United States v. Larson ( 2020 )

United States Court of Appeals
For the First Circuit
No. 18-9007
EDWARD T. STEWART, JR.,
Debtor.
_____________________
SHEILA DEWITT and JOSEPH DEWITT,
Plaintiffs/Creditors, Appellees,
v.
EDWARD T. STEWART, JR.,
Defendant/Debtor, Appellant.
APPEAL FROM THE BANKRUPTCY APPELLATE PANEL
FOR THE FIRST CIRCUIT
Before
Howard, Chief Judge,
Torruella and Selya, Circuit Judges.
Nancy H. Michels, with whom David M. Stamatis and Parnell,
Michels & McKay, PLLC were on brief, for appellant.
Daniel M. Deschenes, with whom Seth M. Pasakarnis and
Hinckley, Allen & Snyder LLP were on brief, for appellees.
February 3, 2020
TORRUELLA, Circuit Judge. In this bankruptcy case,
appellant Edward T. Stewart ("Stewart") -- the debtor -- asks that
we reverse a decision by the Bankruptcy Appellate Panel ("BAP")
concluding that Stewart's debt to Joseph and Sheila DeWitt ("the
DeWitts") was not dischargeable because it was exempted under
§ 523(a)(2)(A) of the U.S. Bankruptcy Code, 11 U.S.C § 523
(a)(2)(A).
The DeWitts hired Stewart and his company, Boardwalk
North ("BN"), in 2013 to remodel their New Hampshire home. During
the course of their dealings, the DeWitts alleged that Stewart
misrepresented, among other things, the financial health of his
company and that he would use so-called "milestone payments" to
both "fund" their renovation project and "leverage"
subcontractors. As matters devolved, after the DeWitts had
already paid ninety percent of the project costs but Stewart and
his company had only completed forty-five percent of the
renovations, Stewart abandoned the project in the summer of 2014.
The DeWitts ultimately hired another company to finish the
renovations for a cost of $736,786.30 -- $558,335.38 in excess of
their pending balance with Stewart and BN.
On September 29, 2014, BN filed for Chapter 7 bankruptcy.
With his personal finances similarly underwater, Stewart also
filed for relief under Chapter 7 on February 23, 2015. The DeWitts
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thereafter filed a proof of claim in Stewart's bankruptcy case,
indicating that they held an unsecured claim for $558,335.38. On
May 26, 2015, the DeWitts commenced an adversary proceeding against
Stewart seeking to exempt their unsecured claim from discharge.
The centerpiece of the DeWitts' thirteen-count complaint was that
their claim against Stewart was ineligible for discharge, per
§ 523(a)(2)(A), because the debt resulted from Stewart's false
statements and misrepresentations. The bankruptcy court disagreed
with the DeWitts, and on August 18, 2017, it entered a final
judgment concluding that their unsecured claim against Stewart was
dischargeable. Unsatisfied, the DeWitts appealed to the BAP,
which reversed the bankruptcy court. Stewart filed a timely
appeal before our Court on November 29, 2018.
For the following reasons, we now vacate the BAP's
decision and remand with instructions that the case be returned to
the bankruptcy court. First, the bankruptcy court misapplied the
standard for fraudulent intent under § 523(a)(2)(A) -- best
articulated by our decision in Palmacci v. Umpierrez, 121 F.3d 781(1st Cir. 1997) -- which it was required to employ when determining
whether Stewart intended to deceive the DeWitts. Second, instead
of reviewing for "clear error," as it was supposed to, the BAP
exceeded the bounds of appellate review by engaging in fact-finding
when it reversed the bankruptcy court.
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I.
A. Factual Background
We begin by offering an overview of the relevant facts,
gleaned from five days of trial testimony and several hundred
exhibits, noting disputes as they arise. Stewart owned BN, which
was a design-build firm based in New Hampshire.1 Even though she
had no formal training in accounting, Stewart's wife Linda managed
BN's accounts, while Stewart focused on the company's management
and business development. Stewart left the finances to Linda and
BN's accountant, Peter Pike. During the lean years of the Great
Recession, starting in 2008, the Stewarts ceased taking personal
salaries and loaned money to the company. It was not until April
2013 that the Stewarts began taking a salary from BN again,
although at a reduced rate.
