Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 1:08-cv-02808-Joan B. Gottschall, Judge.
The opinion of the court was delivered by: Kanne, Circuit Judge
Before KANNE, ROVNER, and WILLIAMS, Circuit Judges.
Ronald and Gail Goldberg were creditors of Ernest and Beverly Ojeda. The Goldbergs executed a short-term, high-interest-rate loan with the Ojedas in August 1998. Despite being unable to pay the $600,000 principal when the loan became due, the Ojedas continued to make monthly interest payments to the Goldbergs, facilitated by numerous extensions of the loan's maturity date. But these interest payments stopped abruptly in January 2006 and the Ojedas defaulted.
The Ojedas filed for bankruptcy in February 2006. As part of the bankruptcy proceedings, Gail filed an adversary proceeding against the Ojedas, seeking to have the $600,000 loan declared non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A). In support of her position, Gail alleged that the Ojedas engaged in fraudulent conduct in conjunction with the extensions of the loan's maturity date. The bankruptcy court entered an order finding that the debt was dischargeable, and that even if it was non-dischargeable, the amount excepted from discharge was only the amount of unpaid interest and attorney's fees. On appeal, the district court determined that the bankruptcy court erred in holding the debt dischargeable and in calculating the amount excepted from discharge. We affirm the district court's decision in both respects.
The Goldbergs were in the business of making short-term, high-risk loans. A mutual friend introduced the Ojedas to the Goldbergs because the Ojedas were seeking a $600,000 loan. As a part of the loan application process, the Ojedas provided the Goldbergs with collateral in the form of 160,000 Pan American Bank stock shares, valued at $800,000.*fn1 The Goldbergs took possession of the stock certificate, which was registered in Ernest's name, but did not file a financing statement with the Illinois Secretary of State or a notice of stock power or hypothecation agreement with the bank.
The Ojedas also informed the Goldbergs that they were the sole owners of two entities, Dices Enterprises and Pelham Enterprises, Inc. The Ojedas owned and operated a McDonald's restaurant in Chicago through Dices Enterprises, while Pelham Enterprises was the owner of a second McDonald's restaurant in Chicago. These McDonald's restaurants were not used as security for the loan, but rather were disclosed to the Goldbergs so that the latter could have a full picture of the Ojedas' finances.
The Goldbergs executed a loan agreement with the Ojedas in August 1998, providing the Ojedas with a $600,000 loan, secured at an annual interest rate of 18%. Initially, the loan was supposed to be a short-term "bridge" loan, with the maturity date set at October 6, 1998. At some point, the maturity date was extended orally to January 6, 2000. After the Ojedas failed to meet the January maturity date, they delivered to the Goldbergs a new "collateral note" extending the loan's maturity date yet again, this time until December 1, 2000. This note continued the pledge and grant of the security interest in the 160,000 shares to the Goldbergs. In the interim, due to Pan American's financial difficulties, on October 5, 1999, its holding company, Bancshares, entered into a purchase agreement with JD Financial in which JD Financial purchased all of Bancshares' interest in Pan American Bank. JD Financial thus became the new holding company for Pan American. Ernest subsequently informed Bancshares shareholders (but not the Goldbergs) that incident to the sale,*fn2 Bancshares had executed a one-for-one-hundred reverse stock split of Bancshares common stock, resulting in a reduction of the Bancshares common stock to 15,000 shares.
Following the stock split, the Ojedas yet again failed to pay the remainder of their loan on the December 1, 2000 maturation date. The Ojedas continued, however, to make monthly interest payments to the Goldbergs for approximately eighteen months while Ronald and Ernest negotiated an extension of the now-expired note.*fn3 On November 1, 2001, Gail and the Ojedas executed another written extension in the form of a new secured promissory note for the principal amount of $600,000. Pursuant to this agreement, both Pelham and Dices guaranteed the note, Gail became the sole creditor of the loan, and maturity was set for January 3, 2003. This loan was secured by the now non-existent 160,000 shares of Bancshares stock, a fact unknown to the Goldbergs. Under this agreement, neither the Ojedas nor the corporations were restricted from selling or otherwise disposing of their assets, with the exception of the Bancshares stock.
In what has now become a common recitation, the Ojedas again failed to pay the principal when the newest loan matured in January 2003. They did, however, continue to make monthly interest payments, which Gail continued to accept. Meanwhile, in 2004, the Ojedas began looking for a buyer for their McDonald's restaurants. Because the Ojedas would face significant capital gains tax from any sale of the restaurants, they began to look for a "like-kind" business in which to invest the proceeds from any sale. In early October 2004, the Ojedas sold Pelham's and Dices's interest in the McDonald's restaurants and used approximately $1.1 million dollars from proceeds of the sale to pay the restaurants' outstanding claims and some of the Ojedas' creditors. The balance of the proceeds, approximately $2,300,000, was deposited into a "Starker trust" pending the investment of those funds into a like-kind asset. Shortly thereafter, in late December 2004, the Ojedas negotiated to buy a Joey Buona's Pizzeria Grille with the remaining proceeds from the McDonald's sales; they purchased the Joey Buona's franchise through Pelham.
The Ojedas made all of the required interest payments to the Goldbergs until January 2006, when they defaulted. The approximate value of the total interest paid up to that point was $801,000. The Ojedas never repaid any portion of the principal. Subsequent to the default, the Joey Buona's franchise failed in February 2006, prompting the Ojedas' voluntary Chapter 7 bankruptcy petition in January 2007.
Before the bankruptcy court, Gail alleged that the $600,000 loan should be excepted from discharge because the Ojedas engaged in fraudulent conduct designed to procure extensions of their loan. Namely, Gail alleged that her forbearance on the loan was fraudulently induced because the Ojedas never informed the Goldbergs of the sale of the McDonald's restaurants, continued to make interest payments with checks bearing the McDonald's account logo, and failed to inform the Goldbergs of the stock split. The bankruptcy court found that Gail was not justified in relying on the Ojedas' representation of the stock value because of Ronald's familiarity with Pan American's financial troubles, and that Gail was not justified in relying on the Ojedas' continued ownership of the McDonald's restau-rants because the restaurants did not secure the loan. The bankruptcy court also found that even if Gail was justified in relying on the Ojedas' fraudulent misrepresentations, the amount that was excepted from discharge included only attorney's fees and unpaid interest.
On appeal, the district court reversed, finding that Gail was justified in relying on the Ojedas' fraudulent conduct that led Gail to believe they still owned the McDonald's restaurants. The court further found that the entire debt-$600,000-should be excepted from discharge because Gail was fraudulently induced ...