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ORDERED PUBLISHED

UNITED STATES BANKRUPTCY APPELLATE PANEL

OF THE NINTH CIRCUIT

In re: ) BAP No. NC-12-1081-MkHPa

 )

RAUL MACHUCA, JR., ) Bk. No. 10-55227

 )

Debtor. ) Adv. No. 10-05301

________________________________)

 )

HERITAGE PACIFIC FINANCIAL, LLC,)

 )

Appellant, )

 )

v. ) O P I N I O N

 )

RAUL MACHUCA, JR., )

 )

Appellee. )

________________________________)

Argued and Submitted on October 18, 2012

at San Francisco, California

Filed – December 14, 2012

Appeal from the United States Bankruptcy Court

for the Northern District of California

Honorable Charles D. Novack, Bankruptcy Judge, Presiding

 

Appearances: Brad A Mokri, Esq. argued for Appellant Heritage

Pacific Financial, LLC; and Stanley Zlotoff, Esq.

argued for Appellee Raul Machuca, Jr. 

 

Before: MARKELL, HOLLOWELL and PAPPAS, Bankruptcy Judges.

FILED

DEC 14 2012

SUSAN M SPRAUL, CLERK

U.S. BKCY. APP. PANEL

OF THE NINTH CIRCUIT
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Unless specified otherwise, all chapter and section 1

references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and

all “Rule” references are to the Federal Rules of Bankruptcy

Procedure, Rules 1001-9037.

2

MARKELL, Bankruptcy Judge:

I. INTRODUCTION

Heritage Pacific Financial, LLC (“HPF”) sued debtor Raul

Machuca, Jr. (“Machuca”), alleging that a debt incurred by

Machuca was nondischargeable. HPF not only lost, but the

bankruptcy court entered summary judgment for Machuca. HPF did

not appeal that order. Machuca thereafter sought an award of

roughly $9,000 in attorneys’ fees under 11 U.S.C. § 523(d).1

The bankruptcy court granted Machuca’s attorneys’ fees motion. 

HPF then appealed from the fee order. We AFFIRM.

II. FACTS

In January 2007, Machuca purchased a single-family

residence in Salinas, California (“Property”). To finance his

purchase, Machuca obtained two real estate secured loans. The

senior loan was for $1 million. The junior loan, which is the

subject of this appeal, was for $147,000 (“Loan”). It was made

by National City Bank (“National City”).

Most of Machuca’s actions in obtaining the Loan are

undisputed. In December 2006, Machuca telephoned Westar Real

Estate and Mortgage, a loan brokerage firm, seeking to obtain a

loan to purchase the Property. During this phone call, Machuca

answered many questions regarding his finances. These included

the name of his employer and the amount of his salary.
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3

Sometime later, Machuca was notified that National City had

approved his Loan. He was asked to and did attend a meeting to

sign the necessary loan documentation. At the meeting, he

signed and initialed a stack of documents. Machuca testified

that he did not read any of the documents, although he admits

that he signed them in order to obtain the Loan. These

documents included a standard form loan application

(“Application”).

Most of the documents that Machuca signed are not in the

record before us. We do have, however, multiple copies of the

Application signed by Machuca. They are each dated January 16,

2007. We also have multiple copies of the signed promissory

note (“Note”). They are each dated January 12, 2007 – four days

before the date of the Application.

The record also includes:

1. An unsigned and undated version of the Application

(“Unsigned Application”), presumably filled out by

Westar during or after the telephone call between

Machuca and Westar.

2. A document entitled Uniform Underwriting and

Transmittal Summary (“Underwriting Summary”).

3. A Buyer Estimated Closing Statement (“Closing

Statement”) dated January 16, 2007, and referring to a

closing date of January 17, 2007.

4. Closing Instructions from National City to Chicago

Title Co. (“Closing Instructions”) anticipating a

disbursement date of January 17, 2007.

The Application stated that Machuca was a correctional
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The Unsigned Application and the Underwriting Summary 2

listed Machuca's income differently than did the Application. 

