Wednesday, April 14, 2010
Court: Unlicensed Contractor Recovery Awards Are Dischargeable
By STEVEN M. ELLIS, Staff Writer
Awards under a state law allowing recovery of compensation paid to unlicensed contractors can be discharged in bankruptcy, the Ninth U.S. Circuit Court of Appeals ruled yesterday.
A three-judge panel unanimously held that discharge was not barred by an exception for debts obtained by fraud because the state statute is not premised on fraud or actual harm.
The Ninth Circuit Bankruptcy Panel split on the issue when Abdul Ghomeshi appealed a bankruptcy judge’s determination that his $123,000 judgment against Yehuda Sabban over a home remodeling project was not excepted from discharge by 11 U.S.C. § 523(a)(2)(A).
Ghomeshi entered into a series of contracts with Sabban in 2002 after Sabban falsely represented that his company was licensed by California’s Contractors State License Board. Ghomeshi paid Sabban $123,000 for the work performed, and Sabban paid over $129,000 to licensed subcontractors and other material and labor providers on the project.
State Law Action
Ghomeshi later sued Sabban in state court for violations of Business & Professions Code Secs. 7160 and 7031(b) after discovering Sabban was not licensed. The former provides a cause of action to individuals induced to contract for home improvements in reliance on fraudulent statements, while the latter allows a party who has used the services of an unlicensed contractor to recover all compensation paid to that contractor.
The state court found that Ghomeshi relied on false and fraudulent representations by Sabban and awarded him full reimbursement under Sec. 7031(b), but only awarded a $500 penalty under Sec. 7160, reasoning that “[t]echnically there are no damages.”
Sabban then filed for Chapter 7 bankruptcy protection and Ghomeshi filed suit in bankruptcy court to prevent discharge of the awards under 11 U.S.C. § 523(a)(2)(A).
The statute bars discharge of a debt where the debtor made representations he or she knew were false at the time, and did so with the intent of deceiving the creditor. The creditor must also have relied on the representations and sustained the alleged loss as a result.
U.S. Bankruptcy Court Judge Kathleen Thompson of the Central District of California determined that only the penalty was nondischargeable, and the Bankruptcy Appellate Panel affirmed in an opinion by Chief Judge Dennis Montali.
Montali, joined by Judge Randall L. Dunn, reasoned that the $123,000 award was not a debt obtained by “false pretenses, false representation, or actual fraud” because the state court specifically found that Ghomeshi had not been damaged, and because state law would still have allowed disgorgement had Ghomeshi known of Sabban’s unlicensed status.
Judge Jim D. Pappas wrote in dissent:
“[T]he facts show that but for the debtor’s fraud, Creditor would have never hired nor paid him. Plainly, the debtor’s responsibility to disgorge payments to Creditor is directly traceable to his deception.”
However, on appeal to the Ninth Circuit, the court agreed with the Bankruptcy Appellate Panel majority in an opinion by Judge William A. Fletcher, who rebuffed Ghomeshi’s argument that permitting the discharge of Sec. 7031(b) awards undermines state policy.
“Congress has made a considered judgment that the ‘fresh start’ policy of the Bankruptcy Code should override other state and federal laws under which debtors incur enforceable legal obligations,” Fletcher wrote.
Judge Richard R. Clifton U.S. District Court Judge James K. Singleton of the District of Alaska, sitting by designation, joined Fletcher in his opinion.
The case is In re Sabban, 08-60017.
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