Ordinarily, there is a clear winner and a clear loser when a circuit court decides an appeal. In a dischargeability case involving allegedly false representations and pretenses, the First Circuit reversed both the bankruptcy court and the Bankruptcy Appellate Panel.
It isn’t clear whether the debtor or the creditor will come out on top after remand to the bankruptcy court. The First Circuit, however, wrote an opinion laying out everything you need to know about the standards for nondischargeability under Section 523(a)(2)(A). In terms of appellate practice, the opinion recommends that cases be remanded for further findings or explanations if the appeals court is tempted to make findings of fact different from those in the trial court.
The Trial and Reversal in the BAP
A contractor who goes bust is begging to be sued for nondischargeability. This case reads like hundreds of others in the law books.
A couple signed a contract for a contractor to build a home for $1.3 million. As usual, the contract called for the couple to make progress payments. Unknown to the couple, the contractor was having financial problems.
The contractor offered the couple a discount if they would make progress payments before they otherwise would be due. The couple believed that the contractor would use the progress payments only for their project. In fact, the contractor used the payments to pay other debts.
When the contractor walked away from the job and filed bankruptcy, the couple had paid almost $1.2 million, representing some 90% of the contract price, but the contractor had only completed 45% of the job. The couple hired another contractor to complete the home. They ended up paying about $550,000 more than what the bankrupt contractor agreed to charge.
The contractor and his company both ended up in chapter 7. The couple filed a claim for $550,000.
In addition, the couple sued the contractor, alleging that he had used his company as his alter ego. They also sought to have the debt declared nondischargeable.
After trial with witnesses, the bankruptcy judge ruled in favor of the debtor and dismissed the couple’s nondischargeability claim for obtaining money by “false pretenses” or “false representation” under Section 523(a)(2)(A). The bankruptcy court did not reach the corporate veil issue.
On appeal, the Bankruptcy Appellate Panel found that the contractor had made at least three misrepresentations and that many of the lower court’s findings were contrary to the witnesses’ testimony. Viewing the record “as a whole,” the BAP decided that the contractor made false representations and that he had intent to deceive.
Although the bankruptcy judge had not ruled on the issue, the BAP said the record was sufficient to pierce the corporate veil under state law. The BAP reversed and remanded for the bankruptcy court to fix damages.
The contractor appealed to the circuit.
Reversal in the Circuit
In a 39-page opinion on February 3, Circuit Judge Juan R. Torruella reversed both the bankruptcy court and the BAP and remanded to the bankruptcy court. Without indicating who should win after remand, he told the bankruptcy judge to make additional findings.
Judge Torruella disagreed with the BAP’s decision to reverse the bankruptcy court based on the “record as a whole.” When the record is complex and the testimony is contested, “we leave this sort of factfinding to the trier of fact,” he said. The appropriate remedy in the BAP should have been to remand for further fact-finding.
Rather than simply reverse the BAP and reinstate the bankruptcy court’s judgment, Judge Torruella next analyzed whether the bankruptcy court had applied the correct legal standard. His opinion lays out the elements of a nondischargeability claim for false representations.
According to Judge Torruella, the debtor must make a knowingly false representation or one with reckless disregard for the truth; the debtor must intend to deceive; the debtor must intend for the creditor to rely on the false statement; the creditor must actually rely on the false statement; the creditor’s reliance must be justifiable; and the reliance must cause damage.
Judge Torruella concluded that the “bankruptcy court erred when determining what is required to prove a false representation” by taking “too narrow a view of what constitutes intent to deceive.” Intent is present, he said, if the debtor knows the matter is not as represented, does not have confidence in the accuracy of the representation, or knows he or she does not have a basis for the representation.
Judge Torruella therefore said that a false representation about one’s intention “can qualify as a misrepresentation under Section 523(a)(2)(A).”