Those documents listed his base employment income as $7,250 per

month, plus additional “other income” of $13,475 per month. 

According to the Unsigned Application, $3,725 of the “other

income” consisted of Machuca’s overtime wages. The source of the

remaining $9,750 per month in “other income” was not specifically

described in either document.

These documents perhaps suggest that whoever filled out the

final version of the Application erroneously listed Machuca’s

claimed aggregate monthly income – his base employment income and

his “other income” – as his base employment income.

4

officer who had worked for the California Department of

Corrections for five years. That much was true. It also

stated, however, that his “base employment income” was $20,725

per month, or almost $250,000 a year. That was untrue. 

According to Machuca, however, not only was the stated salary

amount false, it was patently absurd. For purposes of this 2

litigation, however, both sides agreed that the $20,750 amount

was inaccurate.

Machuca made his Loan payments for a little over a year. 

He then defaulted. After several more years, in May 2010, he

filed a chapter 13 bankruptcy. During this time, HPF had

acquired National City’s rights under the Loan. After Machuca

filed his bankruptcy, HPF filed an adversary proceeding seeking

a determination that the Loan was a nondischargeable debt under

§ 523(a)(2)(A) and (B).

Machuca responded by filing a motion to dismiss the

§ 523(a)(2)(A) claim, which the bankruptcy court granted. 

Machuca then filed a motion for summary judgment on HPF’s
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Section 523(a)(2)(B) provides that a debt is 3

nondischargeable if the debtor obtained “money, property,

services, or an extension, renewal, or refinancing of credit” by

using 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 for such money, property, services, or credit

reasonably relied; and

(iv) that the debtor caused to be made or published

with intent to deceive . . . .

11 U.S.C. § 523(a)(2)(B).

By identifying his Loan as a stated income loan, Machuca 4

implicated the now-discredited practice of indiscriminately

making mortgage loans without verifying the income stated on the

loan application. Lenders who made these so-called “liar’s

loans” often did not care what income the borrowers listed and

sometimes actively encouraged misstatements of income. Indeed,

(continued...)

5

remaining § 523(a)(2)(B) claim.3

In his summary judgment motion, Machuca primarily argued a

lack of reasonable reliance on the Application. He asserted

that National City did not actually rely on his income

representation and that, even if it did, such reliance would

have been unreasonable. Machuca’s argument focused on the

discrepancies in income between the Application and the Unsigned

Application. Machuca also noted that the cover sheet

accompanying the Underwriting Summary identified the loan type

as a “stated income” loan, the upshot of which was that National

City had never asked Machuca to provide any tax returns or pay

stubs to verify any of his income. Machuca further pointed out 4
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(...continued) 4

the economic incentives associated with originating such highrisk, high-interest rate loans led some brokers to falsify loan

applications without the borrower’s knowledge or active

participation. For a discussion of these and related points, see

Charles W. Murdock, Why Not Tell the Truth?: Deceptive Practices

and the Economic Meltdown, 41 Loy. U. Chi. L.J. 801, 843-46

(2010); see also Andrea J. Boyack, Lessons in Price Stability

from the U.S. Real Estate Market Collapse, 2010 Mich. St. L. Rev.

925, 947-50 (2010); Patricia A. McCoy, Andrey D. Pavlov & Susan

M. Wachter, Systemic Risk Through Securitization: the Result of

Deregulation and Regulatory Failure, 41 Conn. L. Rev. 1327, 1351-

53 (2009).

6

that the dates on the loan documents indicated that National

City had approved the Loan before he signed the Application.

In its opposition to the summary judgment motion, HPF

contested Machuca’s claim of a lack of reasonable reliance. It

supported its contentions with three items of evidence: (1) the

language in the Application; (2) the declaration of HPF’s

managing partner Ben Ganter (“Ganter”); and (3) the declaration

of HPF’s expert Mark G. Schuerman (“Schuerman”).

