Davenport v. Frontier Bank

Filing 10

MEMORANDUM OPINION AND ORDER that the bankruptcy court properly found Malcolm Davenport's debt to Frontier Bank non-dischargeable under 11 U.S.C. § 523(a)(2)(B). Accordingly, the bankruptcy court's decision is AFFIRMED. Signed by Honorable Judge Mark E. Fuller on 7/5/2012. (Attachments: # 1 Civil Appeals Checklist)(cc, )

IN THE UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF ALABAMA
EASTERN DIVISION
MALCOLM CLIFTON DAVENPORT,
Appellant,
Bankruptcy Appeal
Case No. 3:11-cv-642-MEF
(WO—Do not publish)

v.

FRONTIER BANK,
Appellee.

M EMORANDUM O PINION AND O RDER
I. INTRODUCTION
This cause comes before the Court on an appeal taken from the United States
Bankruptcy Court for the Middle District of Alabama. After a trial, Bankruptcy Judge
Dwight Williams held that the debt incurred by the appellant, Malcolm Davenport, was
non-dischargeable. For the reasons discussed below, this decision is due to be
AFFIRMED.
II. JURISDICTION
United States District Courts have jurisdiction to hear appeals from “final
judgments, orders and decrees” issued by bankruptcy courts. 28 U.S.C. § 158(a)(1).

1

Typically a final judgment obtains when a decision “ends the litigation on the merits and
leaves nothing for the court to do but execute the judgment.” Catlin v. United States, 324
U.S. 229, 233 (1945). In the bankruptcy context, however, the concept of finality is more
flexible: “it is generally the particular proceeding or controversy that must have been
finally resolved, rather than the entire bankruptcy litigation.” Charter Co. v. Prudential
Ins. Co. (In re Charter Co.), 778 F.2d 617, 621 (11th Cir. 1985) (emphasis added).
III. BACKGROUND1
A.

Malcolm Davenport, Frontier Bank, and their banking relationship
Malcolm Davenport, V (“Davenport”), hails from the Valley area in Alabama. He

graduated from college with an accounting degree and then worked for a few years as an
accountant. In 1978, he decided to return to school, and so he enrolled at Cumberland
School of Law. After graduating three years later, he spent a year trying to earn an
L.L.M. in tax at Miami School of Law before heading off into private practice. He was
admitted to the Georgia and Alabama bars and wound up practicing for about two years.
Around 1994 or 1995, he shared an accounting practice, but he only did so as an
accommodation to his partner. He did not himself practice. By 1999, he had no staff at
the accounting firm other than a consultant who helped him pay the bills. Meanwhile, he
served on the board of a number of privately-held companies and directed some familyowned businesses and telephone companies in the Valley.
1

The facts are taken almost wholesale from Judge Williams’s Memorandum Opinion (Doc. # 3-

3.)

2

In 1997, Davenport and his wife began building a home in Lanett, Alabama. To
this end, he borrowed $150,000 from Frontier Bank (“Frontier”)2 on November 20, 1997.
The parties memorialized their relationship by way of a promissory note that contained
the loan amount and Davenport’s promise to repay in full. Less than a year later, the
parties agreed to increase the loan to $1,002,348. Davenport signed and delivered a
mortgage to Frontier to secure repayment under a newly executed promissory note.
Frontier then promptly recorded the mortgage in the Chambers County, Alabama,
probate office. About eight months later, the parties agreed once again to modify their
agreement, this time executing a promissory note that increased the loan amount to
$2,500,000. And just seven months after that, on March 16, 1999, Davenport and
Frontier agreed to increase the loan to $3,000,000. This required Davenport to take out a
second mortgage on the home, which Frontier again recorded promptly.
B.

Davenport’s financial statements
All told, the parties renewed the loan 23 times from November 1997 to October

2009. Each time a renewal took place, a loan officer with Frontier would prepare a credit
memorandum summarizing the information that Davenport had submitted on his most
recent personal financial statement.3 The document would also include the bank’s

2

Davenport technically borrowed the money from Frontier Bank’s predecessor, Valley National
Bank of Lannett, Alabama, which merged with First National Bank of Sylacauga to become Frontier
Bank. For simplicity’s sake, the Court has referred to the loan originator as Frontier Bank throughout this
Memorandum Opinion.
3

An accountant drafted Davenport’s first financial statement. He prepared the other seven.