For their part, in early 2013, the DeWitts were looking
to renovate and expand their home ("the project") to better
accommodate their community outreach activities. Sheila DeWitt,
a scientist and entrepreneur, and her husband Joe DeWitt, a high
school teacher with degrees in Divinity and Economics, had settled
on an initial budget for the project between $700,000 and $1
1 A design-build firm is hired to put together architectural plans
for a construction project and then serves as the general
contractor throughout.
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million. Searching for the right contractor, the DeWitts attended
a New Hampshire Home Builders Association home show on March 3,
2013. There, the DeWitts met Stewart at BN's company booth. The
DeWitts described their project to Stewart, who indicated that BN
was well qualified for the job. After this conversation, BN joined
the shortlist of contractors the DeWitts would potentially hire
for the project.
On March 23, 2013, as part of their vetting process, the
DeWitts emailed Stewart with questions about BN's financials,
including its revenues and number of projects for recent years, as
well as its revenue projections for 2013 without the DeWitt
project. According to the DeWitts, their purpose in asking these
questions was to confirm that their project "would not be a large
portion of [BN's] revenues and that [BN] was healthy and
prospering." In response to the DeWitts' request for information,
Stewart claimed that BN's revenue numbers were approximately as
follows: $2.3 million in 2011; $1.7 million in 2012; and $1.2
million as of March 2013. Stewart projected that BN's 2013 revenue
would be between $2.4 and $2.9 million without the DeWitts'
project. His reply did not answer the question about the number
of projects. According to BN's tax returns submitted into
evidence, BN's actual revenues for those years were approximately
$1.95 million in 2011, $1.55 million in 2012, and only $335,000
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through March 2013. At trial, Joe DeWitt testified that had BN
disclosed the real numbers, it "would have dropped out of the
running." During an in-person conversation around this time,
according to the DeWitts' testimony, they also inquired about
Stewart's relationships with subcontractors, which Stewart
described as "excellent." Brian Lessard, the project lead,
testified at trial that some of the relationships with
subcontractors were "good, [and] some were bad" due to "payment
history."
Ultimately, the DeWitts hired BN. First, the DeWitts
and BN entered into a "Design Fee Purchase Agreement" on April 19,
2013. For a fee of $2,895, BN would come up with a conceptual
drawing using the DeWitts' project goals and proposed budget. The
contract terms provided for two office visits of approximately
three hours each with additional visits to be invoiced at $90 per
hour. The contract included a penalty provision of eight percent
of the high end of the project price range ($1 million at that
point) if the DeWitts were to unilaterally withdraw.
Approximately two months later, the parties executed the
Purchase Agreement with a price tag of $1,649,936. The day before,
on June 26, 2013, the DeWitts had wired a $200,000 "good faith
deposit" to Stewart, an amount in excess of the ten to fifteen
percent deposit provided for in the design agreement. Having
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second thoughts because of the high final price, on July 2, 2013,
Joe DeWitt informed Stewart that they wanted out of the agreement,
which, Stewart testified, did not surprise him. Stewart also
stated that, at that point, BN was prepared to return the $200,000
deposit, although the DeWitts never asked for it back.2 Despite
the DeWitts' misgivings, negotiations resumed, and on August 2,
2013, the parties settled on changes to the project's design that
reduced costs to $1.3 million; this reduction was reflected in an
amendment to the original contract.
The contract contained a "milestone" payments schedule
so that at the start of most construction activities, a milestone
was triggered, and the DeWitts were required to pay a uniform
amount of $40,619.05. Stewart told the DeWitts that these
"milestone payments" would allow them to "fund their own project."
The DeWitts testified that they interpreted the milestone payment
scheme, in light of Stewart's representations, to mean that their
payments would be used specifically for their own project and would
never have given this money in advance if they had known it was
going to pay off BN's existing debts. Stewart countered that he
never said that the DeWitts' payments would only go toward their
2 The DeWitts presented evidence that a portion of the deposit
was spent within days of BN's receipt. Stewart responded that he
still would have been able to pay back the deposit even a month
after it was received.