According to HPF, the Application’s certification of the

truth and correctness of the Application’s information supported

both National City’s and HPF’s reliance without HPF’s

introduction of any independent evidence of that reliance. In

the same vein, HPF also pointed to the Application’s provision

stating that the lender and its successors and assigns “may

rely” on the information in the Application.

Ganter’s declaration attempted to establish that both

National City and HPF had relied on the information regarding

Machuca’s income set forth in the Application. Although

possibly relevant for HPF, Ganter’s declaration did not explain
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Schuerman did claim that HPF and the secondary mortgage 5

market typically rely on the “stated income” in loan

applications. If he meant to suggest, however, that such

reliance actually and reasonably occurs without independent

income verification, especially when there are red flags extant

on the face of the loan documents, his suggestion contradicts

everything that has been revealed about stated income loans in

(continued...)

7

how he would have any reason to know anything about National

City’s reliance.

Finally, Schuerman opined that both lenders and loan

purchasers routinely rely on the certifications, acknowledgments

and information contained in loan applications, and that this

reliance is a crucial factor in the secondary mortgage market. 

He also opined that income representations are particularly

important to junior secured debt holders and purchasers because

any collateral supporting their junior position would be lost if

a senior lienholder foreclosed.

Schuerman did not attempt to give any opinion as to how the

types of patent defects evident in Machuca’s application might

have affected a lender’s or a successor’s reliance. In fact,

Schuerman’s declaration mostly ignored: (1) the income

discrepancies between the Application and the Unsigned

Application; (2) the implausible amount of base employment

income claimed by a five-year state corrections officer; (3) the

last-minute signing of the Application, just before funding of

the Loan and after the date of the promissory note; (4) National

City’s approval and funding of the Loan without income

verification; and (5) HPF’s purchase of the loan without income

verification.5
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(...continued) 5

the wake of the subprime lending crisis. In other words, there

is a reason why knowledgeable people in the mortgage lending

industry cynically referred to these loans as “liar’s loans.” 

See note 4, supra.

Actually, this misstates Boyajian’s holding. Boyajian held 6

that an assignee’s reliance was not necessary to satisfy

§ 523(a)(2)(B)’s reliance element when the assignee had already

established the original lender’s reasonable reliance. See id.

at 1090. Boyajian did not address the question of whether, and

under what circumstances, the assignee’s reliance might be

sufficient by itself under § 523(a)(2)(B).

The Panel has indicated that an assignee’s reliance, under

appropriate circumstances and when not contested, can support a

finding of reliance under § 523(a)(2)(B)(iii). See Tustin Thrift

& Loan Ass’n v. Maldonado (In re Maldonado), 228 B.R. 735,

737–740 (9th Cir. BAP 1999). Given the bankruptcy court’s

finding that no reasonable person could rely upon the income and

other contents of the Application, this case does not present the

unaddressed issue of whether an assignee’s alleged but contested

reliance is sufficient to satisfy § 523(a)(2)(B)(iii). Cf. id.

at 737 (such reliance conceded and not contested).

8

The bankruptcy court heard the summary judgment motion on

November 28, 2011. It adopted Machuca’s lack-of-reliance

argument, and granted summary judgment. According to the

bankruptcy court, Boyajian v. New Falls Corp. (In re Boyajian),

564 F.3d 1088 (9th Cir. 2009) made only the original lender’s

reliance relevant with respect to § 523(a)(2)(B)’s reliance

element.6

The bankruptcy court further ruled that HPF had not met its

burden of presenting evidence from which National City’s actual

or reasonable reliance could be inferred. HPF attempted to show

reasonable reliance from the contents of the loan documents

Machuca signed, and from an unsupported inference that Machuca

inserted the contents to induce a lender’s reliance. But the

bankruptcy court was unpersuaded. It identified the following
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The bankruptcy court also stated that it was going to 7

sustain Machuca’s evidentiary objections to both Ganter’s

declaration and Schuerman’s declaration. We could not, however,

find these objections in the record. Nonetheless, the propriety

of the bankruptcy court’s evidentiary rulings is not at issue in

this appeal. For purposes of determining whether the bankruptcy

(continued...)