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explanation of the loan, the borrower’s history with the bank, a breakdown of the loan, a
discussion of the borrower’s ability to repay, a valuation of the collateral used to secure
the loan, and a recommendation about whether to renew the loan. On top of that, Frontier
would sometimes prepare a loan approval request during the loan renewal process. The
loan officer would use the request to relay to his superiors any information he knew or
had learned about Davenport’s assets and liabilities in summary form.
Davenport provided Frontier with eight financial statements during the
twelve-year life of the loan.4 His first financial statement revealed that he and his wife
had $7.7 million in assets and $947,000 in liabilities for a net worth of $6.85 million. His
assets included about $5 million in securities of publicly traded and closely held
companies and $2.3 million in real estate. He listed an ownership interest in 25
companies, including over $1 million worth of stock in ITC DeltaCom, Inc., and over
half a million dollars in each of two other companies.
Davenport’s second financial statement, which he submitted in February of 1999,
stated that he had $11 million in assets and $4.7 million in liabilities for a net worth of
$6.6 million. A year later he submitted his third financial statement, which showed that
he had $17 million in assets and $3.6 million in liabilities. The increase in assets was
attributable to an increase in value of the various stocks he held, a jump in real estate
values, and an outstanding $3 million loan he made to Spintek Gaming Technologies.
4

Under the bank’s policy, a debtor would have to file a new financial statement at least once
every 15 months.

4

The increase in his outstanding liabilities was due mainly to the growth in the amount of
the loan made to him by Frontier.
By March 2002, when Davenport filed his fourth financial statement, his situation
had deteriorated significantly. He still had $13 million in assets, but his liabilities had
ballooned to $8.5 million. This brought his net worth down to $4.4 million. Looking
behind the financial statements reveals that the value of the stock of the publicly traded
companies he held had plummeted from $7.8 million to $156,400. The value of his
“receivables and licenses” had increased to $5.8 million, however. The increase in his
liabilities came by way of a $3.9 million personal guaranty he made on a loan by RBB,
an Austrian bank, to his family trust.
Davenport’s fifth financial statement, which he filed in December of 2002, listed
$14 million in assets, $4.8 million in liabilities, and a $9.6 million net worth. The value
of his securities had once again declined, but the value of his receivables and royalties
account had increased to $7 million. He omitted the previously listed personal guaranty
obligation of $3.9 million that he owed to RBB.
Davenport’s finances did not improve over time. His November 2005 financial
statement, his sixth, listed $8 million in assets, $5 million in liabilities, and a $3 million
net worth. The value of his securities had dropped to just $57,900. The credit
memorandum prepared by Frontier in November of 2006 shows that the status of
Davenport’s loan changed sometime during the year. It states: “This loan has been a

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classified credit in the bank for quite some time because of the lack of repayment and the
reduction in collateral value. A principal reduction is expected at the next renewal.”
Davenport had made only interest payments up to that point, and the bank would not
have continued renewing his loan but for those payments.
His seventh financial statement, filed in July of 2007, listed $4.9 million in assets.
He had liabilities in an almost equal amount. His net worth was only $28,817, and his
Frontier-financed house stood as his chief asset and chief liability. In September of 2009,
his eighth and final financial statement revealed that Davenport’s $5.7 million in
liabilities outstripped his $4.9 million assets, giving him a net worth of negative
$773,417. By October of 2009, Davenport became past due on his interest payments. The
principal balance on the loan was $2.85 million at the time.
C.

Davenport’s undisclosed financial information
1.

