i. in re smirth

THE D'OENCH, DUHME DOCTRINE IS NOT ASURROGATE FOR PROOF OF ACTUAL RELIANCE IN ANONDISCHARGEABILITY CLAIM BASED ON FRAUD: In reSmith, 133 B.R. 800 (N.D. Tex. 1991).

I. IN RE SMIrTH'

James Smith and his cousin Vernon Smith allegedly conspiredwith officers and the owner of Vernon Savings to deceive lendinginstitution examiners with respect to three loans. 2 Both debtors filedfor bankruptcy in 1988.1 Shortly thereafter, the FDIC took over as

1. FDIC v. Smith (In re Smith), 133 B.R. 800 (N.D. Tex. 1991).2. See id. at 298 (Bankr. N.D. Tex. 1990), revd, 133 B.R. 800 (N.D. Tex. 1991). The

three loan transactions in issue were the Cedar Springs, Celestial/Montfort and New YorkAvenue loans. Id. The debtors operated through several entities known as the Smith entitiesor companies which were under a holding company called Landmark Properties, Inc. Id. at299. Vernon Savings' subsidiary, Dondi Residential Property, Inc. (DRPI) owned distressedproperty with loans that needed to be removed from Vernon's books. See id. If the losseswere not removed they would adversely effect Vernon's ability to issue dividends. See id. Thefunctioning chief officer of Vernon Savings decided to sell the DRPI property; however, soas not to reflect a loss, the property had to be sold at a price greater than its appraised value.Id. at 300. DRPI property included the Cedar Springs tract which the Smiths agreed topurchase in order to secure their status as preferred Vernon customers. Id. In return, Vernonagreed to finance the entire inflated purchase price. Id. The loan documents reflected only theamount of the appraised value to avoid questions by lending institution examiners. See id. at301.

With regard to the Celestial/Montfort loan application, Smith stated that the purpose ofthe loan was to carry land prior to build-out (within one year). Id. at 302. On the New YorkAvenue loan application, Smith stated the loan purpose was acquisition of land, constructionof infrastructure, interest carry, etc. Id. James Smith explained to Vernon Savings' presidentDixon and senior officers that the loans would actually be used to cover the Smith companyoperating expenses, such as cash flow and salaries. Id. Clearly, the Vernon underwriter wasunaware of these additional uses of the loan proceeds. See id.

The bankruptcy court held that the Cedar Springs and Celestial/Montfort loans werenondischargeable based on fraud. Id. at 308. However, the bankruptcy court found that thecircumstances and loan documents of the New York Avenue loan did not support a findingof fraud. Id. The court reasoned that even if there was deception with regard to this loan, itwas not material because the funding of the New York Avenue loan was prudent based onthe real estate values at that time. Id. Also, the court found that the Smiths did not, deceivelending institution examiners as to the purpose of the New York Avenue loan. Id. The exactpurpose was left unspecified on the application. Id. at 308-09. Therefore, the debtors appealedthe bankruptcy court's findings of nondischargeability as to the Cedar Springs and Celestial/Montfort loans. See FDIC v. Smith (In re Smith), 133 B.R. 800, 802 (Bankr. N.D. Tex. 1991).

3. See 113 B.R. at 298.

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receiver for Vernon Savings and filed a complaint to determine thenondischargeability of the Smiths' outstanding debts pursuant tosection 523 of the Bankruptcy Code.4 The bankruptcy court foundthe debts nondischargeable, holding that the D'Oench, Duhme doc-trine allowed the FDIC to rely on the documents in the loan file asa matter of law.6 The debtors appealed, questioning the FDIC's rightto invoke the D'Oench, Duhme estoppel rule to satisfy the relianceelement of a nondischargeability claim.7 The United States DistrictCourt for the Northern District of Texas reversed the bankruptcycourt, holding that the D'Oench, Duhme doctrine is not a surrogatefor proof of actual reliance under the Bankruptcy Code.'

II. D'OENCH, Dumm: THE FEDERAL COMMON LAW DOCTRINE

A. D'Oench, Duhme & Co. v. FDIC

In the landmark case of D'Oench, Duhme & Co. v. FDIC,9 theUnited States Supreme Court recognized a "federal policy to protect[the FDIC], and the public funds which it administers against mis-representations as to the securities or other assets in the portfoliosof the banks which [the FDIC] insures or to which it makes loans."' 0

In D'Oench, Duhme, a securities dealer and broker sold bonds to abank for the bank's portfolio." Subsequently, the bonds were de-faulted upon and the bank wished to conceal its ownership of thebonds. 12 The president of the bond company directed the executionof unconditional notes secured by the bonds and payable to the bank

4. Id. See 11 U.S.C. § 523(a)(2)(A) (1988).

S. D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942).6. 113 B.R. at 306.7. FDIC v. Smith (In re Smith), 133 B.R. 800, 802. There was also a preliminary

procedural question presented by James Smith's notice of appeal. Id. at 803. Unlike Vernon'sappeal, James' did not expressly appeal the bankruptcy court's final judgment. Id. James'notice stated that he "appeals ... from the Order on Motions for New Trial, for Reconsid-eration and Additional Findings of Fact and Conclusions of Law of the Bankruptcy Court .. "Id. The district court held that, "the failure to specify the correct judgment is irrelevant whereit is clear which judgment the appellant is appealing." Id. at 804 (citing Foman v. Davis, 371U.S. 178, 181 (1962)).

8. Id. at 806.9. 315 U.S. 447 (1942).

10. Id. at 457.11. See id. at 454.12. See id.

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for their face amount in order to allow the bank to show the notesas "good assets" on its books. 3 In exchange, the bank gave thecompany a receipt for the notes which stated: " 'This note is givenwith the understanding it will not be called for payment. All interestpayments to be repaid.' ,,"4 The FDIC insured the bank and, whenthe bank failed, it acquired the notes in, its corporate capacity. 5

When the FDIC demanded payment of the notes, it learned of theexistence of the receipts which provided that the loans never had tobe repaid.16

The borrowers argued that there was a failure of considerationin addition to the existence of a side agreement which excused theobligation to pay under state law. 7 The FDIC argued that it shouldbe given the status of a holder in due course." The Court rejectedboth arguments, stating that the maker's acts were "designed todeceive the creditors or the public authority, or would tend to havethat effect."' 9 The Court further held that the maker was estoppedfrom asserting lack of consideration as a defense. 20 The Court'sholding has evolved into what is known as the D'Oench, Duhmedoctrine.