9

as reasons it rejected HPF’s argument: (1) HPF presented no

competent evidence from which the court could ascertain National

City’s business practices in making stated income loans; (2) the

Application was signed and dated after the date on the

promissory note, and just before the loan closed; and (3) “red

flags” — that is, facts which would require a reasonable person

to investigate further before making the loan — were present,

and these red flags should have caused National City to question

and investigate Machuca’s income representations if National

City sufficiently cared about the income representations to

constitute reliance. Combined with other arguments, these

factors persuaded the bankruptcy court that HPF had failed to

carry its summary judgment burden with respect to

§ 523(a)(2)(B)’s reliance element.

As the bankruptcy court put it, HPF had not presented any

evidence from which the court reasonably could infer National

City’s reasonable reliance on Machuca’s income representations. 

Moreover, the court stated that no lender could have reasonably

relied upon the Application and the other evidence in the

record, given the numerous red flags contained in those

documents. Accordingly, the bankruptcy court granted Machuca’s

summary judgment motion, and entered its order confirming that

grant on December 19, 2011. HPF did not appeal that order, nor 7
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(...continued) 7

court erred in finding that HPF lacked substantial justification

for its position, we can and will consider the contents of both

declarations, even though the bankruptcy court considered them

inadmissable for purposes of the summary judgment motion. See

First Card v. Hunt (In re Hunt), 238 F.3d 1098, 1103 (9th Cir.

2001) (stating that a finding regarding substantial justification

“need not be based solely on the admissible evidence before the

court”).

10

has it challenged it under Rule 9024.

Machuca then filed a motion to recover his attorneys’ fees

under § 523(d). HPF opposed, arguing that its filing and

prosecution of the adversary proceeding was substantially

justified, as it had a reasonable basis in both law and fact for

its position.

Relying on its then-final summary judgment order, the

bankruptcy court rejected HPF’s substantial justification

argument. More specifically, the court focused on the complete

absence of competent evidence that could support an inference of

reasonable reliance. According to the bankruptcy court, this

absence of evidence established that HPF did not have a

reasonable basis in law and fact for its defense of the summary

judgment motion. As the court explained:

The law is straightforward: You need reasonable

reliance by National City. Yet despite this clear

requirement, no admissible facts of any kind were

presented, no personal knowledge offered by any

personal — was again, was offered to establish

reasonable reliance. This is not surprising given the

fact that stated income loans were magnets for

misrepresentations and a convenient excuse by lenders

to bypass even the most rudimentary attempt at due

diligence of the borrower’s income, all in an effort

to make the loan and sell it on the secondary market.

Hr’g Trans. (Jan. 24, 2012) at 8:7-16.

The bankruptcy court entered an order on January 26, 2012,
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The bankruptcy court had jurisdiction pursuant to 28 U.S.C. 8

§§ 1334 and 157(b)(2)(I) and (O). We have jurisdiction under 28

U.S.C. § 158, subject to the jurisdictional issue discussed

below.

The pendency of Machuca’s fee motion did not toll the time 9

to appeal the summary judgment ruling. It was a collateral

matter to the disposition of the adversary proceeding; see Rule

8002(b). See also Lindblade v. Knupfer (In re Dyer), 322 F.3d

1178, 1186 (9th Cir. 2003) (“[W]e have held that unresolved

issues related to attorneys’ fees do not defeat finality,

regardless of whether the attorneys’ fees are available under a

statute, by contract, or as a sanction for bad faith

litigation.”).

