Ghomeshi v. Sabban (In Re Sabban)

OPINION

The debtor, an unlicensed contractor, entered into a home improvement contract with the creditor. Prior to bankruptcy, a state court entered a judgment against the debtor in the amount of $123,500 and additionally awarded the creditor attorneys’ fees in the amount of $71,269.30. The creditor sought summary judgment from the bankruptcy court that all of the amounts awarded by the state court were nondischargeable under 11 U.S.C. § 523(a)(2)(A).1 The bankruptcy court ordered that the $123,500 award to the creditor was dischargeable but that the $71,269.30 in attorneys’ fees was nondis-chargeable. The creditor appealed; the debtor did not cross-appeal, nor did he file a responsive brief. We AFFIRM in part and REVERSE in part to correct a $500 error in drafting.

I. FACTS

A. The State Court Action

Following trial, a state court entered a judgment in the amount of $123,500 in favor of appellant Abdul M. Ghomeshi (“Creditor”) against appellee Yehuda Sab-ban (“Debtor”). The state court also stated that Creditor was entitled to recover attorneys’ fees, which it later fixed at $71,269.30. The state court also made certain factual findings which the bankruptcy court later adopted under the doctrine of issue preclusion.2 No party has appealed the bankruptcy court’s application of issue *3preclusion principles, thus this recitation of facts incorporates the findings of the state court as adopted by the bankruptcy court.

Debtor held an eighty percent interest in a general partnership, Pacific Coast Creations (“Pacific”), created to provide home improvement work. Even though neither Debtor nor Pacific were licensed in California, Debtor represented himself and Pacific as licensed contractors.

A representative of Pacific contacted Creditor soliciting home improvement work. Creditor entered into a series of written and oral contracts with Debtor and Pacific, which served as the general contractor for the remodeling of Creditor’s home. Creditor testified that he would not have hired Pacific if he had known the truth about the unlicensed status of Pacific and Debtor.

The state court specifically found that Creditor acted in reliance on Debtor’s representations that Pacific was licensed and was thus induced into entering into the contracts with Pacific. The state court also found that when Debtor represented to Creditor that Pacific was a licensed contractor, he “knew it was a false representation, a fraudulent representation, and a false statement knowingly made.”

Creditor paid $123,000 to Pacific and Debtor while and after the improvement work was performed.3 Debtor in turn paid $129,217.95 to licensed subcontractors and other providers of goods and services for the benefit of Creditor.

After “considerable problems developed” between Creditor and Debtor, Creditor sued for breach of contract, fraud and violations of California Business and Professions Code section 7160 (“ § 7160”) and California Business and Professions Code section 7031(b) (“ § 7031(b)”). Creditor eventually dismissed the breach of contract and fraud causes of action, and trial proceeded on the allegations that Debtor had violated § 7160 and § 7031(b).

Section 7160 provides that any person who is induced to contract for a work of home or other improvement “in reliance on false or fraudulent representations or false statements knowingly made” may recover a penalty of $500, plus reasonable attorneys’ fees “in addition to any damages sustained by him by reason of such statements or representations made by the contractor or solicitor.” Cal. Bus. & Prof. Code § 7160. The state court awarded Creditor $500 plus attorneys’ fees under this section, but specifically held that the $123,000 paid by Creditor, and which Creditor sought to recover pursuant to § 7031(b), did not constitute damages for the purposes of § 7160. In other words, the state court found that Creditor did not sustain such damages “by reason of such statements or representations made by the contractor or solicitor.” Cal. Bus. & Prof. Code § 7160.

Even though the state court found that Creditor did not suffer actual damages for purposes of the fraud provisions of § 7160, it nonetheless awarded Creditor $123,000 “in the nature of disgorgement” pursuant to § 7031(b). Section 7031 prohibits unlicensed contractors from maintaining actions to recover compensation and additionally permits a party who has utilized the services of an unlicensed contractor “to recover all compensation paid” to the contractor. The statute does not on its face limit disgorgement only to those who have been defrauded by an unlicensed contractor. Instead, as the California Supreme Court has held, the statutory prohibition against compensation to unlicensed con*4tractors “operates even where the person for whom the work was performed knew the contractor was unlicensed.” Hydrotech Sys., Ltd. v. Oasis Waterpark, 52 Cal.3d 988, 997, 277 Cal.Rptr. 517, 803 P.2d 370, 376 (1991).

B. The Nondischargeability Action

Debtor filed his chapter 7 case on August 8, 2005, and Creditor filed his complaint to determine dischargeability on November 14, 2005. Creditor filed a motion for summary judgment. Debtor’s opposition to the motion included a cross-motion for summary judgment. The bankruptcy court issued a tentative ruling stating that it would grant summary judgment in favor of Creditor declaring the full amount of the state court judgment (the $123,000 awarded under § 7031(b) plus the $500 penalty and attorneys’ fees awarded under § 7160’s fraud provisions) nondischargeable.

At the initial hearing on the motion for summary judgment, counsel for Debtor argued that the court had erred in its tentative ruling by treating the $123,000 award under § 7031(b) as a claim for money, property, services, or credit obtained by fraud under section 523(a)(2)(A), particularly when the state court specifically held that Creditor did not suffer damages in that amount as a result of Debtor’s fraud (under § 7160) in procuring the contracts. The court therefore permitted the parties to submit supplemental briefs on the issue of whether the § 7031(b) award of $123,000 would be nondischargeable under Cohen v. De La Cruz, 523 U.S. 213, 118 S.Ct. 1212, 140 L.Ed.2d 341 (1998).

At a subsequent hearing the court modified its tentative ruling and ordered that the amount awarded under § 7031(b) was dischargeable. The court noted that § 7031(b) is “a regulatory statute about status” and “not a tort statute about misconduct.” The bankruptcy court agreed with the state court that the $123,000 in damages did not result from Debtor’s fraud or misrepresentation. The court did find that the $500 penalty and the attorneys’ fees in excess of $71,000 awarded under § 7160 were nondischargeable.4

On June 20, 2007, the bankruptcy court entered a stipulated order on Creditor’s motion for summary judgment, providing that the portion of the state court judgment ($123,500) attributable to § 7031(b) was subject to discharge and that attorneys’ fees in the amount of $71,269.30 awarded under § 7160 were nondischargeable.5 Creditor filed a timely notice of appeal on June 29, 2007.

*5II.JURISDICTION

On October 3, 2007, the clerk of this panel entered an order noting that the order on the motion for summary judgment is not a separate final judgment itself, citing Casey v. Albertson’s, Inc., 362 F.3d 1254, 1256 (9th Cir.2004). The clerk ordered the parties to obtain a separate judgment no later than October 17, 2007, or the separate document requirement would be deemed waived pursuant to Bankers Trust Co. v. Mallis, 435 U.S. 381, 98 S.Ct. 1117, 55 L.Ed.2d 357 (1978). Neither Creditor nor Debtor obtained a separate judgment by the deadline, so the separate document requirement is deemed waived. See Casey, 362 F.3d at 1256 (party waived separate judgment rule where district court had granted summary judgment in a 7-page civil minute order that concluded “IT IS SO ORDERED” even though no separate judgment was entered).

The bankruptcy court had jurisdiction pursuant to 28 U.S.C. §§ 1334 and 157(b)(2)(I) and we have jurisdiction under 28 U.S.C. § 158.

III.ISSUE

Did the bankruptcy court err in holding that the state court’s award of $123,000 to Creditor under § 7031(b) was not excepted from discharge pursuant to section 523(a)(2)(A)?

IV.STANDARD OF REVIEW

We review de novo the bankruptcy court’s ruling on a motion for summary judgment. Tobin v. San Souci Ltd. P’ship (In re Tobin), 258 B.R. 199, 202 (9th Cir. BAP 2001); Woodworking Enters., Inc. v. Baird (In re Baird), 114 B.R. 198, 201 (9th Cir. BAP 1990).

V.DISCUSSION

Section 523(a)(2)(A) excepts from discharge any debt for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation, or actual fraud. 11 U.S.C. § 523(a)(2)(A). In order to establish that a debt is nondis-chargeable under section 523(a)(2)(A), a creditor must establish five elements by a preponderance of the evidence:

(1) misrepresentation, fraudulent omission or deceptive conduct by the debtor;

(2) knowledge of the falsity or deceptiveness of his statement or conduct; (3) an intent to deceive; (4) justifiable reliance by the creditor on the debtor’s statement or conduct; and (5) damage to the creditor proximately caused by its reliance on the debtor’s statement or conduct.

Turtle Rock Meadows Homeowners Ass’n v. Slyman (In re Slyman), 234 F.3d 1081, 1085 (9th Cir.2000).

Because an exception to discharge impairs a debtor’s fresh start, section 523(a)(2)(A) “should not be read more broadly than necessary to effectuate policy, e.g., preventing debtors from avoiding debts incurred by fraud or other culpable conduct.” Hayhoe v. Cole (In re Cole), 226 B.R. 647, 654 (9th Cir. BAP 1998).

The limits on the dischargeability of debts contained in section 523 should be construed strictly against creditors and in favor of debtors. E.g., Gleason v. Thaw, 236 U.S. 558, 562, 35 S.Ct. 287, 289, 59 L.Ed. 717 (1915) (“[I]n view of the well-known purposes of the [bankruptcy laws], exceptions to the operations of a discharge should be confined to those plainly expressed.”); In re Houtman, 568 F.2d 651, 656 (9th Cir. 1978).

Klapp v. Landsman (In re Klapp), 706 F.2d 998, 999 (9th Cir.1983); see also *6Snoke v. Riso (In re Riso), 978 F.2d 1151, 1154 (9th Cir.1992); Beaupied v. Chang (In re Chang), 163 F.3d 1138, 1140 (9th Cir.1998).

At issue here is whether the state court’s award of $123,000 to Creditor pursuant to § 7031(b) constitutes damages “proximately caused” by Creditor’s reliance on Debtor’s misrepresentation regarding his unlicensed status. More particularly, the question is whether in light of Cohen v. De La Cruz, the § 7031(b) award is a debt for money “obtained by” false pretenses, a false representation, or actual fraud under section 523(a)(2)(A). Given that we are to construe strictly the exceptions to discharge and that the exception under section 523(a)(2)(A) is limited to debts arising from a debtor’s fraudulent conduct, we conclude that the § 7031(b) award is dischargeable.

In Cohen v. De La Cruz, 523 U.S. at 221, 118 S.Ct. 1212, the Supreme Court held that the fraud exception to discharge contained in section 523(a)(2)(A) “prohibits] the discharge of any liability arising from a debtor’s fraudulent acquisition of money, property, etc., including an award of treble damages for the fraud.” Id. (emphasis added). The debtor landlord in De La Cruz had charged rents in violation of a rent control ordinance, and the creditors/tenants asserted that the rent payments had been obtained by “actual fraud” and were thus nondischargeable under section 523(a)(2)(A). The tenants also sought treble damages and attorneys’ fees pursuant to the New Jersey Consumer Fraud Act. Id. at 215,118 S.Ct. 1212.

The debtor landlord argued that the treble damages were not encompassed by section 523(a)(2)(A) because they did not represent money or services that the debt- or “obtained” from the creditors. The Supreme Court disagreed, stating that the “most straightforward reading of [section] 523(a)(2)(A) is that it prevents discharge of ‘any debt’ respecting ‘money, property, services, or ... credit’ that the debtor has fraudulently obtained, including treble damages assessed on account of the fraud.” Id. at 218, 118 S.Ct. 1212 (emphasis added).

While the Supreme Court held that a debtor need not “obtain” or receive money or property fraudulently in order for a creditor to prevail under section 523(a)(2)(A), it repeatedly acknowledged that the liability must “arise from” the fraud to be nondischargeable.6 All such damages, including statutory punitive damages “assessed on account of the fraud,” escape discharge. Here, however, the § 7031(b) damages were not “assessed on account” of or flow from Debtor’s fraud; in fact, the state court held that Creditor *7suffered no compensatory damages as a result of Debtor’s fraudulent representation.

The statutory disgorgement did not require a showing of fraud; section 7031 is neutral as to fraudulent intent and was enacted to deter unlicensed contractors from offering their services for pay. Hydrotech Systems, 277 Cal.Rptr. 517, 803 P.2d at 374. Creditor could have been awarded the $123,000 disgorgement even if he had known before entering the home improvement contract that Debtor and Pacific were unlicensed. Id. at 376. The disgorgement award was thus unrelated to Debtor’s fraud, and could have been granted in the absence of justifiable reliance, another essential element of section 523(a)(2)(A).

As a consequence, the award did not “arise from” Debtor’s fraud and Cohen v. De La Cruz is distinguishable.7 Creditor has not demonstrated that the amount represents damages he incurred as a result of Debtor’s fraud, a requisite for the application of section 523(a)(2)(A).8 Slyman, 234 F.3d at 1085. Therefore, the bankruptcy court did not err in holding that such damages fall outside the ambit of the fraud exception to discharge.9

VI. CONCLUSION

Because the $123,000 disgorgement of compensation under § 7031(b) did not *8arise or flow from Debtor’s fraudulent conduct, the bankruptcy court correctly held that section 523(a)(2)(A) did not apply to that debt. We therefore AFFIRM the determination that the award of $128,000 was dischargeable, but REVERSE as to the determination that the $500 penalty was dischargeable.