FILED
JUL 27 2015
1 NOT FOR PUBLICATION
SUSAN M. SPRAUL, CLERK
2 U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
3 UNITED STATES BANKRUPTCY APPELLATE PANEL
4 OF THE NINTH CIRCUIT
5 In re: ) BAP No. NC-14-1025-TaPaJu
)
6 CHRISTOPHER MICHAEL COTE, ) Bk. No. 12-53464
)
7 Debtor. ) Adv. Pro. No. 12-05160
______________________________)
8 CHRISTOPHER MICHAEL COTE, )
)
9 Appellant, )
)
10 v. ) MEMORANDUM*
)
11 AL V., INC., )
)
12 Appellee. )
______________________________)
13
Argued and Submitted on February 19, 2015
14 at San Francisco, California
15 Filed - July 27, 2015
16 Appeal from the United States Bankruptcy Court
for the Northern District of California
17
Honorable Stephen L. Johnson, Bankruptcy Judge, Presiding
18 ________________________________
19 Appearances: Charles Alex Naegele argued for Appellant
Christopher Michael Cote; Mark B. Freschi argued
20 for Appellee Al V., Inc.
__________________________________
21
Before: TAYLOR, PAPPAS, and JURY, Bankruptcy Judges.
22
23
24
25
26
*
This disposition is not appropriate for publication.
27 Although it may be cited for whatever persuasive value it may
have (see Fed. R. App. P. 32.1), it has no precedential value.
28 See 9th Cir. BAP Rule 8024-1(c)(2).
1 INTRODUCTION
2 Chapter 71 debtor Christopher Cote appeals from the
3 bankruptcy court’s judgment after trial awarding damages of
4 $490,883.85 to appellee Al V., Inc. (“Contractor”) and declaring
5 this debt excepted from discharge under § 523(a)(2)(A).
6 Contractor sought a nondischargeable judgment based on
7 alleged fraud relating to a construction contract between it and
8 Cote. Its alleged damages consisted primarily of amounts in
9 excess of its right to recovery under the construction contract
10 at its formation.
11 The bankruptcy court found that Cote intentionally deceived
12 Contractor by knowingly misrepresenting his ability to perform
13 under the construction contract. It then determined that this
14 proximately caused damages to Contractor. We determine that
15 these findings were clearly erroneous.
16 The record is inconsistent with a determination that Cote
17 lacked necessary funding at initiation of the construction
18 contract. It also does not support the conclusion that the
19 damages awarded were contemplated by the construction contract
20 at formation or that they were completely recoverable under the
21 construction contract as thereafter amended. Therefore, we
22 REVERSE.
23 FACTS
24 The Agreements Between Cote and Contractor. Contractor, a
25 licensed general contracting company owned by Al Valles and his
26
1
Unless specified otherwise, all chapter and section
27 references are to the Bankruptcy Code,
11 U.S.C. §§ 101-1532,
and all “Rule” references are to the Federal Rules of Bankruptcy
28 Procedure, Rules 1001-9037.
- 2 -
1 wife,2 entered into a construction contract with Cote's
2 development company3 to build 10 homes (“Phase I”) of a planned
3 18-home solar-powered residential subdivision called Hanna
4 Square in Gilroy, California.4
5 At the beginning of the relationship, the parties signed a
6 Letter of Understanding & Confidentiality Agreement dated
7 June 4, 2007 (the “Confidentiality Agreement”). Cote agreed to
8 provide financial, technical, and management data to Contractor,
9 which included bank construction loan approval letters and
10 banking data. Valles testified at trial that this
11 Confidentiality Agreement somehow prohibited him from contact
12 with Cote’s construction lender.
13 The parties also entered into a Construction Services
14 Contract (“Initial Contract”) along with an Addendum to and
15 Modification of Construction Services Contract (“Addendum,” and
16 together with the Initial Contract, the “Construction
17 Contract”).5 Contractor later argued that he was fraudulently
18
19 2
Valles had been in the contracting business more than
20 years and had built over 150 custom homes and three
20 commercial buildings; he primarily worked as an owner-builder
and not as a third party contractor.
21
3
Cote was the sole owner. At no point did Cote argue
22 that he was not the proper defendant. For simplicity, we refer
to the development company and Cote hereinafter as “Cote.”
23
4
Cote’s schedules disclosed that his employment for
24 21 years was as a Safari Guide and that he received $11,000.00
per month in gross income. The record suggests, however, that
25 he may have developed at least one prior project.
26 5
Each party admitted a copy of the Initial Contract into
evidence at trial. Both copies contained identical text and
27 contained signatures over the signature line for Valles and the
initials “A.V.” on every page. The handwritten dates differ
28 (continued...)
- 3 -
1 induced to enter into and to perform under this contract. The
2 Construction Contract’s terms, thus, are critical to the
3 analysis, and we highlight the most relevant terms (or lack
4 thereof) as follows:
5 1. The Construction Contract made clear that it did not
6 provide for the payment of the cost of building the homes in
7 Phase II. This necessarily excluded any of the Phase II “under
8 roof” costs and certain site improvements. Instead, the
9 Construction Contract provided that the parties would proceed to
10 build the eight homes in Phase II within one year of execution
11 of the Construction Contract if the sales of homes in Phase I
12 were sufficient.
13 2. Contractor agreed to construct the 10 homes in Phase I
14 for a maximum “under roof” price of $120.756 per square foot or
15 a total of $1,929,585 ($120.75 multiplied by 15,980 total square
16 feet). The Construction Contract, however, also contained
17 numerous provisions that either required, under certain
18 circumstances, or incentivized Contractor, in all events, to
19
20 (...continued)
between the copies. At trial, Valles testified that the
signature on his exhibit was not his signature. But, he did not
21 dispute his signature on the Initial Contract introduced into
evidence by Cote. Aside from speculation in Contractor’s
22 closing argument, there was no further evidence or discussion
regarding the disparity in signature.