Davenport’s debts

Davenport had a tax liability arise in 1998, shortly after Frontier made its initial
loan to him. The IRS, as a result of this outstanding tax liability, filed a lien against
Davenport in November of 2002. The liens covered almost $900,000 in taxes stretching
back to 1998. The liens encumbered the house, which Davenport had used as collateral
for the loans provided by Frontier. In mid-2002, Davenport disclosed this tax liability to
the bank—four years after the initial loan. He did not disclose any of his tax liabilities on
a financial statement until September 11, 2009, the date on which he filed his last one.

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Davenport also had an outstanding debt owed to RBB, an Austrian bank. This debt
was by no means insignificant: Davenport owed RBB a couple million dollars.5 Yet he
did not list the RBB debt on a financial statement submitted to Frontier until 2002. Nor
did he settle the debt before then. In fact, it wasn’t until December of 2003 that he
entered into a settlement agreement with RBB, and even then, he only partially settled the
debt; he still owed $700,000 after the settlement. He failed to mention this fact to Frontier
or disclose the $700,000 debt on future financial statements. Davenport also remained
liable on a $5 million obligation to RBB’s successor, and he failed to disclose this
liability to Frontier, too.
2.

Davenport’s contingent liabilities

Davenport personally guaranteed the debts of Clifcoe and Sunset Land Holdings,
two companies in which he had an interest. The guaranty of Clifcoe’s debt exceeded
several million dollars.6 Davenport testified at trial that he did not know that he had to list
contingent liabilities on his financial statement and that Frontier never asked him about
any. He further stated that because Clifcoe was “doing well and building,” and since he

5

There is some confusion in the briefs and the bankruptcy court’s opinion about the exact nature
and extent of the RBB debt. It appears from the various court documents that the debt owed to RBB was
incurred by the Davenport family trust and personally guaranteed by Malcolm Davenport, and that the
proceeds were then re-lent to a gaming company. Without delving too far into the details, what is
important here is that the debt guaranteed by Davenport arose before the 2002 financial statement he filed
(in which he listed the liability) and remained outstanding even after he filed his 2003 financial statement
that made no mention of the liability.
6

There was no evidence in the record about the value of the Sunset Holdings debt that Davenport
guaranteed.

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did not know how to report a guaranty, he did not list the obligation on his financial
statement. He also testified that he did not think he needed to list the obligations because
the property serving as collateral exceeded the debt incurred.
D.

Procedural history
Frontier filed an adversary proceeding on April 30, 2010, in the Bankruptcy Court

for the Middle District of Alabama. After a trial on the matter, the bankruptcy court
found Frontier Bank’s claim against Davenport non-dischargeable. The bankruptcy court
hinged its decision on how Davenport failed to disclose his tax liabilities, misrepresented
the status of the RBB debt he owed, and failed to disclose other debts and liabilities
material to his financial condition. Davenport filed a timely notice of appeal regarding
the bankruptcy court’s decision on July 8, 2011.
IV. STANDARD OF REVIEW
A district court reviews a bankruptcy court’s legal conclusions de novo and factual
findings for clear error. See Enron Corp. v. New Power Co., 438 F.3d 1113, 1117 (11th
Cir. 2006); Jet Florida, Inc. v. Am. Airlines, Inc. (In re Jet Systems, Inc.), 861 F.2d 1555,
1558 (11th Cir. 1988).

V. DISCUSSION

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Generally speaking, the Bankruptcy Code allows a debtor experiencing financial
hardship to get a fresh start. To this end, it allows for the discharge of the debtor’s debts
by extinguishing all or some of his creditors’ claims. But this general rule has exceptions.
For example, a debt is non-dischargeable when a debtor, with the intent to defraud,
induces a creditor to lend to him by making materially false statements about his financial
condition when the creditor reasonably relies on the accuracy of those statements. In this
scenario, the inducing debtor seeking protection from a defrauded creditor’s claims will
get no help from the federal courts. See 11 U.S.C. § 523(a)(2)(B).
Yet courts construe exceptions to the rule of discharge narrowly, favoring the
debtor over the objecting creditor as a first principle. Schweig v. Hunter (In re Hunter),
780 F.32d 1577, 1579 (11th Cir. 1986), abrogated on other grounds, Grogan v. Garner,
498 U.S. 279 (1991). Hence an objecting creditor must prove each element by a
preponderance of the evidence. Grogan, 498 U.S. at 291. A failure to do so makes the
debt dischargeable.
Davenport contends that Frontier Bank failed to shoulder its burden, claiming the
bankruptcy court erred by concluding he could not discharge the debt he owed to
Frontier. More specifically, Davenport argues that Frontier failed to prove that he
intended to defraud the bank by a preponderance of the evidence, that minimal
investigation would have revealed the true state of his financial affairs, and that Frontier
disregarded numerous red flags contained in his financial statements.