11

granting Machuca’s fee motion. HPF timely filed a notice of

appeal on February 7, 2012.8

III. LIMITED REVIEW

HPF’s February 7, 2012 notice of appeal only refers to the

bankruptcy court’s January 26, 2012 order granting Machuca’s fee

motion. It does not mention the court’s December 19, 2011

summary judgment ruling. Nonetheless, HPF’s opening appeal

brief suggests that HPF is now seeking appellate review of both

the fee order and the summary judgment. That we cannot do. An

order granting summary judgment on all remaining counts is final

for purposes of filing an appeal. Key Bar Invs., Inc. v. Cahn

(In re Cahn), 188 B.R. 627, 630 (9th Cir. BAP 1995). HPF’s 9

election not to appeal the bankruptcy court’s summary judgment

ruling means that the summary judgment order is now final, and

cannot be collaterally attacked.

Accordingly, the scope of our review in this appeal is

limited to the bankruptcy court’s fee order.

IV. APPLICATION OF § 523(d)

HPF’s appeal challenges the bankruptcy court’s substantial
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Before 1984, § 523(d) read as follows: 10

If a creditor requests a determination of

dischargeability of a consumer debt under subsection

(a)(2) of this section, and such debt is discharged,

the court shall grant judgment against such creditor

and in favor of the debtor for the costs of, and a

reasonable attorney’s fee for, the proceeding to

determine dischargeability, unless such granting of

judgment would be clearly inequitable.

12

justification ruling. “Substantial justification” has a long

history, and one not wholly within the Bankruptcy Code. We thus

begin our analysis with a review of the origins and purpose of

§ 523(d)’s substantial justification standard.

A. Statutory Development of § 523(d)

Prior to 1984, § 523(d) did not contain a substantial

justification standard for awarding attorneys’ fees. Rather, it

contained an explicit shifting of fees in favor of the consumer

debtor, unless such a shift was “clearly inequitable.” The 10

purpose of § 523(d) as originally drafted was to deter

groundless nondischargeability actions brought primarily to

coerce settlements from honest debtors who couldn’t effectively

fight back. See S. Rep. No. 95-989 at 80 (1978).

When Congress enacted the Bankruptcy Amendments and Federal

Judgeship Act of 1984, Pub. L. 98-353, § 307(b), 98 Stat. 333

(“BAFJA”), however, it cut back on this broad grant. It

replaced the “clearly inequitable” standard with a standard that

allowed attorneys’ fees under § 523(d) only if the creditor’s

position was not “substantially justified.”

This standard was not created out of whole cloth. Congress

borrowed it from the Equal Access to Justice Act (“EAJA”). See
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Senate Report 98-65 accompanied a predecessor bill that 11

ultimately led to the enactment of BAFJA. That predecessor bill,

commonly known as the Omnibus Bankruptcy Improvements Act of 1983

(“OBIA”), contained proposed amendments to § 523(d)’s attorneys’

fees provision identical to those contained in BAFJA. See OBIA,

S. 445, 98th Cong. § 209(b) (1983).

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First Card v. Hunt (In re Hunt), 238 F.3d 1098, 1103 (9th Cir.

2001) (citing First Card v. Carolan (In re Carolan), 204 B.R.

980, 987 (9th Cir. BAP 1996)). In adopting this different, more

creditor-friendly, standard, Congress wished to shift incentives

so that creditors would not be unduly discouraged from pursuing

well-founded nondischargeability actions. As Congress put it:

The original congressional intent in the drafting S.

523(d) of the existing Bankruptcy Code was to

discourage frivolous objections to discharge of

consumer debts, but not to discourage well-founded

objections by honest creditors. The language of the

subsection, however, makes the award of the debtor’s

costs and attorney’s fees virtually mandatory in an

unsuccessful challenge of a consumer debt. It has

been interpreted as requiring the award of fees and

costs even when the creditor acted in good faith. 

CF., In re Majewski, 7 B.R. 904 (Bd. D. Conn. 1981). 

The net effect of this provision has been to preclude

creditors from objecting to discharge of any consumer

debt unless they are certain that the court will

sustain the objection.

The Committee, after due consideration, has concluded

that amendment of this provision to incorporate the

standard for award of attorney’s fees contained in the

Equal Access to Justice Act strikes the appropriate

balance between protecting the debtor from

unreasonable challenges to dischargeability of debts

and not deterring creditors from making challenges

when it is reasonable to do so. This standard

provides that the court shall award attorney’s fees to

a prevailing debtor where the court finds that the

creditor was not substantially justified in

challenging the dischargeability of the debt, unless

special circumstances would make such an award unjust.

S. Rep. No. 98-65, at 9-10 (1983).11

///
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B. Application of the Substantial Justification Standard

to HPF

To support a request for attorneys’ fees under § 523(d), a

debtor initially needs to prove: (1) that the creditor sought to

except a debt from discharge under § 523(a), (2) that the

subject debt was a consumer debt, and (3) that the subject debt

ultimately was discharged. Stine v. Flynn (In re Stine), 254

B.R. 244, 249 (9th Cir. BAP 2000). “Once the debtor establishes

these elements, the burden shifts to the creditor to prove that

its actions were substantially justified.” Id.; see also In re

Hunt, 238 F.3d at 1103 (citing In re Carolan, 204 B.R. at 987,

and holding that “the creditor bears the burden of proving that

its position is substantially justified”).

To satisfy the substantial justification standard, HPF

needed to demonstrate that it had a reasonable factual and legal

basis for its claim. See In re Hunt, 238 F.3d at 1103 (citing

Pierce v. Underwood, 487 U.S. 552, 565 (1988)). As stated in

the legislative history, and mirrored in subsequent cases:

To avoid a fee award [under § 523(d)], the creditor

must show that its challenge had a reasonable basis

both in law and in fact. The requirement that the

creditor must show that it was substantially justified

to avoid a fee award is necessary because it is far

easier for the creditor to demonstrate the

reasonableness of its action than it is for the debtor

to marshal the facts to prove that the creditor was

unreasonable.

S. Rep. No. 98-65 at 59.

1. The Relationship Between Summary Judgment and

Substantial Justification

Substantial justification is thus a higher standard than

that used to determine whether litigation is frivolous. Pierce,
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487 U.S. at 566 (interpreting EAJA). Although frivolous

litigation is never substantially justified, under EAJA some

nonfrivolous litigation also fails the test. The issue often

arises when a creditor loses an action otherwise filed in good

faith by summary judgment, directed verdict, or a judgment on

the pleadings. In such cases, the bankruptcy court must

scrutinize the merits of the action with particular care, as

these types of outcomes often suggest a lack of substantial

justification. See Keasler v. United States, 766 F.2d 1227,

1231 (8th Cir. 1985) (interpreting EAJA); see also F.J. Vollmer

Co. v. Magaw, 102 F.3d 591, 595 (D.C. Cir. 1996) (“In some

cases, the standard of review on the merits is so close to the

reasonableness standard applicable to determining substantial

justification that a losing agency is unlikely to be able to

show that its position was substantially justified.”).

But not all such losses lead to fee-shifting. There is no

presumption of a lack of substantial justification just because

a debtor prevailed on summary judgment. As this Panel has said

on prior occasions, the substantial justification requirement

“should not be read to raise a presumption that the creditor was

not substantially justified simply because it lost.” In re

Carolan, 204 B.R. at 987; see also Hill v. INS (In re Hill), 775

F.2d 1037, 1042 (9th Cir. 1985); S. Rep. No. 98-65 at 59 (“The

standard, however, should not be read to raise a presumption

that the creditor was not substantially justified, simply

because it lost the challenge.”).

For instance, a novel but reasonable legal theory in

support of its opposition to Machuca’s summary judgment motion
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might have served as a basis for concluding that HPF’s

opposition was substantially justified. See Renee v. Duncan,

686 F.3d 1002, 1017-18 (9th Cir. 2012) (interpreting EAJA and

citing Timms v. United States, 742 F.2d 489, 492 (9th Cir.

1984)). So too might have a legal theory subject to a split of

non-binding authority when there is no case on point. See

Mattson v. Bowen, 824 F.2d 655, 656-57 (8th Cir. 1987) (also

interpreting EAJA).