23
6
Valles testified at trial that when he was presented
24 with the Initial Contract for execution at the title company,
Cote tried to reduce the agreed building costs from $120.75 per
25 square foot to $115 per square foot. Their agreement to $120.75
is contained in the Addendum. As later discussed, Contractor’s
26 theory of the case does not turn on whether $115 might have been
sufficiently funded, but $120.75 was not; and Cote never
27 disputed that he agreed to $120.75 per square foot for the under
roof building costs when he entered into the Construction
28 Contract.
- 4 -
1 construct the 10 homes at a lower cost.7 Based on these
2 provisions, Contractor was aware at the time that it entered
3 into the Construction Contract of Cote's stated goal to have
4 Phase I completed by January 1, 2008. There is no evidence that
5 Contractor advised Cote that his goal was unreasonable.
6 3. The Construction Contract also provided for the payment
7 of certain costs for site improvements and established $589,930
8 as the total maximum price for site improvements for both phases
9 of Hanna Square. Contractor agreed to later provide the
10 allocated cost of Phase I site improvements; there is no
11 evidence in the record that it did so or that the parties ever
12 agreed to a specific number. The bankruptcy court concluded
13 that the agreed upon number for Phase I offsite improvements was
14 $556,461; we disagree. The Initial Contract stated that this
15 was the maximum amount payable for both Phase I and Phase II
16 site improvements. The Addendum increased the site improvement
17 budget for both phases to a maximum of $589,930. The bankruptcy
18
7
First, the Construction Contract required Contractor to
19 reduce the maximum payable under the agreement if it obtained
reductions in amounts payable to sub-contractors through
20 negotiations. Contractor guaranteed in the Construction
Contract that such negotiations were ongoing. The Addendum also
21 required a downward adjustment if Cote provided a WRAP insurance
policy covering Contractor and all sub-contractors at Cote’s
22 expense. The record establishes that Cote provided insurance of
some type.
23 Second, the Construction Contract obligated or incentivized
Contractor to build the homes in Phase I quickly and to complete
24 Phase I at a total cost below budget. Contractor agreed to
identify “the most efficient economic means of achieving
25 Developer’s objective, which is to bring all homes to market and
be sold before 1/1/08.” Pl.’s Trial Ex. 1 at 3. Cote agreed to
26 pay Contractor a bonus payment of 50% of all construction cost
savings if the project completed below budget and a $50,000
27 bonus if the Contractor completed 8 of the 10 homes within four
months of building permit issuance and the remaining 2 homes
28 within five months of building permit issuance.
- 5 -
1 court’s use of $556,461, thus, is not logical or supported by
2 the record. In particular, this number was never mentioned by
3 any party in testimony or in argument at the trial.
4 The record, however, does support some assumptions as to
5 what Cote must or should have known regarding Phase 1 site
6 improvements at the time of the Construction Contract.8 The
7 only other evidence regarding the site improvement cost for
8 Phase I is a construction loan progress disbursement request
9 including a cost allocation recap (“Disbursement Request”),
10 identified as an exhibit to the construction loan, which
11 budgeted $358,014 to bonded site improvements and $68,754 to
12 non-bonded site improvements, for a total of $426,768 in
13 budgeted site improvement costs. There is no evidence in the
14 record that any other amount for allocated Phase I site
15 improvements was discussed by Contractor and Cote prior to
16 execution of the Construction Contract, reasonably contemplated
17
8
First, Cote had to assume that something, albeit less
18 than $589,930, would be payable in relation to site
improvements.
19 Second, Cote could not assume that simple division would
provide the answer. The loan documents in the record budgeted
20 bonded site improvements of $358,014 and made clear that the
bonded site improvements related to both phases of the Hanna
21 Square project. The bankruptcy court correctly assumed that
Cote was familiar with his lender’s assumptions and documents;
22 he, thus, knew that he needed to pay the budgeted amount of the
bonded site improvements when he entered into the Construction
23 Contract.
Third, as the bankruptcy court correctly found, the
24 Construction Contract did not relate to both Phase I and
Phase II. Thus, it would not be reasonable for Cote to assume
25 that he needed to pay for all the remaining site improvement
expense through Phase I financing; for example, it is impossible
26 to properly landscape a home that is not yet built. The loan
documents used a budgeted amount of $68,754 for non-bonded site
27 improvements. The record, thus, establishes that Cote must have
known that he needed to pay for $426,768 of site improvements in
28 connection with Phase I.
- 6 -
1 by Cote prior to execution of the Construction Contract, or ever
2 provided by Contractor either before or after the Construction
3 Contract.
4 4. Contractor agreed to receive payment of $39,500 from
5 the sale of each home if it required payment in excess of any
6 amounts detailed in the schedule of payments from United
7 American Bank (the “Bank”). At trial, Contractor and Cote
8 disagreed as to the intended meaning and effect of this
9 provision.
10 5. Pursuant to the Addendum, Cote was responsible for
11 certain expenses including those related to solar arrays and
12 fill dirt.
13 6. The Construction Contract contained a confidentiality
14 provision that repeated some paragraphs contained in the
15 Confidentiality Agreement. As with the Confidentiality
16 Agreement, Valles contended that this provision prohibited him
17 from contact with Cote’s construction lender.
18 7. The Construction Contract provided that Cote would pay
19 Contractor in accordance with the Bank’s “Construction Loan draw
20 system schedule as described in the United American Bank
21 Construction Loan Document.” Pl.’s Trial Ex. 1 at 15. Further,
22 Cote and Contractor agreed that all draw monies would be
23 evaluated to confirm that the total monies paid corresponded
24 with the total percentage of project completed as of the date
25 the progress payment was requested and paid.
26 8. There was no provision for any award of attorney’s fees
27 or interest.
28 Funding for Phase I Construction. Cote obtained a
- 7 -
1 construction loan in the total amount of $3.8 million (the
2 “Construction Loan”) from the Bank. After payment of existing
3 liens and other closing costs, there was approximately
4 $2.6 million in Construction Loan proceeds. Contractor later
5 argued that this amount was insufficient to pay amounts owed
6 under the Construction Contract and, necessarily, that Cote knew
7 it. The bankruptcy court ultimately agreed.
8 The record shows that the Bank also financed an additional
9 $155,000.9 The bankruptcy court, however, did not address this
10 additional loan.
11 Valles testified at trial that, at the formation of the
12 Construction Contract, Cote stated that he had additional funds
13 available to him outside the Construction Loan. The record
14 supports this statement as there was evidence that some
15 construction costs were paid where the source of these payments,
16 is unknown. The bankruptcy court did not address this evidence.