In fashioning this rule, the Court noted that the act whichcreated the FDIC, the National Banking Act, had a specific provisionprohibiting the misrepresentation of bank assets. 2' Since its inception,the D'Oench, Duhme doctrine has been extended to protect theFSLIC 22 and the FDIC as both receivers and as corporations. 2

13. See id.

14. Id.

15. See id.16. See id.17. See id. at 456.18. See id.

19. Id. at 460.20. See id. at 459. The Court affirmed the judgment of the district court. Id. "The

District Court held that [the FDIC] was an innocent holder of the note in good faith and forvalue and that petitioner was estopped to assert want of consideration as a defense." Id. at456.

21. Whoever, for the purpose of obtaining any loan from the Corporation . .. orfor the purpose of influencing in any way the action of the Corporation under thissection, makes any statement, knowing it to be false, or wilfully overvalues anysecurity, shall be punished by a fine of not more than $5,000, or by imprisonmentfor not more than two years or both.

Id. at 456-57 (quoting Federal Reserve Act, 12 U.S.C. § 264(s) (1933)).22. See, e.g., FSLIC v. Kearney Trust Co., 151 F.2d 720 (8th Cir. 1945). The court held

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TEXAS TECH LAW REVIEW [Vol. 23:935

B. Codification of D'Oench, Duhme

The Federal Deposit Insurance Act contained a section (nowcodified at 12 U.S.C. section 1823(e)) which is the legislative com-plement of the D'Oench, Duhme doctrine.24 The statute mandatesthat, when the FDIC acquires a loan in its corporate capacity, theFDIC must only honor those agreements between the bank and theborrower which meet the following criteria: the agreements (1) shallbe in writing, (2) shall have been executed by the bank and theperson or persons claiming an adverse interest thereunder, includingthe obligor, contemporaneously with the acquisition of the asset bythe bank, (3) shall have been approved by the board of directors ofthe bank or its loan committee, which approval shall be reflected inthe minutes of said board or committee, and (4) shall have beencontinuously, from the time of its execution, an official record ofthe bank. 2 Thus, in keeping with the purpose of the federal commonlaw doctrine, section 1823(e) prevents the borrower from avoidinghis debts to the FDIC by asserting secret agreements between himselfand the lending institution.26

that the FSLIC was an instrumentality created by Congress under 12 U.S.C. § 1725(c);therefore, it has the power to sue and to be sued, complain and defend, in any court of lawor equity, state or federal. Id. at 725.

23. See, e.g., FDIC v. First National Finance, 587 F.2d 1009 (9th Cir. 1978). The courtrejected the argument that D'Oench, Duhme only applied to the FDIC in its corporatedcapacity and not when acting as a receiver. The court reasoned that "[t]he express languageof the Court in D'Oench, which refers to receivers as well as creditors, precludes thisdistinction." Id. at 1012. As explained by one commentator:

When a bank has failed, or, in the opinion of the FDIC, is about to fail, the FDIChas three basic options: (1) it can become the receiver of the bank and liquidate thebank; (2) it can arrange a purchase of the bank by another financial institution,with the acquiring institution then assuming the liabilities to the depositors of thefailed bank (also referred to as 'purchase and assumption'); or (3) it can use avariety of tools for 'bailing out' the failing institution. If the FDIC chooses the firstoption, it will bring suit to collect loans in its capacity as receiver of the liquidatingbank. If it chooses either the second or third option, any uncollected loans are heldin its corporate capacity as insurer, and the FDIC will bring suit in that capacity.Thus, whether the FDIC is suing as receiver or in its corporate capacity is a resultof the manner in which it chooses to handle the failed bank.

Marsha Hymanson, Borrower Beware: D'Oench, Duhme and Section 1823 Overprotect theInsurer When Bank Fails, 62 S. CAL. L. REv. 255, 259-60 (1988).

24. 12 U.S.C. § 1823(e) (1982); see D'Oench, Duhme & Co., v. FDIC, 315 U.S. 477(1942).

25. 12 U.S.C. § 1823(e) (1982).26. "Such a result would contravene the important federal policies of promoting stability


III. EXCEPTIONS TO DISCHARGEABILITY: 11 U.S.C. SECTION523(A)(2)(A) AND (B)

Upon a determination of the debtor's insolvency in bankruptcyproceedings, the court will grant a discharge of all their debts.27 Theburden then shifts to the creditors to prove that specific debts shouldnot be discharged.2" Section 523(a) provides for nine exceptions uponwhich a creditor may rely to except its particular debt from the totaldischarge.2 9 Each exception covers either different types of debts orinstances of wrongful conduct by the debtor and provides differentelements which the creditor must prove to qualify for each excep-tion.3°

The two exceptions to dischargeability which are relevant to thisdiscussion are contained in sections 523(a)(2)(A) and (B). 31 Section523(a)(2)(A) and (B) provide that:

(a) A discharge under section 727 ... of this title does notdischarge an individual debtor from any debt...(2) for money, property, services, or an extension, renewal, orrefinancing of credit, to the extent obtained by(A) false pretenses, a false representation, or actual fraud, otherthan a statement respecting the debtor's or an insider's financialcondition; [or](B) use of a statement in writing(i) that is materially false;(ii) respecting the debtor's or an insider's financial condition;(iii) on which the creditor to whom the debtor is liable forobtaining such money, property, services, or credit reasonablyrelied; and(iv) that the debtor caused to be made or published with intentto deceive. ..32

and confidence in the nation's banking system. Therefore, public policy supports the continuedapplication of D'Oench and section 1823(e)." Stephen W. Lake, Banking Law: The D'OenchDoctrine and 12 U.S.C. § 1823(e): Overextended, but Not Unconstitutional, 43 OKLA. L. REv.

315, 336 (1990).27. 1i U.S.C. § 727(a) (1988). Discharge is granted unless the debt falls under one of the

enumerated exceptions. Id.28. See 11 U.S.C. § 727(b) (1988). See, e.g., Zerega Distrib. Co. v. Gough, 325 P.2d

894, 896 (Wash. 1958).29. See 11 U.S.C. § 523(a) (1988).30. Id.31. 11 U.S.C. § 523(a)(2)(A)-(B) (1988).32. Id.

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It is clear from the statute that section 523(a)(2)(B) enumeratesthe specific elements that a creditor must prove in order to establishnondischargeability of a debt based on a false written statement. 33

However, section 523(a)(2)(A) does not list the elements a creditormust prove to obtain an exception to discharge based on falsepretenses, false representation or actual fraud. 34 These elements wereinstead incorporated into section 523(a)(2)(A) by case law.3 1 In theearly cases, Friendly Finance Co. v. Stover3 6 and Zerega DistributionCo. v. Gough,37 the courts held that the elements of actual fraudmust be established by the creditor in order for a debt to benondischargeable under section 523(a)(2)(A). 3

1 The elements the courtsrequired were: (1) that the defendant made the representations; (2)that at the time he knew they were false; (3) that he made them withthe intention and purpose of deceiving the plaintiff; (4) that theplaintiff relied on such representations; and (5) that the plaintiffsustained the alleged loss and damage as a proximate result of theirhaving been made.3 9

Although the elements of both section 523(a)(2)(A) and (B) havebeen firmly established, there is a controversy over the standard ofreliance that must be met under section 523(a)(2)(A). Unlike subsec-tion (B)(iii) which explicitly calls for "reasonable reliance,'"'4 theactual fraud elements that have been judicially incorporated intosubsection (A) merely require the creditor to have "relied" on thedebtor's misrepresentations. 4 ' However, there currently exists a dis-tinct split in authority over the standard of reliance.4 2 The Fifth

33. Id. § 523(a)(2)(B) (1988).34. Id. § 523(a)(2)(A) (1988).35. See 134 S.E.2d 837, 839 (Ga. Ct. App. 1964); Zerega Distrib. Co. v. Gough, 325

P.2d 894, 896 (Wash. 1958). Section 523(a)(2)(A) was formerly section 17(a)(2); therefore,existing case law construing section 17(a)(2) is applicable. See Fournet v. Miller (In re Miller),5 B.R. 424, 427 (Bankr. W.D. La. 1980) (citing In re Jones, 3 B.R. 410 (Bankr. W.D. Va.1980)).

36. Friendly Finance Co. v. Stover, 134 S.E.2d 837, 839 (Ga. Ct. App. 1964).37. OZerenga Distrib. Co. v. Gough, 325 P.2d 894, 896 (Wash. 1958).38. See 134 S.E.2d at 839; 325 P.2d at 896.39. 134 S.E.2d at 839 (citing 325 P.2d at 896).40. See 11 U.S.C. § 523(a)(2)(A) (1988).41. See 134 S.E.2d at 839. The elements of proof under actual fraud require that the

plaintiff rely on such representations. Id.42. Courts which recognize the reasonableness requirement include: First Bank of Colorado

Springs v. Mullet (In re Mullet), 817 F.2d 677 (10th Cir. 1987); Schweig v. Hunter (In reHunter), 780 F.2d 1577 (11th Cir. 1986); Coman v. Phillips (In re Phillips), 804 F.2d 930 (6th

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Circuit decisions to date implicitly adopt the reasonable reliancestandard over a simple reliance standard, although the appellate courthas not had occasion to explicitly resolve the conflict. 4 However, inIn re Christian," the bankruptcy court suggests in dicta that it woulddo away with the reasonableness requirement. 45 Regardless of whichstandard of reliance the courts eventually adopt, the FDIC will haveto prove some level of reliance in order to get a debt excepted fromdischarge pursuant to either section 523(a)(2)(A) or (B).

IV. FDIC's USE OF D'OENcH, DUHME AS SUBSTITUTE FOR ACTUAL

RELIANCE

The use of the D'Oench, Duhme doctrine to satisfy the actualreliance element of a nondischargeability claim pursuant to 11 U.S.C.section 523(a)(2)(A)r first appeared in In re Bombard.47 In In re

Cir. 1986); First Nat'l Bank of Red Bud v. Kimzey (In re Kimzey), 761 F.2d 421 (7th Cir.1985); Cooke v. Howarter, (In re Howarter), 95 B.R. 180 (Bankr. S.D. Cal. 1989); Fluehr v.Paolino (In re Paolino), 89 B.R. 453 (Bankr. E.D. Pa. 1988); Armstrong Rubber Co. v.Anzman (In re Anzman), 73 B.R. 156, (Bankr. D. Colo. 1986); Thorp Credit Inc. v. Saunders(In re Saunders), 37 B.R. 766 (Bankr. Ohio 1984); Merrill Lynch, Pierce, Fenner & Smith,Inc. v. Younesi (In re Younesi), 34 B.R. 828 (Bankr. C.D. Cal. 1983).

Courts which reject the reasonableness requirement include: Thul v. Ophaug (In reOphaug), 827 F.2d 340 (8th Cir. 1987); City Federal Savings Bank v. Seaborne (In re Seaborne),106 B.R. 711 (Bankr. M.D. Fla. 1989); Northwest Bank Des Moines, N.A. Card Services Div.v. Stewart (In re Siewart), 91 B.R. 489 (Bankr. S.D. Iowa 1988); Kansas Nat'l Bank & TrustCo. v. Kroh (In re Kroh), 88 B.R. 972 (Bankr. W.D. Mo. 1988); Rowe v. Showalter (In reShowalter), 86 B.R. 877 (Bankr. W.D. Va. 1988).

43. See Texas Venture Partners v. Christian (In re Christian), 111 B.R. 118, 121 (Bankr.W.D. Tex. 1989) ("This court, while it agrees in principal with these recent decisions [requiringmere reliance], need not reach the issue because the jury in the state court case found'reasonable' reliance, at least indirectly.")

44. Texas Venture Partners v. Christian (In re Christian), 111 B.R. 118 (Bankr. W.D.Tex. 1989).

45. Id. at 121 n.l. Addressing the argument that reasonable reliance should be the requiredstandard for a section 523(a)(2)(A) nondischargeability action, the bankruptcy court asserted

[tihe argument has the practical effect of imposing an affirmative duty on theinvesting public to avoid being defrauded. As a matter of jurisprudence, the lawshould serve larger societal purpose. While it is certainly desirable that the consumingand investing public be cautious, knowledgeable and diligent, it is even moreimportant that the marketplace be ridded of con artists and flim flar schemes.

Id.46. 11 U.S.C. section 523(a)(2)(A) (1988) provides in relevant part that:

A discharge under . . . this title does not discharge an individual debtor from anydebt . . . for money, property, services, or an extension, renewal, or refinancing ofcredit, to the extent obtained by false pretenses, a false representation, or actualfraud, other than a statement respecting the debtor's or an insider's financialcondition....

47. FDIC v. Bombard (In re Bombard), 59 B.R. 952 (Bankr. D. Mass. 1986).

TEXAS TECH LAW RE VIEW

Bombard, the FDIC sought to prove that Bombard's debt wasnondischargeable on the basis of fraud." Bombard signed an unse-cured note for $35,000.49 Bombard claimed he was induced to signthe note by his employer as part of a scheme to evade the bank'slending limitations to any one individual.50

The FDIC was able to establish four of the five elements of anondischargeability action under section 523(a)(2)(A). 5

1 However, theFDIC could not prove actual reliance.5 2 The Court pointed out that,"but for the FDIC's special position vis-a-vis the [d]ebtor. . .theproof of the [b]ank's reliance was unpersuasive."l The requisitespecial position, the court opined, was established in 12 U.S.C.section 1823(e), the codification of the D'Oench, Duhme doctrine.5 4

The court reasoned that the statute protected the FDIC from secretagreements and allowed it to rely on the records of a bank whenpurchasing its assets. 55 Therefore, in finding the debts nondischarge-able by application of section 1823(e), the court held the FDIC wasaccorded the position of a holder in due course56 and could thussatisfy the reliance element of section 523(a)(2)(A) as a matter oflaw.