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project and, like with all of BN's projects, "the money went into
the business" and "funded [the DeWitts'] project indirectly."
Stewart also offered the DeWitts a five percent discount
on the milestone payments if they paid in advance of the
corresponding construction phase. Stewart told the DeWitts that
the prepayment of milestones would allow him to "leverage"
subcontractors.3 The DeWitts opted for the prepayment discount,
and on August 27, 2013, at Stewart's request, paid a second deposit
of $172,000, plus the price of two milestones. The DeWitts
presented evidence at trial that BN expended this payment within
weeks primarily on "Non-DeWitt Project Costs."
Work began in August, but from the get-go, the project
suffered from delay and inefficiencies. Stewart and Lessard
testified at trial that the DeWitt project was BN's most
3 Later, the DeWitts would raise concern about how early they
were being asked to prepay the milestones. In an email sent on
March 6, 2014, Lessard offered the following explanation:
As far as the pre-payment goes, as you imagine in
order for us to offer this discount the idea is that
we are leveraging your money to save money. So we
would need to leverage your money for more then [sic]
a couple days to off set [sic] the ($20,000.00 over
all [sic]) discount being applied. This program was
designed with the intention that there would be
multiple payments made at a time and that would allow
us plenty of time to leverage and save money, with
time being the catch. Having the benefit of your
funds for a mere few days in return for such a large
amount of money would be ill advised by even the most
liberal accounts . . . .
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comprehensive and complex. This was consistent with what Stewart
had relayed to the DeWitts during their due diligence process --
that BN's highest ranging job was for $825,000 -- and Lessard's
April 1, 2014 email to the DeWitts comparing the 850 hours of
redesign time spent on their project to the ten hours that usually
were required for BN's average sale of $80,000.
When the DeWitts asked about delays, Lessard explained
they were because the subcontractors had failed to show up, never
disclosing to the DeWitts that certain products or services had
not arrived because BN actually lacked the money to purchase them.
Having witnessed the project unfold firsthand from the vantage of
the basement apartment where the DeWitts resided during
construction, Joe DeWitt testified to examples of what he believed
to be improper sequencing of phases of the project, like the
erecting of a stone veneer prior to completing electrical wiring
which would have to go behind it, concluding that this progression
"was geared to getting to the next milestone." Lars Traffie, the
head of Hutter Construction whom the DeWitts eventually hired to
complete the project, also testified to this mis-sequencing,
stating that, as he found it, the sequencing was "so inexplicable
I guess that one could, you know, jump to the opinion then that it
was more motivated by payment schedules and -- and based on the
contract than to quality of a construction project." Countering
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these allegations of abusing the milestone payment scheme,
Stewart, by way of Lessard, offered the following explanation:
payments were triggered to "keep the business moving forward," and
it was better to make some progress than none at all. Stewart
opined on the project schedule: "there's just too many reasons for
things to go bump in the night in the remodeling business."
Meanwhile, as the DeWitt project was playing out, BN's
financial problems deepened, and in February 2014, Stewart met
with Pike to explore a possible way forward, including a sale of
the business, potential avenues for additional credit, or a
bankruptcy filing. By July 2014, BN's coffers were entirely
depleted. Unable to continue work on the DeWitts' project,
Stewart and Lessard met with the DeWitts on July 22, 2014 to inform
them of the firm's financial collapse and that a subcontractor had
placed a mechanic's lien on the DeWitts' property. Two more liens
from other subcontractors were to follow. Within the prior three
weeks, the DeWitts had paid BN almost $80,000. From the inception
of their tumultuous relationship up to that point, the DeWitts had
paid BN $1,178,245.12, approximately ninety percent of the project
price, for only forty-five percent of the work and a home that was
reportedly in "shambles." Two days after the July 22 meeting,
Stewart emailed the DeWitts that BN's financial problems had been
resolved; the DeWitts were unconvinced.
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On August 5, 2014, Stewart borrowed $50,000 from his
401(k) account to put into the company after trying to access the
entire amount for this purpose. But this and any other last-ditch
effort to save BN and the DeWitt project would eventually fail.