17 Cote obtained a bond insuring payment in relation to
18 $358,014 of site improvements. The bond was effective;
19 Contractor sued the bonding company and apparently the bonding
20 company paid. The bankruptcy court did not address the bond.
21 While the parties disagreed about the meaning of the
22 provision requiring payment from home sale proceeds, there was
23 no evidence presented establishing that it was unreasonable for
24 Cote to believe, when he signed the Construction Contract, that
25 home sales would be sufficient to pay Contractor in full. The
26
9
An unchallenged document admitted into evidence at trial
27 (defendant’s trial exhibit N) reflects that with the line of
credit Cote’s maximum credit from the Bank for costs payable
28 during Phase I of the Hanna Square project was $3,955,000.
- 8 -
1 only evidence in the record was that the Bank valued the entire
2 Hanna Square project at over $12 million, which left it with a
3 healthy loan to value ratio of 31% at the time the parties
4 entered into the Construction Contract. The bankruptcy court
5 did not address this evidence.10
6 Construction Loan Funding. Valles also executed an
7 Acknowledgment of Assignment, part of a form bank document
8 titled Assignment of Construction Contracts dated July 11, 2007
9 (“Contract Assignment”). The Contract Assignment recited that
10 Cote requested a $3,800,000 construction loan from the Bank.
11 Contractor expressly acknowledged that it was familiar with the
12 disbursement provisions of the Bank’s loan documents, that the
13 Bank’s disbursement provisions were satisfactory, and that a
14 change to the Construction Contract would not be effective
15 unless Bank approved it.
16 Valles never disputed that he signed the Contract
17 Assignment. He described it, however, as the document Cote
18 produced to intentionally mislead Valles into believing that
19 there was a full $3.8 million loan to cover construction costs
20 for the project.
21 Phase I Construction. Once started, construction of
22 Phase I proceeded with no payment problems until the sixth
23 month. Contractor submitted monthly invoices to Cote. Cote
24 then submitted monthly progress payment requests to the Bank.
25
10
There is no evidence or argument in the record that
26 Cote, Valles, or Bank anticipated the rapidly approaching real
estate recession at the time of the Construction Contract and
27 Construction Loan Agreement; unfortunately as Phase I of the
Hanna Square project neared completion, the recession had
28 arrived.
- 9 -
1 The Bank’s construction auditor walked the project with
2 Contractor’s project manager and discussed the work and
3 percentage completed. The Bank deposited the approved amounts
4 drawn from the loan into Cote’s account at the Bank. And,
5 thereafter, Cote issued checks to Contractor, which paid its
6 invoices in full. Indeed, on some occasions, the Bank’s auditor
7 did not approve the full amount requested by Contractor; when
8 Cote paid these amounts in full, he did so with other funds.
9 During this time, Cote also utilized Construction Loan
10 proceeds to pay other related construction costs. There is no
11 evidence in the record, however, that he improperly utilized
12 Construction Loan proceeds or received any payment for personal
13 benefit.
14 Cote and Contractor also agreed to a few changes to the
15 Construction Contract and executed formal change orders in the
16 total amount of $175,502. Under these change orders, Cote
17 agreed to pay Contractor on account of charges notwithstanding
18 the maximums in the Construction Contract.
19 Then, in the sixth month (at which point Phase I was
20 approximately 94% complete), Cote paid only part of Contractor’s
21 invoice, which brought total payments to Contractor up to
22 $1,778,350. This was the last payment made by Cote to
23 Contractor;11 the relationship fell apart. Cote advised
24 Contractor that he was out of money. His trial testimony and
25
11
Valles testified at trial that Contractor continued work
26 on the project and that its final invoice was dated February 28,
2008. He did not testify regarding the party for whom
27 Contractor continued the work, even after Cote allegedly told
him he had no more money. But, there is no dispute that
28 Contractor continued the work.
- 10 -
1 the documentary evidence established, however, that at the time
2 there was $536,501.79 in available credit under the Construction
3 Loan. That the Bank later paid additional amounts to Contractor
4 further evidenced that the Construction Loan was not then fully
5 drawn. It appears instead that Cote was not able to immediately
6 access remaining loan proceeds at the time of default — not that
7 they did not exist.
8 The following month, Contractor issued a final invoice for
9 over $1 million dollars, which included contract overages and
10 profit thereon of over $447,879 – 19% more than the maximum
11 amount stated in the Construction Contract. The same month,
12 Contractor also filed a mechanic’s lien and initiated a lawsuit
13 against Cote, the Bank, the bonding company, and others; and, it
14 filed a lis pendens against the Hanna Square property.
15 Contractor eventually settled12 the litigation with the Bank
16 and the bonding company; the settlement brought Contractor’s
17 receipts just shy of the maximum amount stated in the
18 Construction Contract for construction of the Phase I homes plus
19 the entire amount allocated by the Bank for site improvements.
20 But, it did not cover the 19% overage amount. At trial,
21 Contractor offered into evidence copies of authorized change
22 orders to support only $175,502 of the overages.
23
24 12
The settlement agreement was among the documents
admitted into evidence by the bankruptcy court (“Settlement
25 Agreement”). By its terms, it involved settlement of claims for
construction work on both phases of Hanna Square. Neither the
26 parties nor the bankruptcy court raised any issue on this point
and we, therefore, mention it only in passing. There is no
27 evidence in the record that Phase II homes were constructed; we
assume the reference to Phase II is attributable to some
28 Phase II site improvements.
- 11 -
1 The bankruptcy and adversary proceeding. Nearly one year
2 after the settlement, Cote filed his chapter 7 bankruptcy
3 petition. In August 2012, over five years after the parties
4 entered into the Construction Contract, Contractor filed a
5 complaint initiating the adversary proceeding seeking judgment
6 and determination of nondischargeability under § 523(a)(2)(A)
7 and (a)(2)(B). The complaint alleged that Cote falsely
8 represented that he had a $3.8 million Construction Loan because
9 the loan was actually funded in the principal amount of
10 $2.1 million. It alleged that Cote knew the loan amount
11 representation was false, knew the Construction Loan was
12 insufficient, and knew the costs of construction were beyond
13 Cote’s ability to pay. The complaint alleged that Cote never
14 intended to fully compensate Contractor as required under the
15 Construction Contract but, rather, intended to deprive it of
16 “money, property and services.” Contractor asserted damages in
17 the amount of $769,123.01 as a proximate result of Cote’s
18 alleged misrepresentations regarding his intent to pay and the
19 sufficiency of funding.
