bank and the rushed nature of the loan approval and subsequent funding without income verification. Relying in part of this evidence in the record, the court ruled that there was an absence of evidence to support the claim of “reasonable reliance.”

The Ninth Circuit noted that once a debtor establishes an entitlement to attorney fees under Section 523(d), the burden shifts to the creditor to prove that its actions were “substantially justified.” This requires the creditor to demonstrate that it had a colorable legal basis to pursue the claim. The court concluded that based on the record presented, HPF could not establish “reasonable reliance.” The order granting fees was affirmed on that basis.