57

One year later, the United States Bankruptcy Court for theNorthern District of Illinois came to the same conclusion in In reBoebel.55 In Boebel, the Boebels signed a note for a loan of $15,00.19

48. Id. at 952-53.49. Id. at 953.50. Id.51. See id. at 954. The elements required to prove nondischargeability of a claim based

on fraud pursuant to 11 U.S.C. section 523(A)(2)(a) are: (1) that the debtor made materiallyfalse representations; (2) that the debtor knew the representations were false at the time hemade them; (3) that the debtor made the false representations with the intention and purposeof deceiving the creditor; (4) that the creditor reasonably relied upon the debtor's materiallyfalse representations and; (5) that the creditor sustained loss and' damages as a proximateresult of the materially false representations made by the debtor. Id. (citing Mack v. Dixie-Shamrock Oil & Gas, Inc. (In re Dixie-Shamrock Oil & Gas, Inc.), 53 B.R. 262, 266 (Bankr.M.D. Tenn. 1985)).

52. Id.53. Id.54. See id. at 955. Section 1823(e) has been held to protect the FDIC from secret

agreements. Accordingly, the FDIC can rely on the records of the bank in purchasing itsassets. Id. (citing FDIC v. First Mortgage Investors, 485 F. Supp. 445, 451 (E.D. Wis. 1980)).

55. Id.56. Id.57. Id. at 954.58. FDIC v. Boebel (In re Boebel), 79 B.R. 381 (Bankr. N.D. Il. 1987).59. Id. at 382.

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The security agreement stated the collateral to be "3500 bu. storedsoybeans."' 6 The Boebels alleged that they informed the loan officerthat these soybeans were in fact still in the field. 6' When the soybeanswere destroyed by continuous rain, the Boebels defaulted on theirloan and sought bankruptcy protection. 62 Subsequently, the lendingbank was deemed insolvent and the FDIC was appointed as itsreceiver.63 The FDIC then filed a motion for summary judgment todetermine the nondischargeability of the Boebels' debt under 11U.S.C. section 523(a)(2)(A). The court refused to grant the summaryjudgment in favor of the FDIC, finding that a question of factexisted regarding the intent element of the claim. 6 However, thecourt held that the D'Oench, Duhme doctrine, as codified in 12U.S.C. section 1823(e), precluded the Boebels from asserting unwrit-ten agreements or understandings as a defense to actual reliance.6Therefore, the court established that the FDIC was entitled to relyon the bank's records, fulfilling section 523(a)(2)(A)'s reliance re-quirement as a matter of law.67

The case that most clearly stands for the proposition thatD'Oench, Duhme may be used to satisfy the reliance prong of section523(a)(2)(A) is In re Figge.68 In Figge, the Figges executed two notesfor personal loans, allegedly in collusion with the bank president, inorder to secure otherwise prohibited multi-million dollar loans forcertain partnerships. 69 Allegedly, the bank president was aware thatthe partnerships would be the sources for repayment of the personalloans.70 Shortly after the lending bank went under the receivershipof the FDIC, the Figges filed under Chapter 7 of the Bankruptcy

60. Id.61. Id. at 383.62. Id.63. Id.64. Id. at 382.65. See id. at 385. The court noted that the Boebels' alleged conversation with the bank

representative, informing him that the soybeans were still in the field, was relevant todetermining whether the debtor had the requisite intent to deceive. Because it was a questionof fact for the jury, the court refused to grant the FDIC's motion for summary judgment.See id.

66. Id.67. Id.68. FDIC v. Figge (In re Figge), 94 B.R. 654 (Bankr. C.D. Cal. 1988).69. Id. at 656.70. Id.

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Code.7 ' The FDIC filed a complaint to determine the nondischarge-ability of the debts pursuant to section 523(a)(2)(A). 72 As a defense,the Figges claimed that the bank did not rely on any fraudulentinformation in making the loans because the bank president knewthat repayment would be made by the partnerships, and had anulterior business motive for approving the loans.73 In finding thedebts nondischargeable, the court held that the D'Oench, Duhmedoctrine barred the debtor's assertion of the estoppel defense basedon the side agreements with the bank president. 74 The court furtherheld that D'Oench created a presumption of reasonable reliance undersection 523(a)(2)(A).75

In 1989, the proof of reliance issue was considered by the onlydistrict court at that time decide the question in a published opinion.In re Cerar7e 6 involved a debtor, Bernard Cerar, who, in cooperationwith bank officials, forged a note for $33,400 in the name of MarkCerar in an attempt to exceed loan limits. 7 7 Shortly thereafter, thebank failed and the FDIC was appointed as receiver. 78 After theCerars filed for bankruptcy, the FDIC brought an action to establishthe nondischargeability of the debt based on false representationunder 11 U.S.C. section 523(a)(2)(A). 79 The court discussed thedifference between applying the D'Oench, Duhme doctrine when theFDIC acts in its corporate capacity and 12 U.S.C. section 1823(e),applicable when the FDIC acts as receiver.80 The court reasoned thatthe result would effectively be the same under either rule.8' The courtnoted that, under either version, the FDIC is entitled to rely on the

71. Id.

72. Id.

73. Id.

74. Id. at 668.75. Id.76. FDIC v. Cerar (In re Cerar), 97 B.R. 447 (C.D. Ill. 1989).77. See id. at 448.78. Id.79. Id.80. See id. at 450. The court notes that when the FDIC sues in its capacity as receiver,

the common law D'Oencho Duhme doctrine applies. See FDIC v. McClanahan, 795 F.2d 512(5th Cir. 1986). However, 12 U.S.C. section 1823(e) usually comes into play when the FDICis suing in its corporate capacity. See FDIC v. Cerar (In re Cerar), 97 B.R. 447, 450. Sincesection 1823(e) is basically a codification of the common law D'Oench, Duhme doctrine, thedistinction between corporate or receiver capacity is essentially meaningless. That is, "[tiheresult, though not the analysis is the same." Id.

81. Id.

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bank's written records and is not required to prove actual reliance.8 2

Therefore, the court held that both D'Oench, Duhme and section1823(e) may satisfy the reliance element of a section 523(a)(2)(A)nondischargeability claim as a matter of law.13

In In re Stefanoff," debtors Stefanoff and Walsh formed apartnership and arranged to borrow $2.5 million from Victor Savingsto purchase and improve property known as the Sallisaw RV Park."Both debtors had been members of the Victor Savings loan approvalboard. 6 In order to receive some extra cash from the deal, thedefendants artificially inflated the property's purchase price usingwhat is known as a "strawman" or "turnaround sale." ' 87 From that,the loan application was submitted and approved based on theinflated value. 8 After being appointed receiver for Victor Savings,the FSLIC foreclosed on the Sallisaw RV Park. 9 An involuntarypetition for bankruptcy was filed against Stefanoff, and the FSLICfiled a complaint asking the court to find the debt nondischargeablepursuant to 11 U.S.C. section 523(a)(2)(A).90

The main issue before the court was whether Victor Savingsrelied on the false representations of Stefanoff and Walsh in makingthe loans. 91 The court determined that the evidence alone was notclear and convincing in order to establish Victor Savings' actualreliance. 92 However, the court went on to hold that the FSLIC neednot prove actual reliance by Victor Savings to establish a case undersection 523(a)(2)(A). 93 Pursuant to the D'Oench, Duhme doctrine,the court reasoned the FSLIC was deemed, as a matter of law, to

82. Id.83. Id.84. FSLIC v. Stefanoff (In re Stefanoff), 106 B.R. 251 (Bankr. N.D. Ok. 1989).85. Id. at 253.86. See id.87. Id. The debtors knew they could purchase the property for far less than the loan

amount they procured. However, in order to make the loan amount appear legitimate theyestablished a fictitious third party from whom they could buy the property and make it looklike the third party, the "strawman," had charged them the inflated price. See id.

88. Id.89. Id. at 255.90. Id.91. See id. at 256.92. Id. The defendant, Stefanoff, as a member of the executive committee of the bank,

had arranged for the loan appraisal himself. Clearly, he was aware of his own false represen-tations as to the purchase price of the property. Id.

93. Id.

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TEXAS TECH LAW REVIEW [Vol. 23:935

have relied solely on the written records of Victor Savings as theyexisted at the time the FSLIC was appointed receiver. 94 Based on theforegoing discussion, it is clear that the courts were uniformly infavor of allowing the D'Oench, Duhme doctrine, and section 1823(e)to satisfy the reliance element pursuant to a section 523(a)(2)(A)nondischargeability action.

V. IN RE SMH7W 5

James Smith and his cousin, Vernon Smith, allegedly conspiredwith officers and the owner of Vernon Savings to deceive lendinginstitution examiners with respect to three loans.96 Both debtors filedfor bankruptcy in 1988. 97 Shortly thereafter, the FDIC took over asreceiver for Vernon Savings and filed a complaint to determine thenondischargeability of the Smiths' outstanding debts pursuant to 11U.S.C. section 523(a)(2)(A). 9 The bankruptcy court found the debtsnondischargeable, holding that the D'Oench, Duhme9 doctrine al-lowed the FDIC to rely on the documents in the loan file, and thusestablish the reliance requirement of section 523(a)(2)(A) as a matterof law. I°° The debtors appealed, questioning the FDIC's right toinvoke the D'Oench, Duhme estoppel rule to satisfy the relianceelement of a nondischargeability claim.' 0 ' The United Stated District

94. Id. See Mainland Say. Ass'n v. Riverfront Associates Ltd., 872 F.2d 955 (10th Cir.1989), cert. denied Riverfront Associates, Inc. v. FSLIC, 493 U.S. 890 (1989) (applyingD'Oench, Duhme to cases involving the FSLIC as well as FDIC). Additionally, in 1991, theUnited States Bankruptcy Court in Mississippi heard the companion cases, In re Lefeve andIn re Lefeve. FDIC v. Lefeve (In re Lefeve), 131 B.R. 588 (Bankr. S.D. Miss. 1991) andFDIC v. Lefeve (In re Lefeve), 131 B.R. 604 (Bankr. S.D. Miss. 1991). In neither case,however, did the borrower act in collusion with the failed lender to defraud regulators. See131 B.R. at 594, 609. In fact, the borrower perpetrated the fraud on the lenders themselves.Id. Pursuant to the FDIC's actions under I1 U.S.C. section 523(a)(2)(A), the court found thedebts nondischargeable, holding that the lending institutions actually relied on the fraud. Id.However, the court pointed out in dicta that even absent evidence of actual reliance by thefailed institutions, the FDIC was presumed to have relied on the fraud as a matter of law.See id. at 595, 610.

95. FDIC v. Smith (In re Smith), 133 B.R. 800 (N.D. Tex. 1991).96. FDIC v. Smith (In re Smith), 113 B.R. 297, 298 (Bankr. N.D. Tex. 1990) rev'd 133

B.R. 800 (N.D. Tex. 1991). See supra note 2 and accompanying text.97. Id.98. Id.99. D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942).

100. 113 B.R. at 306.101. 133 B.R. at 802. See supra note 7 and accompanying text.

1992] THE D'OENCH, DUHME DOCTRINE

Court for the Northern District of Texas reversed the bankruptcycourt, holding that the D'Oench rule is not a surrogate for proof ofactual reliance. 0 2

VI. THE SMITH DECISION

The district court's holding in In re Smith declined to adopt theprevailing rule that D'Oench, Duhme excuses the FDIC from provingactual reliance by bank regulators or by the failed institution in asection 523(a)(2)(A) claim. 03 With its decision, the court declined tofollow firmly established precedent in the bankruptcy courts therebylimiting the scope and application of the D'Oench, Duhme doctrinein the bankruptcy context. The district court judge acknowledged thegeneral acceptance of D'Oench in nondischargeability actions bystating that, "[a]ll cases decided prior to the bankruptcy court'sdecision . .. have uniformly reached the same conclusion as did thebankruptcy court."'' 0 The court further realized the uniqueness ofits decision by stating that, "[tioday's opinion stands alone."' °5

With his maverick opinion, Judge Fitzwater halted developingjudicial expansion of the D'Oench, Duhme doctrine. Since its incep-tion in 1942 as a bar to the borrower's failure of consideration

102. Id. at 806.103. See id. The most recent case following the bankruptcy court's decision in In re Smith

is In re Calhoun. 131 B.R. 757 (Bankr. D.D.C. 1991). In Calhoun, the debtor was a memberof a partnership that borrowed $10 million from National Bank of Washington (NBW). Id.at 758. The partnership succeeded in deceiving NBW as to its financial condition and stabilityin securing the loan. Id. at 759. The FDIC took over as receiver for NBW and Calhoun filedfor bankruptcy. Id. at 758. The FDIC instituted an action to determine the nondischargeabilityof the loan under 11 U.S.C. section 523(a)(2)(A) and (B). Id. However, the FDIC failed toallege in the pleadings that NBW relied on the borrower's fraud in making the loan. Id. at759.

The FDIC argued that, as a matter of law, a conclusive presumption existed that NBWrelied upon the accuracy of the representations. Id. The court granted Calhoun's motion todismiss with leave to amend, based on the FDIC's failure to allege sufficient facts which, ifproven, would demonstrate actual reliance. Id. at 758. In the Calhoun opinion, however, thecourt asserted that ". . . the FDIC is correct in stating that where a loan document fails tocomply with section 1823(e) 'the element of reliance required by [s]ection 523(a)(2)(A) and (B)is satisfied upon documentary evidence from the debtor's loan file, showing the written termsand conditions of the loan agreement."' Id. at 760 (quoting FDIC v. Figge (In re Figge), 94B.R. 654, 668 (Bankr. C.D. Cal. 1988). Therefore, Calhoun reaffirmed In re Cerar holdingthat the FDIC need not prove reliance where the creditor and the debtor have acted jointlywith the intent to defraud the bank examiners or FDIC. Id.

104. Id.105. Id.


defense, °6 the doctrine has been expanded to bar a wide range ofaffirmative defenses, including: (1) fraudulent inducement, 07 (2) oralagreements to fill in the blanks,' 8 (3) side agreements, including oralrepresentations, l°9 (4) breach of fiduciary duty," 0 (5) accord andsatisfaction,"' (6) deceptive trade practices," 2 (7) tortious interferencewith contractual relations,"' (8) material alteration," 4 (9) undue in-fluence," 5 and (10) affirmative claims for relief."16 One commentatorhas stated, "[in sum, the courts regularly apply D'Oench to barnearly every defense and affirmative claim by the maker of a noteagainst the FDIC. '"7

The district court judge's decision to overrule all existing caselaw on point, thereby limiting the applicability of D'Oench, arisesprimarily from his theory that, "[tlo invoke this estoppel rule to fillthe factual void is to expand the reach of the doctrine beyond itsoriginal and even current moorings to perform a function for whichthe rule was not intended and which it cannot properly serve underbankruptcy law."" 8

Judge Fitzwater also accepted various arguments and theoriesconcerning the general requirements pursuant to a section 523(a)(2)(A)action, the expectations of the FDIC, and the scope of D'Oench,Duhme. Ordinarily, to satisfy a section 523(a)(2)(A) claim, fiveelements must be established.' 9 The party objecting to discharge on

106. 315 U.S. 447, 460-61.107. See, e.g., FDIC v. Galloway, 856 F.2d 112 (10th Cir. 1988); FSLIC v. Lafayette Inv.

Properties, Inc., 855 F.2d 196 (5th Cir. 1988).108. See, e.g., FSLIC v. Murray, 853 F.2d 1251 (5th Cir. 1988); FDIC v. Armstrong, 784

F.2d 741 (6th Cir. 1986).109. See, e.g., Templin v. Weisgram, 867 F.2d 240 (5th Cir. 1989), cert. denied, 493 U.S.

814 (1989); FDIC v. Simon, 607 F. Supp. 1254 (N.D. II. 1985).110. See, e.g., Beighley v. FDIC, 676 F. Supp. 130 (N.D. Tex. 1987), aff'd 868 F.2d 776

(5th Cir. 1989).111. See, e.g., Public Loan Co. v. FDIC, 803 F.2d 82 (3rd Cir. 1986); FSLIC v. Ziegler,

680 F. Supp. 235 (E.D. La. 1988).112. See, e.g., RSR Properties v. FDIC, Inc., 706 F. Supp. 524 (W.D. Tex. 1989).113. See id.114. See, e.g., FDIC v. Armstrong, 784 F.2d 741 (6th Cir. 1986). But see FDIC v. Turner,

869 F.2d 270 (6th Cir. 1989) (allowing defense of material alteration as fraud in fact).115. See, e.g., FSLIC v. Musacchio, 695 F. Supp. 1044 (N.D. Cal. 1988).116. See, e.g., Beighley v. FDIC, 676 F. Supp. 130 (N.D. Tex. 1987) aff'd 868 F.2d 776

(5th Cir. 1989); FDIC v. First Mortgage Investors, 485 F. Supp. 445 (E.D. Wis. 1980).117. Lake, supra note 26, at 319.118. 133 B.R. at 808.119. See, e.g., Dodson v. Church (In re Church), 69 B.R. 425, 432 (Bankr. N.D. Tex.

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the basis of fraud must prove: (1) the debtor made representations,(2) at the time they were made, the debtor knew they were false, (3)the debtor made the representations with the intention and purposeto deceive the creditor, (4) the creditor relied on such representations,and (5) the creditor sustained losses as a proximate result of therepresentations. 120

In establishing these elements, the courts have formulated somegeneral rules of proof. First, and fairly apparent, the creditor isresponsible for demonstrating each of the five elements of fraud. 2'Clearly, without such proof, a judgment cannot be entered for thecreditor. 122 Second, "[i]n determining whether a particular debt fallswithin one of the exceptions to section 523, the statute should bestrictly construed against the objecting creditor and generally in favorof the debtor.' ' 23

In addition to these general rules of applicability, the court hadto accept one basic factual premise in order for the reliarice elementto become an issue. That is, the FDIC could not prove actual reliance,only reliance as a matter of law.124 In In re Smith, the FDIC couldnot prove that it had actually relied on the debtor's misrepresentationsbecause the FDIC did not furnish the loan. 25 Furthermore, the FDICcould not prove that the lending bank had actually relied on themisrepresentation because the bank was in collusion with the debtor.'26As a result of this inadequacy of proof, the only way the FDICcould establish the reliance element was by application of D'Oench,Duhme.1

27

According to the court, the D'Oench doctrine traditionally per-formed two functions: (1) an estoppel rule for defenses such as fraud,

1987). These elements are basically the common law elements of fraud originally adopted insection 17(a)(2) which has been incorporated into 11 U.S.C. section 523(a)(2)(A). Fournet v.Miller (In re Miller), 5 B.R. 424, 427 (Bankr. W.D. La. 1980).

120. 133 B.R. at 805 (citing Bank of Louisiana v. Bercier (In re Bercier), 934 F.2d 689,692 (5th Cir. 1991) (emphasis added)).

121. Id. at 805. See 1 W. NORTON, BANKRUPTCY LAW & PRACTICE § 27.41 (1982).122. 133 B.R. at 805.123. Id. (quoting Allstate Ins. Co. v. Foreman (In re Foreman), 906 F.2d 123, 127-8 (5th

Cir. 1990)).