20 The bankruptcy court held a one-day 6-hour timed trial13 on
21 December 3, 2013. The parties objected to virtually none of the
22 documentary evidence, and the bankruptcy court admitted the
23 numerous documents into evidence for all purposes; this included
24 documents submitted without any explanatory testimony and
25
26 13
We have exercised our discretion to review documents
filed on the bankruptcy court’s electronic docket in the
27 Adversary Proceeding and in the main case. See O’Rourke v.
Seaboard Sur. Co. (In re E.R. Fegert, Inc.),
887 F.2d 955,
28 957–58 (9th Cir. 1989).
- 12 -
1 documents that appear incomplete or include unexplained
2 notations. After trial, the bankruptcy court took the matter
3 under submission and did not receive further briefing.
4 The bankruptcy court entered its Order Following Trial on
5 First Amended Complaint Objecting to Discharge of Debtor (“Order
6 After Trial”) on January 3, 2014, as its findings of fact and
7 conclusions of law. It found that Valles was not sophisticated
8 in business. It found that “Cote misrepresented the amount of
9 funds at his disposal to complete the Hanna Square project[]”;
10 he did not have $3.8 million in the loan, as he told Contractor,
11 because nearly $1 million was paid to holders of first and
12 second deeds of trust; and he told the Bank maximum costs would
13 be $2,041,636.55 – an amount less than the amount required by
14 Contractor under the Construction Contract. Order After Trial
15 at 11. The bankruptcy court found that “[d]ue to these
16 differences, it appears the project ran out of money in January
17 2008, leaving [Contractor] unpaid.”
Id.
18 Cote timely appealed.14
19 JURISDICTION
20 The bankruptcy court had jurisdiction pursuant to 28 U.S.C.
21 §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C.
22 § 158.
23 ISSUE
24 Whether the bankruptcy court erred in determining that a
25 debt owed by Cote to Contractor was excepted from discharge
26
27 14
Cote filed the notice of appeal after entry of the Order
After Trial, but before the Judgment. Nonetheless, the appeal
28 was timely. See Fed. R. Bankr. P. 8002(a)(2).
- 13 -
1 pursuant to § 523(a)(2)(A).
2 STANDARD OF REVIEW
3 Whether a claim is nondischargeable presents mixed issues
4 of law and fact. Deitz v. Ford (In re Deitz),
760 F.3d 1038,
5 1042 (9th Cir. 2014). Mixed questions of law and fact are
6 generally reviewed de novo. See Mathews v. Chevron Corp.,
7
362 F.3d 1172, 1180 (9th Cir. 2004); In re Deitz, 760 F.3d at
8 1043. In the context of a dischargeability analysis, however,
9 the bankruptcy court’s factual findings are reviewed under the
10 clearly erroneous standard. Candland v. Ins. Co. of N. Am.
11 (In re Candland),
90 F.3d 1466, 1469 (9th Cir. 1996). Thus,
12 whether a creditor proved an essential element under
13 § 523(a)(2)(A) is a factual determination reviewed for clear
14 error. Am. Express Travel Related Servs. Co., Inc. v. Vee
15 Vinhnee (In re Vee Vinhnee),
336 B.R. 437, 443 (9th Cir. BAP
16 2005).
17 “Clearly erroneous review is significantly deferential,
18 requiring that the appellate court accept the [trial] court’s
19 findings absent a definite and firm conviction that a mistake
20 has been made.” United States v. Syrax,
235 F.3d 422, 427 (9th
21 Cir. 2000). The bankruptcy court’s choice among multiple
22 plausible views of the evidence cannot be clear error. United
23 States v. Elliott,
322 F.3d 710, 714 (9th Cir. 2003). The
24 deference owed to the bankruptcy court is heightened where its
25 choice is based on the credibility of live witnesses.
26 Rule 8013. A factual finding is clearly erroneous, however, if,
27 after examining the evidence, the reviewing court “is left with
28 the definite and firm conviction that a mistake has been
- 14 -
1 committed.” Anderson v. City of Bessemer City, NC,
470 U.S.
2 564, 573 (1985) (internal citation omitted).
3 In general, contract interpretation is a question of law
4 reviewed on a de novo basis. “This is particularly true where
5 the intent of the parties is easily ascertainable from the clear
6 and explicit language of the contract.” U.S. v. 1.377 Acres of
7 Land,
352 F.3d 1259, 1265 (9th Cir. 2003). If the bankruptcy
8 court relies on extrinsic evidence in rendering its decision,
9 however, its findings of fact are reviewed for clear error. See
10
id. at 1264.
11 DISCUSSION
12 A. Exception to discharge
13 A claim for denial of a discharge under § 523 is construed
14 liberally in favor of the discharge and strictly against a
15 person objecting to the discharge. Inst. of Imaginal Studies v.
16 Christoff (In re Christoff),
527 B.R. 624, 629 (9th Cir. BAP
17 2015). A creditor objecting to the dischargeability of its
18 claim bears the burden of proving, by a preponderance of the
19 evidence, that the particular debt falls within one of the
20 exceptions to discharge enumerated in section 523(a). Grogan v.
21 Garner,
498 U.S. 279, 286-91 (1991).
22 To prevail on a claim under § 523(a)(2)(A), a creditor must
23 establish the existence of five distinct elements: (1) the
24 debtor made representations; (2) debtor knew the representations
25 were false at the time he made them; (3) debtor made the
26 representations with the intention and purpose of deceiving the
27 creditor; (4) the creditor justifiably relied on the
28 representations; and (5) the creditor sustained the alleged loss
- 15 -
1 and damage as the proximate result of the representations having
2 been made. Ghomesh v. Sabban (In re Sabban),
600 F.3d 1219,
3 1221 (9th Cir. 2010); Britton v. Price (In re Britton),
950 F.2d
4 602, 604 (9th Cir. 1991).