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A.

Davenport made materially false representations
A false statement meets the materiality requirement if it is “significant in both

amount and effect on the creditor receiving the financial statement.” Citizens Bank v.
Wright (In re Wright), 299 B.R. 648, 659 (Bankr. M.D. Ga. 2003) (quoting Enter. Nat’l
Bank of Atlanta v. Jones (In re Jones), 197 B.R. 949, 955 (Bankr. M.D. Ga. 1996)
(internal quotations omitted)). In other words, “[t]he information must have actual
usefulness to the creditor and must have been an influence on the extension of credit.” Id.
(quoting Jones, 197 B.R. at 955). Here, Davenport made a number of materially false
representations on the financial statements he submitted to Frontier Bank by failing to
disclose his tax liabilities and the RBB debt he had personally guaranteed. And Frontier’s
executives—namely, Steve Townson and Jimmy Yates—testified that the information in
the financial statements influenced the bank’s decision to extend credit to Davenport.7
Because the parties do not dispute these two facts, the bankruptcy court did not err by
holding that Davenport made materially false statements, in writing and respecting his
financial condition, to Frontier Bank.

B.

The bankruptcy court did not err by finding Frontier’s reliance reasonable

7

In fact, Townson testified that Frontier does not lend money to people with outstanding IRS
liabilities due to the risk involved.

10

“Reasonable reliance analysis is done on a case-by-case basis considering the
totality of the circumstances.” Wright, 299 B.R. at 659. The first part of the analysis is
subjective—it asks whether the creditor actually relied on the financial statement. Jones,
197 B.R. at 961. If the creditor did so rely, the court moves onto the second part of the
test, which asks whether the reliance was reasonable. Id.
The bankruptcy court held that Frontier reasonably relied on Davenport’s
representations. In support of this holding, the court found that the bank reviewed each
one of Davenport’s financial statements, asked him questions about his disclosures, and
had ongoing and extensive discussions with him about the state of his finances. (Doc. #
3-3 at 21.) Frontier Bank even drafted a credit memorandum incorporating this
information for its internal use. (Id.) Moreover, the bankruptcy court found that a number
of factors gave Davenport’s representations extra credence: he is a certified public
accountant and a licensed attorney, he began course work on an L.L.M. in taxation, he sat
on the board of directors for a number of companies, and his family’s sterling reputation
in the community preceded him. (Id. at 22.)
1.

Actual reliance

The bankruptcy proceeding produced sufficient evidence of Frontier’s reliance on
Davenport’s representations. Steven Townson and Jimmy Yates, Frontier’s executives,
testified that the bank relied on Davenport’s financial statements. And although the bank
relied on other factors as well, including Davenport’s education, training, and family

11

history, it did “not have to demonstrate that a financial statement was the only factor
influencing its credit making decision,” because “[p]artial reliance is all that is needed.”
First Commercial Bank v. Robinson (In re Robinson), 192 B.R. 569, 576 (Bankr. N.D.
Ala. 1996). Townson and Yates’s testimony thus provided the bankruptcy court with
ample leeway to find actual reliance on the part of Frontier Bank.
2.

Reasonableness

The objective reasonableness prong asks what an average and ordinary person
would do under the circumstances. See City Bank & Trust v. Vann (In re Vann), 67 F.3d
277, 280 (11th Cir. 1995). This places some responsibility on the creditor to make sure it
has good reason to rely on the debtor’s representations. Id. (citing First Bank of Colorado
Springs v. Mullett (In re Mullet), 817 F.2d 677, 679 (10th Cir. 1987)). Relevant questions
include:
•

Would previous business dealings have created a relationship of trust
between the parties?

•

Should the creditor have noticed red flags that would have tipped off an
ordinarily prudent person?

•

Would minimal investigation by the creditor have revealed the falsity of the
debtor’s representations?

•

Did an error appear on the face of the financial statement?

See, e.g., Vann, 67 F.3d at 280–81 (quoting Coston v. Bank of Malvern (In re Coston),
991 F.2d 257, 261 (5th Cir. 1993) (en banc)); Mester v. Brevard (In re Brevard), 200
B.R. 836, 845 (Bankr. E.D. Va. 1996); see generally Michael J. Lichtenstein,
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Non-dischargeability of Debts Under Section 523(a)(2)(B) of the Bankruptcy Code, 126
Banking L.J. 529, 532 (2009).
Creditors, however, generally do not have to undertake an independent
investigation to verify the information on a debtor’s financial statement. See Lichtenstein,
Non-dischargeability, supra, at 531. For instance, in Riggs National Bank of Washington
v. Ross (In re Ross), the debtor did not escape liability even though his financial
statement contained intentional misstatements that the bank failed to investigate. 180
B.R. 121 (Bankr. E.D. Va. 1994). And in Global Express Money Order v. Davis (In Re
Davis), 262 B.R. 673 (Bankr. E.D. Va. 2001), a debtor intentionally misrepresented the
value of one of his checking accounts, some real estate he owned, his mutual funds, and a
tax refund. The bank, although it used a third-party credit report, relied on the financial
statements provided by the debtor. The court held this reliance was reasonable, and the
creditor had no duty to inquire further. 262 B.R. at 679.
The Court cannot say that the bankruptcy court erred by finding Frontier’s reliance
reasonable. A creditor can establish its reasonable reliance by showing it complied with
industry custom when investigating the debtor’s financial condition. See Wright, 299
B.R. at 659–60; Jones, 197 B.R. at 961. Here, both Townson and Yates testified that
Frontier typically evaluated and relied on financial statements submitted by their clients,
and that this amounted to a customary banking procedure. Frontier’s compliance with
industry norms in its dealings with Davenport, consequently, supports the bankruptcy

13

court’s decision. What is more, Davenport’s education and training as a lawyer and
accountant put him in almost as good a position as the banking professionals extending
and servicing his loan to know they would rely on his financial statements in making
business decisions. The bankruptcy court properly took this factor into account, see
Jones, 197 B.R. at 953; First Nat’l Bank of Central Ala. v. Moore (In re Moore), No. 07cv-70948, 2010 WL 1880573, at *1 (Bankr. N.D. Ala. May 6, 2010), and correctly
determined that it weighed in favor of Frontier.
Davenport attempts to overcome the fact that numerous indicia of reasonableness
weigh in Frontier’s favor by claiming the bank ignored a number of red flags. He asserts
that Frontier ignored the absence of Davenport’s tax returns early on; missed patent
errors on the financial statements; overlooked the disappearance of assets and the
appearance of liabilities; neglected to ask for Mrs. Davenport’s financial information; and
never questioned the volatile increases and decreases in his net worth. But the bankruptcy
court did not err by discounting these supposed anomalies. As to the bank’s initial failure
to ask for Davenport’s tax returns, Frontier did not normally ask for that information
early in the life of a loan, and without evidence of a contrary industry norm, the
bankruptcy court had ample leeway to find that this failure was not unreasonable. Banks,
moreover, have no duty to perform independent investigations into the truthfulness of
financial statements submitted by debtors. See Vann, 67 F.3d at 280–81; Gordon, 277
B.R. at 810; Robinson, 192 B.R. at 578. Despite having no duty to inquire further,

