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In re Shaf – Changing the character of underlying debt.

This early 2012 case delves into the question of when debt based on fraudulent behavior of the Debtor dischargeable. In this case there was a real estate developer and a custom home buyer. The developer is the Debtor in this case. Unbeknownst to the buyer, the developer was engaged in a lengthy court battle of the right to build houses on a certain parcel of land. The developer took the buyer’s down payment and then later convinced the buyer to make another down payment in order to ‘obtain better financing’. What the developer did not disclose to the buyer is that there was no possible way the house could be built in the buyer’s timeframe because of the court battle. This was fraudulent concealment and in violation of 523(a)(2)(A) of the bankruptcy code.

However there were also multiple settlement agreements in this case. The first settlement agreement was reached between the parties as a result of the original fraud. The developer did not pay the settlement amount, so the matter went to litigation and a new settlement agreement was reached. This is where it gets interesting. The 2nd settlement agreement is not based on fraudulent actions and would therefore be dischargeable based on 7th circuit precedent (See In re West, 22F.3d 775 (1994)). What saved the buyer in this case was that the 2nd settlement agreement contained language that the original obligation was not released until the full settlement amount was paid. Since that amount was not paid, there was no release of the original agreement, and therefore the debt was not dischargeable.

Original case available here.

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