5 A debtor’s silence or omission of a material fact can
6 constitute a false representation that is actionable under
7 § 523(a)(2)(A). Citibank (South Dakota), N.A. v. Eashai
8 (In re Eashai),
87 F.3d 1082, 1088-89 (9th Cir. 1996). However,
9 in order to find liability for fraud based upon omission or
10 silence, there must also be a duty to disclose.
Id.
11 In this appeal, Cote challenges the bankruptcy court’s
12 factual findings supporting its determination of
13 nondischargeability under § 523(a)(2)(A).15 He argues that the
14 bankruptcy court’s own math reveals its error in finding that
15 Cote had insufficient funds and that the evidence supports
16 neither a determination that Cote intended to deceive Contractor
17 nor a determination that Contractor justifiably relied on the
18 existence of $3.8 million in construction financing.
19 This was essentially a fraudulent inducement or fraud at
20 contract initiation case. Accordingly, a finding of fraud was
21 appropriate only if Cote knew that he could not pay Contractor
22 as required under the Construction Contract at its formation;
23
24 15
Cote also challenges the § 523(a)(2)(A)
nondischargeability determination on the grounds that his
25 alleged misrepresentation was an oral “statement respecting the
debtor’s or an insider’s financial condition,” which is
26 specifically not excepted from discharge. We disagree entirely.
Assuming Cote adequately preserved the issue, which the
27 bankruptcy court failed to address in its written decision,
because we reverse on other grounds, we need not further address
28 this argument.
- 16 -
1 among other things, this would require that Cote knew that the
2 Contractor would not complete the project as agreed upon, but
3 instead would come in significantly over budget and after the
4 target date for completion. There is no such evidence in this
5 record.
6 While we acknowledge the post-trial deference owed to the
7 bankruptcy court, we conclude that it grounded its
8 determinations on three factual findings that are clearly
9 erroneous. First, it overestimated the amount Cote agreed to
10 pay to Contractor under the Construction Contract in connection
11 with Phase I of the Hanna Square project. Second, it
12 underestimated the funds and sources of funds available to Cote
13 to meet the agreed upon expenses under the Construction
14 Contract. And, third, its award of damages exceeded anything
15 owed under the Construction Contract both as it was initially
16 drafted and even as modified by the change orders.
17 The trial testimony record is minimal, especially
18 considering the amount of debt Contractor sought to have
19 determined nondischargeable. We defer to the bankruptcy court’s
20 credibility assessments as to specific testimony,16 as we must;
21 but, despite the bankruptcy court’s generalized finding that
22 Cote was not a credible witness, we conclude that in critical
23 areas Cote’s undisputed testimony, when corroborated by
24 documentary evidence, could not be disregarded.
25 The documents taken into evidence, many of which involved
26
16
The bankruptcy court, again, specifically found that
27 Valles was not sophisticated in business; nothing in the record
shows otherwise. Contractor built many homes previously but not
28 as a third party general contractor.
- 17 -
1 no explanatory testimony, were substantial. The bankruptcy
2 court undertook to review the record, and we assume it reviewed
3 all the admitted documents. See Tevis v. Wilke, Fleury,
4 Hoffelt, Gould & Birney, LLP (In re Tevis),
347 B.R. 679, 695
5 (9th Cir. BAP 2006)(“It is the bankruptcy court’s responsibility
6 to evaluate the evidence presented . . . [for] [it] has an
7 obligation to consider all of the evidence properly presented
8 and to give it the weight that it deserves.”). Based on our
9 review of the record, Contractor failed to establish all the
10 elements of its § 523(a)(2)(A) claim, and, thus, it failed to
11 carry its burden.
12 B. What was the misrepresentation?
13 Contractor’s complaint alleged that Cote made three
14 distinct misrepresentations; the bankruptcy court found a
15 misrepresentation based on a variation of the third.
16 1. Alleged false promise to pay
17 Contractor alleged that Cote induced it to enter into the
18 Construction Contract without any intention of paying. The
19 bankruptcy court did not base its nondischargeability decision
20 on this theory, therefore, we do not address it in detail here.17
21 2. Alleged false representations to the Bank
22 Contractor also alleged that Cote made misrepresentations
23 to the Bank regarding the agreed upon price under the
24 Construction Contract. The bankruptcy court considered
25
17
In any event, Contractor’s first theory is inconsistent
26 with the undisputed fact that Cote paid Contractor over
$1.7 million prior to default and that Contractor, eventually,
27 received payment of substantially all amounts owed under the
Construction Contract other than cost overruns and profit
28 thereon from Cote, Cote's lender, and the bond Cote obtained.
- 18 -
1 important the difference between the numbers in the (limited and
2 largely incomplete) bank documents in evidence and the
3 Construction Contract cost numbers; but, it did not base its
4 decision on any alleged misrepresentation made to the Bank.18
5 3. False representations regarding the Construction Loan
6 and the sufficiency of funds to pay Contractor
7 Contractor alleged that Cote misrepresented19 that the full
8 $3.8 million of Construction Loan proceeds was available to pay
9 construction costs and that he failed to disclose that
10 approximately $1 million of the proceeds was to be used to pay
11 off existing liens on the property. It, thus, asserted a claim
12 of omission in the face of duty to disclose. Contractor also
13 implicitly argued that the lesser amount available under the
14 Construction Loan proved that Cote had insufficient funding to
15 pay Contractor the full price agreed to under the Construction
16 Contract. The bankruptcy court did not entirely reject this
17 argument; instead, it found fraud on a slightly different basis.
18 The bankruptcy court found that Cote misrepresented the
19 amount of funds at his disposal to complete the project. In
20 connection with this finding, the bankruptcy court correctly
21 found that only a maximum of approximately $2.6 million was
22 available from the $3.8 million Construction Loan to complete
23
24
25
18
Nor did the Bank assert a fraud claim against Cote.
26
19
At trial, Valles provided no details as to when, where,
27 or what Cote actually said to allegedly make Valles believe that
the Construction Loan did not require loan fees, loan and title
28 costs, interest reserves, or other common financing costs.