14

Frontier asked for verification of Davenport’s creditworthiness from third parties, and the
credit reports the bank obtained confirmed Davenport’s financial statements. This made
the bank’s reliance on Davenport’s representations all the more reasonable. See
Robinson, 192 B.R. at 577.
In addition, Yates testified that he questioned Davenport whenever he needed an
explanation about an entry on one of his financial statements. Frontier even included
some of Davenport’s answers to follow up questions in its credit memorandums. For
example, the June 2008 memorandum states that the “customer has reportedly resolved
[his] tax issues.” Townson and Yates also both testified that Davenport told them he had
discharged the RBB debt in December of 2003, even though the debt had not in fact been
settled. This would explain why the liability was not listed on financial statements from
that point forward, thereby absolving Frontier of the duty to investigate further. The
bankruptcy court therefore did not err when it discounted some of the patent
discrepancies and latent inconsistencies on Davenport’s financial statements. Indeed, they
were largely explained away by Davenport with renewed misrepresentations to Townson
and Yates.
Finally, Davenport’s argument that the volatile valuations of his closely held
companies were red flags lacks merit. Not only did the bank have no other way to value
the companies than to rely on Davenport’s representations, but it also likely knew that the
value of a business interest can ebb and flow over time. Because Frontier had no better

15

way to get information than to rely on Davenport, and seeing how it knew about
Davenport’s education and experience in business and accounting, Frontier arguably
acted reasonably by relying on the financial statements Davenport submitted.
Accordingly, the bankruptcy court did not err here, either.
C.

The bankruptcy court did not err in finding Davenport had fraudulent intent
“A debtor will rarely admit that he intended to deceive a creditor.” Consolidated

Bank & Trust v. Dalton (In re Dalton), 205 F.3d 1332 (4th Cir. 2000) (unpublished table
decision). So courts look to see whether they can infer fraudulent intent from the totality
of the circumstances surrounding the debtor’s acts. Equitable Bank v. Miller (In re
Miller), 39 F.3d 301, 304 (11th Cir. 1994). Hence a debtor’s “[r]eckless disregard for the
truth or falsity of a statement combined with the sheer magnitude of the resultant
misrepresentation may combine to produce the inference of intent [to deceive].” Id. at
305 (citations omitted). Relevant too is a debtor’s “knowing renewal of a
misrepresentation,” which can “lead to the conclusion that a debtor intended to deceive.”
Citizens Bank v. Wright (In re Wright), 299 B.R. 648, 660 (Bankr. M.D. Ga. 2003)
(internal citations omitted). Perhaps most importantly at the appeal stage, the question of
a debtor’s fraudulent intent “is an issue of fact” for the bankruptcy court, Miller, 39 F.3d
301, and thus the bankruptcy court’s decision is presumed correct absent a showing of
clear error. See Enron Corp. v. New Power Co., 438 F.3d 1113, 1117 (11th Cir. 2006).

16

The bankruptcy court held that Davenport had fraudulent intent. To support this
conclusion, the court relied on “the sheer magnitude of the amounts involved, the
repeated omissions on subsequent financial statements, and [Davenport’s] oral statements
to the bank.” (Doc. # 3-3 at 24.) The Court sees no reason to disturb this conclusion. The
evidence at trial showed that Davenport owed RBB millions of dollars before Frontier
ever loaned him any money, yet he failed to disclose this obligation until March 2002.
And once Davenport disclosed the debt, it quickly disappeared, which prompted Frontier
to ask him about it. He responded that it had been settled. But this wasn’t true: while the
majority of the RBB debt had been assigned to another entity, he remained liable for
$700,000 of it. Furthermore, the bankruptcy court did not rely solely on these omissions;
to the contrary, Judge Williams considered Davenport’s failure to disclose his tax
liabilities too. This, along with his misrepresentation of the nature of the RBB debt and
his failure to disclose that he personally guaranteed the debts of Clifcoe and Sunset
Holdings, is sufficient evidence to support the bankruptcy court’s finding of fraudulent
intent.
VI. CONCLUSION
The bankruptcy court properly found Malcolm Davenport’s debt to Frontier Bank
non-dischargeable under 11 U.S.C. § 523(a)(2)(B). Accordingly, the bankruptcy court’s
decision is hereby AFFIRMED.
Done this the 5th day of July, 2012.

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/s/ Mark E. Fuller
UNITED STATES DISTRICT JUDGE

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