HPF asserts none of these justifications. Instead, it

defends on the record the bankruptcy court used to grant summary

judgment against it. In particular, it asserts that it was

substantially justified in its position on reliance under

§ 523(a)(2)(B)(iii).

In so doing, it burdened itself with an almost

insurmountable task. HPF did not appeal the summary judgment

ruling and must contend with the issue preclusive effect of that

judgment. See Steen v. John Hancock Mut. Life Ins. Co., 106

F.3d 904, 912 (9th Cir. 1997) (“The determination of an issue on

a motion for judgment on the pleadings or a motion for summary

judgment is sufficient to satisfy the ‘litigated’ requirement

for collateral estoppel.”) (citing Restatement (Second) of

Judgments § 27 cmt. d (1982); and Papadakis v. Zelis (In re

Zelis), 66 F.3d 205, 208 (9th Cir. 1995)).

As noted above, the bankruptcy court’s order granting

summary judgment was final. HPF cannot collaterally attack that

judgment through the § 523(d) proceeding. At most, after the

appeal time had run, it might have sought relief under Rule 9024

(incorporating Federal Rule of Civil Procedure 60(b)). See 18B
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Charles Alan Wright et al., FEDERAL PRACTICE AND PROCEDURE § 4478 (2d

ed. 2012) (“After final judgment, direct relief from the

judgment is governed by the rules governing direct and

collateral attack—principally found in Civil Rule 60(b) . . .

.”).

But HPF neither appealed nor sought relief under Rule 9024. 

In the face of such inaction, this Panel must take the grant of

the summary judgment at its face value: HPF’s complaint and

response to the summary judgment motion presented no genuine

issue of material fact regarding reliance under

§ 523(a)(2)(B)(iii). See In re Hunt, 238 F.3d at 1102 n.5

(failure to appeal merits decision meant that creditor waived

“any right to challenge the evidentiary rulings that led to it”

in subsequent proceeding seeking attorneys’ fees under

§ 523(d)). In short, the doctrine of issue preclusion estops

HPF from arguing that the bankruptcy court was wrong, or that

HPF had an undisclosed basis in law and fact for its reliance

claim. Id.; Steen, 106 F.3d at 912. As a consequence, HPF

cannot argue that it had a reasonable factual and legal basis

for its fraud claim. See In re Hunt, 238 F.3d at 1103. Its

position was thus not substantially justified.

2. Substantial Justification, Abuse of Discretion,

and the Record on Reasonable Reliance

Even if HPF could surmount its issue preclusion hurdle, it

would then face another virtually insuperable hurdle: the abuse

of discretion standard. This circuit has specifically held that

§ 523(d) orders are subject to the abuse of discretion appellate

review standard. In re Hunt, 238 F.3d at 1101.
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Under this highly deferential standard of review, we first

“determine de novo whether the [bankruptcy] court identified the

correct legal rule to apply to the relief requested.” United

States v. Hinkson, 585 F.3d 1247, 1262 (9th Cir. 2009) (en

banc). And if the bankruptcy court identified the correct legal

rule, we then determine under the clearly erroneous standard

whether its factual findings and its application of the facts to

the relevant law were: “(1) illogical, (2) implausible, or (3)

without support in inferences that may be drawn from the facts

in the record.” Id. (internal quotation marks omitted).

In order to apply the first part of this standard – whether

the bankruptcy court used the correct legal rule – we examine

the bankruptcy court’s ruling on Machuca’s summary judgment

motion. This in turn requires us to consider its treatment of

§ 523(a)(2)(B)’s reliance element, on which the summary judgment

motion hinged.

Reasonable reliance is not defined in the Bankruptcy Code;

to ascertain whether it exists, the bankruptcy court must employ

a “prudent person” test. Cashco Fin. Servs., Inc. v. McGee (In

re McGee), 359 B.R. 764, 774 (9th Cir. BAP 2006). Under the

prudent person test, the bankruptcy court must objectively

assess whether the creditor exercised the same degree of care

expected from a reasonably prudent person entering into the same

type of business transaction under similar circumstances. See

First Mut. Sales Fin. v. Cacciatori (In re Cacciatori), 465 B.R.