124. See id. at 806.125. See id.

126. See id.127. See id.

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and (2) a defense to affirmative claims. 2 From this, the courtasserted that the doctrine had been employed defensively in the past;however, it had never been applied offensively to satisfy an affir-mative element of substantive law outside of the bankruptcy setting. 129

The court acknowledged that the FDIC believed D'Oench shouldbe applied to satisfy the reliance element of a nondischargeabilityclaim largely because it sought to enforce its own expectations. 30

The FDIC argued it should be able to rely on an institution's recordsand to fully enforce facially unqualified instruments as written.'The court noted that the FDIC's proposition found support uniformlyin the case precedent on point.3 2 However, in coming to its decision,the court rejected this history. Instead, the judge impliedly acceptedthe argument that the FDIC should not have any greater rights thana bank would have.'33 If the bank participated in the fraud, the courtreasoned, it would have no right to assert nondischargeability. 13 4

Accordingly, since the FDIC stepped into the shoes of the bank, itshould be barred from proving nondischargeability as well.

Finally, the district court judge accepted the argument thatD'Oench had been expanded beyond its intended scope.' The courtnoted that the nondischargeability statute, section 523(a)(2)(A), con-tains no exception to the reliance requirement. 3 6 Therefore, by ex-tending D'Oench, Judge Fitzwater argued that the judiciary waseffectively rewriting the statute. 3 7 Furthermore, he asserted that

128. Id. at 809-10. "Both roles are intended to enable the FDIC to enforce facially validnotes and other obligations contained in the files of regulated institutions without concern forundisclosed schemes or arrangements. Neither function permits the FDIC to assume a debtorcannot discharge an enforceable debt in bankruptcy." Id. at 810.

129. Id. D'Oench has been used as a shield, but never a sword. Id.130. Id.131. Id. "Fundamentally, D'Oench attempts to ensure that FDIC examiners can accurately

assess the condition of a bank based on its books." Id. (quoting Bowen v. FDIC, 915 F.2d1013, 1016 (5th Cir. 1990)). However, "the FDIC's unilateral expectations do not alone fashionthe rule of law in all situations." Id. (citing Buchanan v. FDIC, 935 F.2d 83, 85 (5th Cir.1991)).

132. Id. at 806.133. Id.134. Id. at 809-10. In a situation like this, "the bank has 'dirty hands' and under equitable

principals cannot deny its own secret agreement with the borrower." See HYMANSON, supranote 23, at 286.

135. See id. at 808.136. See id., 11 U.S.C. § 523(a)(2)(A) (1988).

137. See 133 B.R. at 810-11.

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19921 THE D'OENCH, DUHME DOCTRINE

interference with a congressionally mandated scheme is a judicialusurpation of the legislative role.' In the court's opinion, if Congressfelt that an exception should be incorporated into the law, then theproper recourse was for Congress to amend the law. 39

VII. CRITICAL ANALYSIS OF IN RE SATH

The legislative argument upon which Judge Fitzwater relied inreaching his decision was flawed in light of the statutory language,or lack thereof, in section 523(a)(2)(A).'14 Clearly, there was no listof elements required by the statute to satisfy a nondischargeabilityclaim based on fraud. The elements, which are the common lawelements of fraud, have been judicially supplied and incorporated byZerega Distribution Co. v. Gough.'41 If judicial authority existed tosupply the elements to satisfy a claim when the legislature has notdone so, it should be no more a usurpation of authority to judiciallyincorporate another common law doctrine, such as D'Oench, whenthere is no strict congressionally mandated scheme.

Those who support the district court's decision to halt theexpansion of D'Oench argue that application of the doctrine violatesthe rights of borrowers.' 42 Clearly, in contexts where the doctrine isasserted defensively, situations arise where an innocent borrower is

138. See id. (stating that "If this result leads, as the FDIC apparently contends it will, toat least some bankruptcy filings intended to accomplish what D'Oench, Duhme otherwiseprevents, the proper recourse is to ask Congress to amend § 523(a)(2)(A). This court will noteffectively rewrite this provision of the Code by judicial fiat.").

139. See id. "At least one bill, H.R. 3982 has been introduced in Congress to effect this."If enacted, the bill would amend § 523 to provide that 'reliance by a creditor will not berequired to establish an exception to discharge if the creditor is a financial regulatory agentthat is a successor to a bank, savings association, or credit union." Id. at n.16 (citing H.R.3982, 101st Cong., 2d Sess. (1990)).

140. Section 523(a)(2)(A) states:A discharge under ... this title does not discharge an individual debtor from anydebt .. .for money, property, services, or an extension, renewal, or refinancing ofcredit, to the extent obtained by ... false pretenses, a false representation, or actualfraud, other than a statement respecting the debtor's or an insider's financialcondition.

11 U.S.C. § 523(a)(2)(A) (1988).141. Zerega Distrib. Co. v. Gough, 325 P.2d 894, 896 (Wash. 1958) (incorporating the

elements of actual fraud into section 17(a)(2), which later became section 523(a)(2)(A)).142. See, e.g., HyAwsoN, supra note 24, at 255. "[I]n expanding the protection of the

bank insurers, the courts have moved beyond that which is either necessary or desirable. Thisoccurs at the expense of innocent, good faith borrowers who are barred from asserting statelaw defenses which would rescind or modify the borrower's loans." Id.


subjected to a harsh result. 43 In these instances, Judge Fitzwater'sdesire to limit the doctrine's scope seems more plausible. After all,D'Oench is an estoppel theory designed to achieve equitable resultswhen fairness so demands.'"

However, his argument is not as strong considering the natureof the issue before him in In re Smith. The argument loses its appealwhen one considers the relative positions of the players in nondis-chargeability actions instituted by the FDIC. Generally, in thesesituations there will be three classes of borrowers: (1) the borrowerwho has tried to defraud the lending institution, 14 (2) the borrowerwho operated in collusion with the lending institution to defraudbank examiners,'" or in rare instances, (3) the borrower who hasbeen duped into a fraudulent scheme by the misrepresentations of alending officer. 47

In the first situation, where the borrower has tried to defraudthe lending institution, the FDIC will be able to satisfy the relianceelement without D'Oench by proving that the lending institutionactually relied on the borrower's misrepresentations in making theloan. However, in the other two instances, where the bank has takenpart in the fraud, it is impossible for the FDIC to assert that the

143. See, e.g., Gunter v. Hutcheson, 674 F.2d 862 (11th Cir.) cert. denied, 459 U.S. 826(1982). In Gunter the FDIC "agreed that the Gunters were defrauded into their stock purchaseand that this fraud ordinarily would be adequate grounds for rescission." Id. at 866. TheGunters were "the innocent victims of the bank's own scheme and could not be charged withpresumptive knowledge that they had been defrauded." Hymanson, supra note 24, at 317.However, they were precluded from asserting a defense. See id.; FSLIC v. Hsi, 657 F. Supp.1333 (E.D. La. 1986). Mr. Hsi was referred to Mr. Olano, chairman of the board of AllianceSavings and Loan, in order to obtain a loan. Id. at 1335. Olano insisted on certain loan termswhich resulted in Hsi, the unsophisticated borrower, having to act quickly without time toinvestigate the financial situation of the lending institution. Id. The lending institution failedalmost immediately. Id. The court acknowledged that "[a]pparently the Hsis were the victimsof several unscrupulous people who used their relative inexperience in the financial world todefraud them." Id. at 1388. Nevertheless, they were barred from asserting their defense byD'Oench, Duhme. Id.

144. "Equity" is defined as "justice administered according to fairness as contrasted withthe strictly formulated rules. ... BLAcx's LAw DicTONAv 540 (6th ed. 1990).

145. See, e.g., FSLIC v. Stefanoff (In re Stefanoff), 106 B.R. 251 (Bankr. N.D. Ok. 1989)(borrower arranging through third party purchasers to misrepresent land values to the bankand pocket the excess).

146. See, e.g., FDIC v. Figge (In re Figge), 94 B.R. 654 (Bankr. C.D. Cal. 1988) (debtorscontending lending bank president was in on scheme); FDIC v. Cerar (In re Cerar), 97 B.R.447 (Bankr. C.D. Ill. 1989) (debtor's fraud performed in conjunction with his creditor forpurpose of deceiving bank examiners and FDIC).

147. See supra note 140 and accompanying text.

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bank relied on fraudulent misrepresentations in its loan decisions.Therefore, the FDIC must prove that the bank regulators actuallyrelied on the fraud. Clearly, this will be impossible because of thenature of the FDIC's role.'4 In these cases, the FDIC's activeinvolvement begins when the bank is deemed insolvent. The fraud-ulent loans will have been procured prior to the takeover of thebank. Therefore, the FDIC will be unable to prove that it relied onactions prior to its actual involvement. Consequently, it will bevirtually impossible for, the FDIC to satisfy the reliance element ofa nondischargeability claim without the benefit of D'Oench.

Judge Fitzwater's decision effectively emphasizes form over sub-stance.149 Rather than considering the inequitable results that willarise as a consequence of his holding, he concentrates on a proceduralissue. 50 One of his strongest arguments is that, to date, the doctrinehas been used defensively by the FDIC, but has never been usedoffensively to satisfy an affirmative element of a claim outside ofthe nondischargeability context.' 5 ' He emphasizes that he disagreeswith turning a traditionally defensive doctrine into an offensiveweapon.52 However, Judge Fitzwater undermines the effectiveness ofhis own contention when he writes, "[t]he court had no occasiontoday to address whether under all circumstances D'Oench, Duhmemay or may not satisfy as a matter of law a factual element of anaffirmative proof burden."' 53

Furthermore, Judge Fitzwater notes no persuasive authority thatthis affirmative use, which has been uniformly accepted by bank-ruptcy courts in numerous jurisdictions, is an unwise or unjustjudicial expansion of the doctrine. In fact, there is a strong argument

148. In the district court opinion of In re Smith, Judge Fitzwater notes that the FDICcould not assert that it had actually relied on the borrowers' or the banks' fraud because theFDIC did not make the loans. To assert that the debtors received money from the institutionalinsurer when they in fact borrowed from the lending institutions confuses the legal relationshipsbetween the entities. See 133 B.R. at 805.

149. Rather than looking at the issue from a policy perspective and taking into considerationthe equitable purposes for which the doctrine was created, Judge Fitzwater rigidly refuses toextend the doctrine because it would result in a procedurally new application. See id. at 806.

!50. See 133 B.R. at 810.151. Id. "Except in the bankruptcy-and specifically nondischargeability-context the court

has found no case that employs D'Oench, Duhme as a substitute for the proof necessary tosatisfy an element of an affirmative claim." Id.

152. See id.153. Id. at 810 n.12.

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that this expansion most clearly represents the equitable policy pur-poses behind the initial adoption of the doctrine. In his opinion,Judge Fitzwater acknowledges that the D'Oench, Duhme doctrinewas created by the Supreme Court pursuant to a "federal policy toprotect [the FDIC] ... against misrepresentations as to the ...assets in the portfolios of the banks which [the FDIC] insures .... 14

Although procedurally a broad expansion, allowing D'Oench toaffirmatively satisfy the reliance element, which otherwise the FDICcould not meet, would protect the FDIC from a borrower withunclean hands, forcing the burden to fall on the wrongdoer ratherthan on the FDIC.' This result is the manifestation of the equitablepolicy purposes for which D'Oench was originally developed.5 6

E. CONCLUSION

In In re Smith, the court refused to allow the D'Oench, Duhmedoctrine to satisfy the reliance element of a section 523(a)(2)(A)nondischargeability action. This decision declines to follow uniformlyestablished precedent in several jurisdictions.'5 7 More egregiously,however, Judge Fitzwater bases his opinion on substantially falliblearguments and ignores the extensive ramifications of his holding. Insome instances, it will be virtually impossible for the FDIC to proveactual reliance in cases where the borrower acted fraudulently. As aresult of the district court's decision in In re Smith, the rights ofborrowers with "unclean hands" will be legally superior to those ofthe FDIC, innocent depositors, and taxpayers, and thus the policybehind the D'Oench, Duhme doctrine will be thwarted.

Stacey Simmons

154. Id. at 808 (quoting D'Oench, 315 U.S. at 457).155. When the cost of losing money through the discharge of debts falls on the FDIC, the

cost is effectively spread over the entire banking system. All banks are charged for the FDICinsurance, which is then passed on to the customers. This is a risk spreading function commonto all insurance plans. When the FDIC insurance fund incurs a loss, bank costs rise, resultingin fewer earnings on depositors' funds and higher loan costs. See Hymanson, supra note 24,at 303.

156. See D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942).157. See, e.g., FDIC v. Lefeve (In re Lefeve), 131 B.R. 604, 610 (Bankr. S.D. Miss. 1991);

FDIC v. Lefeve (In re Lefeve), 131 B.R. 588, 595 (Bankr. S.D. Miss. 1991); FSLIC v. Stefanoff(In re Stefanoff), 106 B.R. 251, 257 (Bankr. N.D. Okla. 1989); FDIC v. Cerar (In re Cerar),97 B.R. 447, 450 (C.D. Ill. 1989); FDIC v. Figge (In re Figge), 94 B.R. 654, 669 (Bankr.C.D. Cal. 1988); FDIC v. Boebel (In re Boebel), 79 B.R. 381, 384 (Bankr. N.D. I1. 1987);FDIC v. Bombard (In re Bombard), 59 B.R. 952, 954-55 (Bankr. D. Mass. 1986).

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