Assignee creditors are protected by the provision of the Bankruptcy Code that prevents debtors from obtaining a discharge for debts obtained through fraud, the Bankruptcy Appellate Panel for the U.S. Court of Appeals for the Ninth Circuit has held.

The issue in New Falls Corp. v. Boyajian (In re Boyajian), 2007 WL 1119910 (B.A.P. 9th Cir. March 30, 2007) was whether debt held by an assignee creditor could be excepted from discharge when the assignor creditor (as opposed to the assignee) was the party that reasonably relied on a misleading financial statement.

Section 523(a)(2)(B) excepts from discharge debts that were obtained by a written statement (i) that was materially false, (ii) with respect to the debtor’s financial condition, (iii) on which the creditor reasonably relied; and (iv) that the debtor caused to be made with the intent to deceive.

In Boyajian, Blue Diamond Straw & Toothpick Company (“Blue Diamond”) was managed by two sisters, Pateel and Salpsy Boyajian (together “Boyajian”). Blue Diamond entered into a lease agreement with Epic Funding Corporation (“Epic”) that Boyajian supported by extending individual guaranties. As part of its due diligence, Epic required Boyajian to provide personal financial statements, which Boyajian did, but which later turned out to be false.

Epic eventually assigned its interest in the lease to Cupertino National Bank (“Cupertino”). After Blue Diamond and Boyajian defaulted under their underlying agreements, Cupertino commenced a civil action in state court and successfully obtained a judgment holding Blue Diamond and Boyajian jointly and severally liable. After obtaining this judgment, Cupertino assigned its rights in the judgment to Stornawaye Capital, LLC, which in turn assigned its rights to New Falls Corporation (“New Falls”). New Falls was left holding the judgment at the time Boyajian filed for personal bankruptcy.

Based on the discovery of the fact that Boyajian had submitted false financial statements to Epic, New Falls moved under section 523(a)(2)(B) to have the judgment excepted from discharge. After analyzing section 523(a)(2)(B), the bankruptcy court ruled against New Falls. Based partly on the reasoning set forth in a previous California bankruptcy court decision, General Electric Capital Corp1 v. Bui (In re Bui), 188 B.R. 274 (Bankr. N.D. Ca. 1995), the court found that section 523(a)(2)(B) could not except New Falls’ debt from discharge because it never relied on the materially false financial statements—even though Epic did.

Upon appeal, the Ninth Circuit Bankruptcy Appellate Panel reversed the lower court’s decision. Concluding that Bui was wrongly decided, the BAP found that as an assignee, New Falls essentially had “stepped into the shoes” of Epic and accordingly should not be prevented from showing that there was reasonable reliance.

The BAP determined its ruling was consistent with the policies underlying the Bankruptcy Code. If section 523(a)(2)(B) did not apply to assignee creditors, unscrupulous debtors might feel encouraged to submit false financial statements if they suspected the original lender would assign the debt. The BAP found no policy basis for rewarding such a dishonest debtor, and concluded that section 523(a)(2)(B) was intended to protect assignee creditors such as New Falls.