545, 555 (Bankr. C.D. Cal. 2012); see also Gertsch v. Johnson &

Johnson, Fin. Corp. (In re Gertsch), 237 B.R. 160, 170 (9th Cir.

BAP 1999). Bankruptcy courts must make this assessment on a
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case-by-case basis in light of the totality of the

circumstances. See In re McGee, 359 B.R. at 774; In re Gertsch,

237 B.R. at 170.

Against this background, it is standard learning that a

creditor cannot simply ignore red flags that directly call into

question the truth of the statements on which the creditor

claims to have relied. See In re McGee, 359 B.R. at 775. Under

such circumstances, the creditor must support its reasonable

reliance claim with evidence explaining why it was reasonable

for it to rely on the statements notwithstanding the red flags. 

Id. As the bankruptcy court used this standard, it “identified

the correct legal rule.” Hinkson, 585 F.3d at 1262.

It also applied that legal rule correctly. In response to

the summary judgment, HPF argued that a trier of fact reasonably

could infer reasonable reliance from: (1) the language of the

Application; (2) Ganter’s self-serving statement that HPF and

National City had relied on Machuca’s income representation; and

(3) Schuerman’s statement that mortgage lenders and the

secondary mortgage market typically rely on income

representations. But HPF’s evidence does not contradict the

fact that it and its witnesses ignored the red flags associated

with the Loan. HPF’s response to the summary judgment motion

simply failed to account in any meaningful way for the impact

those red flags necessarily would have had on a hypothetical

prudent person’s assessment of whether any reliance should be

placed on Machuca’s income representation.

Against this background, it was not illogical, implausible

or without adequate support in the record, Hinkson, 585 F.3d at
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Scott acknowledged that, in the summary judgment context, 12

the district court had to “view the facts and draw reasonable

inferences ‘in the light most favorable to the party opposing the

[summary judgment] motion.’” Id. at 378 (quoting United States

v. Diebold, Inc., 369 U.S. 654, 655 (1962) (per curiam)). 

Nonetheless, Scott held that “the light most favorable” to the

(continued...)

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1262, to determine that neither HPF nor National City reasonably

could have relied on Machuca’s income representation given the

many “red flags.” These red flags included: (1) the income

discrepancies between the Application and the Unsigned

Application; (2) the implausible amount of base employment

income claimed by a five-year state corrections officer; (3) the

last-minute signing of the Application, just before funding of

the Loan and after the date of the promissory note; (4) National

City’s approval and funding of the Loan without income

verification; and (5) HPF’s purchase of the loan without income

verification.

As the Supreme Court has advised:

When opposing parties tell two different stories, one

of which is blatantly contradicted by the record, so

that no reasonable jury could believe it, a court

should not adopt that version of the facts for

purposes of ruling on a motion for summary judgment.

Scott v. Harris, 550 U.S. 372, 380 (2007).

Here, HPF claimed that both it and National City reasonably

relied on Machuca’s income representation, but the undisputed

facts in the record regarding the red flags associated with the

Loan wholly undermined HPF’s reasonable reliance claims. In the

parlance of Scott, HPF’s “version of events is so utterly

discredited by the record that no reasonable jury could have

believed” it. Id.12
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(...continued) 12

opposing party did not include ignoring the reality of undisputed

facts in the record.

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In sum, given the undisputed facts before the bankruptcy

court undermining HPF’s reasonable reliance claims, no trier of

fact reasonably could have found § 523(a)(2)(B)’s reliance

element satisfied. With the correct legal rule applied, and an

application of the facts to that rule supported by logical,

plausible and supportable inferences from the record, there was

no abuse of discretion in finding a lack of substantial

justification for HPF’s position.

V. CONCLUSION

For all of the reasons set forth above, we AFFIRM the order

granting Machuca’s fee motion.