Applying the standard to the facts at hand, Judge Torruella said that breaching a contract “does not evidence fraudulent intent.” Nonetheless, he said, “the trier of fact may infer the requisite intent or recklessness if the debtor knew or should have known that he could not keep his promise.”
Judge Torruella went on to say that the bankruptcy court, on remand, should focus on the “totality of the circumstances” together with statements about using the accelerated progress payments to fund the couple’s project. “Scienter,” he said, “may be inferred [from] the defendant’s insolvency or some other reason to know that he cannot pay.”
Judge Torruella added that intent to harm is not an element under Section 523(a)(2)(A) as it is under Section 523(a)(6). Although the contractor may not have intended to harm, he said that “the right question is whether he intended to deceive them, through recklessly made misrepresentations, in light of the totality of the circumstances.”
Reliance
Alternatively, the bankruptcy court ruled for the contractor based on finding that the couple had not actually relied on the misrepresentations.
Judge Torruella said the bankruptcy court had taken “too narrow a view of reliance” by not giving “a full read on the credibility of the [couple], particularly with respect to [their] statements on reliance.” On appellate review, he said, the proper remedy is to remand and “give the trial court the opportunity to explain its rationale.”
Judge Torruella therefore remanded for the bankruptcy court “to determine whether the [couple] have proved, by a preponderance of the evidence, that they actually and justifiably relied on [the debtor’s] assurances.”
Corporate Veil
The bankruptcy court did not reach the question of piercing the corporate veil because the issue was unnecessary given the ruling in favor of the debtor on dischargeability. The BAP, however, analyzed the facts and found reason to pierce the veil.
Again, Judge Torruella reversed the BAP and remanded for the bankruptcy court to decide on piercing the veil under state law.
Ordinarily, there is a clear winner and a clear loser when a circuit court decides an appeal. In a dischargeability case involving allegedly false representations and pretenses, the First Circuit reversed both the bankruptcy court and the Bankruptcy Appellate Panel.
It isn’t clear whether the debtor or the creditor will come out on top after remand to the bankruptcy court. The First Circuit, however, wrote an opinion laying out everything you need to know about the standards for nondischargeability under Section 523(a)(2)(A). In terms of appellate practice, the opinion recommends that cases be remanded for further findings or explanations if the appeals court is tempted to make findings of fact different from those in the trial court.
The Trial and Reversal in the BAP
A contractor who goes bust is begging to be sued for nondischargeability. This case reads like hundreds of others in the law books.
A couple signed a contract for a contractor to build a home for $1.3 million. As usual, the contract called for the couple to make progress payments. Unknown to the couple, the contractor was having financial problems.
The contractor offered the couple a discount if they would make progress payments before they otherwise would be due. The couple believed that the contractor would use the progress payments only for their project. In fact, the contractor used the payments to pay other debts.
When the contractor walked away from the job and filed bankruptcy, the couple had paid almost $1.2 million, representing some 90% of the contract price, but the contractor had only completed 45% of the job. The couple hired another contractor to complete the home. They ended up paying about $550,000 more than what the bankrupt contractor agreed to charge.
The contractor and his company both ended up in chapter 7. The couple filed a claim for $550,000.
In addition, the couple sued the contractor, alleging that he had used his company as his alter ego. They also sought to have the debt declared nondischargeable.
After trial with witnesses, the bankruptcy judge ruled in favor of the debtor and dismissed the couple’s nondischargeability claim for obtaining money by “false pretenses” or “false representation” under Section 523(a)(2)(A). The bankruptcy court did not reach the corporate veil issue.
On appeal, the Bankruptcy Appellate Panel found that the contractor had made at least three misrepresentations and that many of the lower court’s findings were contrary to the witnesses’ testimony. Viewing the record “as a whole,” the BAP decided that the contractor made false representations and that he had intent to deceive.
Although the bankruptcy judge had not ruled on the issue, the BAP said the record was sufficient to pierce the corporate veil under state law. The BAP reversed and remanded for the bankruptcy court to fix damages.
The contractor appealed to the circuit.