Third Circuit Court of Appeals: Reckless disregard for truth may be enough to keep a debt from being discharged

When an individual debtor files a bankruptcy, creditors who were duped into extending credit based on a false statement, fraud or false pretenses can sue to keep that debt from being discharged, based on 11 USC 523(a)(2)(A). On July 23, 2015, the Third Circuit held in In re Bocchino that the creditor does not have to prove the debtor making the statement knew it was false. Instead it is enough if the statement was made with reckless diregard of its truth.

Mr. Bocchino was a stockbroker who recommended that his clients invest in two private placement stock purchases. He recommended both based on rumors and little or no actual investigation into what they were about, even though he was aware of facts that should have raised questions about their legitimacy. Both investments turned out to be fraudulent ventures. The principals of both companies were convicted. The investors lost their money. The SEC sued Bocchino and others for various violations of securities laws and got judgments against Bocchino for almost $179,000.00.

Mr. Bocchino then filed a Chapter 13 bankruptcy, and the SEC filed suit in the bankruptcy court asking it to find that the judgments were non-dischargeable. The Bankruptcy Court recognized that Bocchino believed his statements to investors were true, but held that his gross recklessness in not pursuing an independent investigation into the quality of the product he was selling was enough to prevent a discharge of the resulting liability. It was enough that as “an experienced stockbroker, he knew or should have known, that an independent investigation…was imperative”. On appeal, the Third Circuit agreed.

The Court also agreed that Bocchino could not rely on the fraud of the company principals to escape liability. Bocchino claimed that it was this fraud and not his lack of due diligence that caused his clients losses. The Third Circuit disagreed. Instead, the collapse of the investments was “neither abnormal nor extraordinary given Bocchino’s lack of due diligence” and that the “woeful state of the entities when Bocchino solicited the investments…the losses were manifestly foreseeable”. In other words, Bocchino was a substantial cause of the losses, which would not have occurred had he done his job.

This case addresses what had previously been an unsettled question in the Third Circuit. It eases the way for victims of fraud to preserve the collectibility of their judgments.

However, prompt action is critical. The ability to keep such debts from being discharged requires the filing of a bankruptcy lawsuit (called an adversary proceeding) within a relatively short time (usually about 90 days after the bankruptcy filing). Anyone in this situation should retain experienced bankrutpcy counsel right away.

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