- 19 -
1 Phase I of the project.20 It found, in effect, that at the time
2 of the Construction Contract, Cote knowingly misrepresented that
3 he had sufficient funds to pay Contractor the amounts owed
4 pursuant to the Construction Contract. The bankruptcy court
5 reasoned that if Cote “had sufficient funding, he would have
6 paid [Contractor].” Order After Trial at 13. The record does
7 not support this finding.
8 C. The record does not support a finding that Cote knowingly
9 misrepresented that he had sufficient funds to pay
10 Contractor
11 1. The bankruptcy court underestimated Cote’s sources of
12 funding at the time of contract formation
13 a) The Construction Loan proceeds
14 The bankruptcy court commenced its analysis of the
15 sufficiency of funds by deducting the payoffs of existing
16 secured debt ($1,147,199) from the $3.8 million loan amount.
17 The difference, approximately $2.6 million, is supported by
18 Cote’s trial exhibit, an estimated closing statement from
19 Alliance Title Company, “Est. Undisbursed Funds,” which shows
20 $2,604,463 ("Net Loan Proceeds") remained after the payoffs and
21 all costs and charges for the loan.
22
20
The bankruptcy court also found that Cote told the Bank
23 that the project would cost a maximum of $2,041,636.55. We
question this finding; there was no express testimony in this
24 regard, and the Bank obtained an assignment of the Construction
Contract. The bankruptcy court’s finding was based on its
25 review of the Disbursement Request. A representative of the
Bank's construction auditor testified that this document was a
26 progress disbursement request; Valles had no personal knowledge
of who prepared the document that he received in discovery; and
27 Cote testified he did not think it was the budget he submitted
to the Bank. No one testified from the Bank at trial. And the
28 loan officer involved is now deceased.
- 20 -
1 But, rather than analyzing whether the Net Loan Proceeds
2 were sufficient to pay the Construction Contract at the time of
3 formation, the bankruptcy court instead analyzed whether a cost
4 allocation totaling $2,014,636 (roughly identified in the
5 Disbursement Request) was sufficient to pay the Construction
6 Contract. It never further considered whether Cote intended
7 that any of the approximate $500,000 of loan proceeds
8 ($2.6 million less $2.014 million) cover any portion of the
9 costs incurred for Contractor’s services under the Construction
10 Contract. This failure was not harmless. There is no evidence
11 in the record from which the bankruptcy court could logically or
12 plausibly infer that the approximately $500,000 ("Excess Loan
13 Proceeds"), or some part thereof, was not available for payment
14 to Contractor.21
15 Obviously, there is a mathematical problem with the
16 bankruptcy court’s summary conclusion in regard to the Net Loan
17 Proceeds. The maximum under roof cost of Phase I, $1,929,585,
18 plus the maximum site improvement cost for both Phase I and
19 Phase II, $589,930, is only $2,519,515 — an amount less than the
20 Net Loan Proceeds. And, there is no evidence in the record that
21 supports the bankruptcy court’s finding that Cote knew the
22 Phase I site improvements would be more than the Bank's budgeted
23 amount of $426,768. On a facial review, the Net Loan Proceeds
24 were sufficient for payment of the maximum obligations under the
25 Construction Contract reasonably assumed to be payable at the
26
27
21
At trial Cote testified that the loan contained amounts
28 for retainage and contingencies, among other costs.
- 21 -
1 time of its signing: $2,356,353;22 indeed, there was
2 approximately $250,000 in Construction Loan proceeds in excess
3 of this amount.
4 The bankruptcy court reached a different conclusion by
5 focusing on the undisputed facts that: (1) the limited bank loan
6 documents in evidence used $101.06 per square foot (and not
7 $120.75) as the cost of construction for the homes in Phase I
8 (totaling $1,614,868) and $426,768, not the bankruptcy court's
9 erroneously identified $556,461, as the site improvement number.
10 The bankruptcy court then concluded, in the face of contrary,
11 undisputed evidence, that only $2,041,636.55 was available for
12 payment of Construction Contract expenses and that Cote knew it.
13 These findings were clearly erroneous.
14 The record is at odds with a conclusion that all Excess
15 Loan Proceeds were available for construction. The Construction
16 Loan documentation, incomplete as it is, indicates that, as is
17 not uncommon with construction loans, there were interest
18 reserves built into the anticipated uses of funds. The evidence
19 in the record references an interest reserve and interest paid
20 from the initiation of the Construction Loan of $63,850.65.
21 Although the record is less than precise, nothing suggests that
22 Cote reasonably anticipated or should have reasonably
23 anticipated that interest reserves would exhaust the Excess Loan
24 Proceeds. Indeed, as Cote's stated goal was completion of
25 Phase I and sale of the homes by January 1, 2008, this would
26 have been close to the maximum in interest carry reasonably
27
28 22
$1,929,585 + $426,768 = $2,356,353.
- 22 -
1 anticipated at loan initiation.
2 The Construction Contract also provided that Cote was
3 responsible for costs related to certain components of Phase I,
4 including the solar arrays. Cote apparently paid some of these
5 expenses from Construction Loan proceeds. This payment was
6 appropriate; Phase I could not be completed without such
7 advances, but they were draws against the $2.6 million that
8 further reduced its availability to Contractor.
9 Cote testified, however, there was also a contingency
10 budget built into the Construction Loan. The bankruptcy court
11 never addressed this testimony, notwithstanding that the limited
12 loan documents in the record evidence that a contingency line
13 item existed and was utilized. Based on the documentary
14 evidence in the record, the bankruptcy court’s limited view of
15 the amount of Construction Loan proceeds available to pay costs
16 under the Construction Contract was clearly erroneous.
17 The record, instead, supports that as of the formation of
18 the Construction Contract, Cote had access to sufficient funds
19 or significant funds to cover the known costs reasonably
20 anticipated to be incurred under the Construction Contract in
21 Phase I from Construction Loan proceeds. The bankruptcy court’s
22 disregard of the Net Loan Proceeds as a source of payment is
23 clear error.
24 b) The additional $155,000 line of credit
25 In addition to the $3.8 million in Construction Loan
26 proceeds, Cote testified that he had a separate line of credit.
27 The record supports his testimony and there was no contrary
28 evidence. The bankruptcy court never addressed this source of
- 23 -
1 funding. On this record, its failure to consider these funds as
2 a source of repayment was not harmless error.
3 c) The bond for site costs
4 Cote also obtained a bond for site costs.23 Of the $426,768
5 in budgeted site costs, Contractor’s trial exhibit reflects the
6 amount of bonded site costs as $358,014.24
7 The bankruptcy court never considered this insurance of
8 funding in its analysis. Contractor presented no evidence that
9 it was at risk for nonpayment for bonded site improvements
10 despite the fact that payment was substantially assured via the
11 bond obtained by Cote; indeed, the only evidence was that it
12 received post-default payment from the bond. The bankruptcy
13 court’s failure to consider this evidence is not harmless error.
14 d) Deferred funding: $39,500 contract provision
15 At trial the parties disagreed on the meaning and import of
16
23
A recital in the Settlement Agreement states that
17 American Contractors Indemnity Company, as surety for Cote,
“issued certain performance and labor and materials bonds in
18 connection with the project, including without limitation,
Subdivision Public Improvement Payment Bond No. 1000756422 in
19 the amount of . . . ($393,816.00), dated of (sic) July 10 2007
(the “Bond”). It appears that the Bond likely covered both
20 Phase I and II, as “Project” is defined in the Settlement
Agreement to include all phases of Hanna Square, and the amount
21 of the Bond is higher than the amount set forth in the
Disbursement Request for Phase I only. Contractor’s reference
22 to “project” and “Project” in its various pleadings
inconsistently varied as to whether it was referring to one or
23 both phases of Hanna Square. And at trial, Contractor’s counsel
attempted to impeach Cote by reading Cote’s deposition testimony
24 taken in the state court action wherein he stated that he knew
the Bank did not lend enough to complete the entire project.
25 Read in context, Cote was referring to the undisputed fact that
the Bank made its loan only for Phase I of Hanna Square except
26 as to certain bonded site improvements.
27 24
Bonds generally provide a separate source of payment of
site costs in the event funding is unavailable and are
28 frequently required by construction lenders.
- 24 -
1 the provision in the Construction Contract for Contractor’s
2 deferral of payment for up to $39,500 per home until the close
3 of escrow on the homes. Cote testified that he relied on this
4 provision as a source for payment of costs up to $395,000 to the
5 extent Contractor’s costs exceeded the amount provided by the
6 Bank under its progress payment process. Again, there was no
7 evidence presented establishing that it was unreasonable for
8 Cote to believe, when he singed the Construction Contract, that
9 home sales would be sufficient to pay Contractor in full.
10 The bankruptcy court, with no discussion or analysis, found
11 that this contract provision applied only if the Contractor
12 “required” the changes that resulted in the overages. As shown
13 in Contractor’s February 2008 invoice, Contractor requested
14 judgment for costs and profits thereon that were incurred in
15 excess of the maximum amount reasonably viewed as payable under
16 the Construction Contract. This overage equals $447,879 - 19%
17 over the maximum price agreed upon by the parties in the
18 Construction Contract. Even under Contractor’s and the
19 bankruptcy court's interpretation of the $39,500 provision,
20 Contractor agreed to defer receipt of payment of $395,000 of
21 this amount until close of escrow on the homes. Close of escrow
22 never occurred.
23 Thus, the bankruptcy court’s finding that the $39,500
24 provision applied to none of the amounts for which Contractor
25 sought payment is clearly erroneous. This error is not
26 harmless, as the record supports Cote’s testimony that he
27 thought that if problems arose he had up to $395,000 with which
28 to complete construction of the project based upon Contractor’s
- 25 -
1 agreement to defer payment on such required amounts until close
2 of escrow. The only evidence in the record is that at the time
3 the loan was made and the Construction Contract was executed,
4 the Bank valued the Hanna Square project at $12 million, which
5 left it with a healthy loan to value ration of 31%.
6 e) Other funding sources
7 The record is thin on this point, but there is evidence of
8 payments from sources other than the Bank's loan proceeds. The
9 bankruptcy court also ignored this documentary evidence.
10 In sum, the record shows that Cote had funding sources that
11 the bankruptcy court did not consider.
12 2. The bankruptcy court overestimated the reasonably
13 assumed site costs for Phase I
14 It is undisputed that Cote agreed to pay Contractor a total
15 of $589,930 for all site improvement (non-building) costs for
16 Phases I and II together. But, nothing in the record shows what
17 amount, if any, the parties agreed to for the Phase I site
18 costs. The only admitted evidence for Phase I site costs
19 consisted of the site cost number reflected in the Disbursement
20 Request, $426,748. Therefore, the bankruptcy court erred when
21 it assigned $556,461, the amount in the Initial Contract for
22 both phases, to the Phase I site costs; there is no support in
23 the record for this determination. This error was not harmless.
24 3. The bankruptcy court's determination of falsity, thus,
25 was based improperly on findings that were clearly
26 erroneous
27 The errors detailed above led the bankruptcy court to the
28 conclusion of material falsity through statement, omission, or
- 26 -
1 action. Its determination was clearly erroneous. The record is
2 clear that Cote had sources of payment not acknowledged by the
3 bankruptcy court. Further, the record makes clear that the
4 bankruptcy court erroneously inflated the maximum amount due
5 under the Construction Contract at its initiation by including
6 overstated site improvement costs and erroneously concluded that
7 Cote knew that he lacked sufficient funds.
8 Contractor argues on appeal that Cote should have known
9 that the project would go over budget, because all projects go
10 over budget. We disagree. Contractor presented neither
11 evidence supporting its argument that all projects go over
12 budget nor evidence that Cote knew Contractor would go over
13 budget. Rather, the record shows that Cote built in monetary
14 incentives to try to encourage quick construction and cost
15 savings efforts - to bring the project in early and below
16 budget. The record also shows that the amounts in the
17 Construction Contract were maximums and that Contractor was
18 obligated to provide reductions upon certain circumstances.
19 There is nothing in the Construction Contract that allowed
20 Contractor to charge anything in excess of the amounts set forth
21 therein.