After a complete breakdown of communications, BN sent the DeWitts,
on or around August 15, 2014, an "as-built policy invoice" charging
them $183,629.45 ostensibly for unbilled time. The DeWitts did
not render any payments on account of this invoice.
On September 29, 2014, BN filed for Chapter 7 bankruptcy.
Stewart followed suit, filing personally for Chapter 7 in February
2015.
B. Procedural Background
On May 26, 2015, the DeWitts filed an adversary
proceeding against Stewart opposing the discharge of a debt
pursuant to 11 U.S.C. § 523 and the discharge of a debtor pursuant
to 11 U.S.C. § 727.4 The DeWitts alleged that through numerous
false representations, Stewart induced the DeWitts to hire BN and
then proceeded to misuse their advance payments, directing the
4 The various counts in the Amended Complaint follow: (I) piercing
the corporate veil; (II) breach of contract; (III) breach of the
covenant of good faith and fair dealing; (IV) negligence;
(V) conversion; (VI) fraudulent misrepresentation and actual
fraud; (VII) violation of N.H. Rev. Stat. Ann. ch. 358-A;
(VIII) 11 U.S.C. § 523(a)(2)(A); (IX) 11 U.S.C. § 523(a)(2)(B);
(X) 11 U.S.C. § 523(a)(4); (XI) 11 U.S.C. § 523(a)(6); (XII)
11 U.S.C. § 727(a)(2); (XIII) 11 U.S.C. § 727(a)(4).
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funds instead to debts unrelated to the project and for Stewart's
personal enrichment. The complaint requested the corporate veil
be pierced because Stewart had used BN, of which he was the sole
shareholder, President, and Treasurer, as his "alter ego" to
"wrongfully obtain funds from the DeWitts" and "to perpetuate
injustice and fraud." A series of decisions by the bankruptcy
judge reduced the issues for trial.5 The trial proceeded over
five days in February and March 2017, and the court heard testimony
from each of the DeWitts, the Stewarts, Lessard, Pike, and Hutter.
The bankruptcy court issued a final judgment and opinion on
August 18, 2017.
The memorandum opinion began with the court explaining
that it would "assume, without deciding, that the corporate veil
ha[d] been pierced . . . [to] allow[] the Court to cut straight to
the heart of the dispute" because if the debts to the DeWitts were
in fact dischargeable, it would be unnecessary to determine whether
the corporate veil should be pierced. DeWitt v. Stewart (In re
Stewart), Adv. No. 15-1032-JMD, 2017 WL 3601196, at *9 (Bankr.
D.N.H. Aug. 18, 2017). Then, after stating the legal framework
5 On August 18, 2016, the bankruptcy court entered partial summary
judgment for Stewart on counts related to § 523(a)(2)(B) and
§ 523(a)(4). A scheduling order, filed on November 22, 2016,
divided the trial into two parts: Counts VIII-XIII related to the
remaining § 523 and § 727 claims would be heard first, followed by
the state law claims contained in Counts I-VII.
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for finding a debt non-dischargeable under § 523(a)(2)(A), it
attended to the misrepresentations alleged by the DeWitts,
checking off each one in the order it occurred during the parties'
relationship. The court found that the DeWitts had failed to
carry their burden with respect to (1) the incorrect revenue
emails, (2) Stewart's failure to disclose BN's general financial
condition, (3) fraud involving the design agreement, (4) fraud
relating to the use of milestone payments, and (5) the solicitation
of additional payments after the project had ended. Id. at *10-
16. Zooming out, the court assessed the "overall course of dealing
[as] not indicative of actual fraud." Id. at *20. Next, it
addressed the DeWitts' § 523(a)(6) arguments that Stewart had
committed a "willful and malicious injury." Id. Focusing on the
willfulness prong, the court found that "Stewart lacked the intent
required to find willfulness," notwithstanding evidence of "either
mismanagement or negligence." Id. at *21. Having found the debts
not excepted from discharge, the court determined that the damages-
related claims contained in Counts I-VII were moot. