FILED JUL 27 2015 1 NOT FOR PUBLICATION SUSAN M. SPRAUL, CLERK 2 U.S. BKCY.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. 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28
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