22 D. The record does not support the bankruptcy court's
23 determination of proximate cause and justifiable reliance
24 The bankruptcy court found that Contractor sustained
25 damages, although it did not articulate whether the damages were
26 the proximate result of the misrepresentation on which it based
27 its § 523(a)(2)(A) judgment. It awarded the damages as
28 calculated by Contractor in its final February 2008 invoice,
- 27 -
1 subtracted the $535,000 settlement amount received and awarded
2 Contractor $490,883.85.
3 On this record, the bankruptcy court clearly erred in
4 implicitly determining that pre-Construction Contract statement
5 or omission proximately caused the damages that it ultimately
6 awarded. Contractor received payment of all but $47,353 of the
7 maximum under roof cost in the Construction Contract, plus 100%
8 of the site improvement costs included in the Bank's budget.
9 The vast majority of the damages awarded by the bankruptcy
10 court, thus, were amounts that resulted from cost overruns
11 beyond the scope of the Construction Contract.
12 There is no evidence in the record that Cote ever agreed to
13 pay all these requested cost overruns as he executed only
14 $175,000 in change orders. Again, Contractor agreed in the
15 Construction Contract to build the Phase I homes and related
16 site improvements for a maximum amount. It thus requested – and
17 received – damages greater than either the original contract
18 amount or the increased contract amount given the limited change
19 orders. The damages awarded by the bankruptcy court exceed
20 those available even under a breach of contract theory.
21 In sum, it was illogical and implausible for the bankruptcy
22 court to find that Contractor was proximately damaged by being
23 induced to enter into a contract under which Contractor received
24 payment of almost all but the amounts that exceeded the
25 contractual maximums.
26 The bankruptcy court also found that Valles and, thus,
27 Contractor relied on Cote’s representation about the sufficiency
28 of funds at Cote’s disposal. Valles testified that Cote told
- 28 -
1 him he had a $3.8 million loan; as stated, this was true.
2 Contractor, however, presented no evidence that the full
3 $3.8 million amount was necessary to pay Contractor. Both
4 Valles and Frietas testified that when Cote changed the rate of
5 compensation to $115, they insisted it be revised to $120.75.
6 The bankruptcy court did not find Cote believable when he
7 testified that he only agreed to the increase because he was in
8 a hurry to close the loan even though Valles and Frietas were
9 taking advantage of him.25 We do not question this finding, but
10 note that the difference between the two amounts is $5.75 per
11 square foot, a total of $91,885. Based on Contractor’s alleged
12 damages, the insufficiency of funds issue cannot turn on this
13 rate differential.
14 The bankruptcy court did not find that Contractor’s
15 reliance was justifiable, although, again, it found that Valles
16 “did not appear to be particularly sophisticated in business
17 transactions.” Order Following Trial at 9.
18 E. The record does not support unequivocally the bankruptcy
19 court’s inference that Cote intended to deceive Contractor
20 The bankruptcy court found that Cote’s intent to deceive
21 Contractor was clear. The record does not support its finding
22 unequivocally.
23 The bankruptcy court relied on Valles’ testimony that he
24 was kept in the dark on the loan and construction funding
25 process and that he had restricted access to both the Bank and
26
25
Although the bankruptcy court made a general finding
27 that Cote was not a credible witness, this was the only
testimony that the bankruptcy court specifically identified as
28 not credible.
- 29 -
1 its auditor. The record, however, was inconsistent on these
2 points.
3 The bankruptcy court appears implicitly to have concluded
4 that Cote intentionally did not provide Valles any bank
5 documents. But the record is devoid of any testimony to this
6 effect and, in fact, is inconsistent with Valles’ execution of
7 the Contract Assignment wherein he acknowledged and accepted the
8 disbursement provisions in the Bank’s loan documents. Further,
9 at trial, Valles testified that Cote provided him other
10 documentation regarding the funding for the project, although
11 Valles did not recall any other specific documents.26 Thus, the
12 record is unclear as to what loan documentation Valles reviewed.
13 Valles also testified that he was prevented from contacting
14 the Bank’s auditor, but this testimony is inconsistent with
15 testimony by Contractor’s project manager and agent, Frietas.
16 Frietas testified that with each invoice submitted by
17 Contractor, Frietas walked the project with the Bank's auditor
18 and discussed billings and percentage completion. The
19 bankruptcy court found both Valles and Frietas to be credible
20 witnesses. It, however, failed to address or reconcile the
21 inconsistencies in their testimony.
22 The bankruptcy court also found the method of disbursing
23 loan proceeds, the requirement that Contractor acknowledge
24 assignment of the Construction Contract, the fact that the Bank
25
26
The Contract Assignment was the only bank loan document
26 admitted in its entirely into evidence. Contractor’s exhibit
list included a document titled “United American Bank Loan
27 Agreement (Loan #171571)” as exhibit 30, but it, along with
documents numbered 31 through 44, was crossed off the list and
28 never discussed or offered at trial.
- 30 -
1 dealt exclusively with Cote, and other aspects of the lending
2 process supported its determination of intent to defraud. We
3 note that there was no expert testimony or secondary sources
4 discussing construction lending introduced into evidence at
5 trial. Nor was there any testimony that Cote, as opposed to the
6 Bank, dictated the terms of the construction loan and decided
7 how to disburse loan proceeds; one would logically assume that
8 the Bank would make these decisions. The only testimony
9 suggesting concern on these points was from Valles, who, as
10 previously discussed, was found to be unsophisticated in
11 business.
12 Finally, the bankruptcy court found evidence of intent to
13 defraud from what it described as alterations Cote made to the
14 amounts requested by Contractor when he sought payments from the
15 Bank. Nothing in the record, however, shows that Cote made any
16 such alterations. The record evidences that he requested
17 payment consistent with Contractor’s requests, but also sought
18 advances on account of other project costs not covered under the
19 Construction Contract, such as $157,400 for solar arrays and
20 $100,000 for insurance. The Construction Contract made clear
21 that Cote was responsible for these portions of the Phase I
22 construction; nothing in the agreements prohibited him from
23 using some of the Construction Loan proceeds to pay these
24 required costs. Again, there was neither testimony nor evidence
25 presented establishing that this use was inconsistent with the
26 discussions of the parties prior to execution of the
27 Construction Contract or at any point in time.
28
- 31 -
1 CONCLUSION
2 Based on the foregoing, we REVERSE.
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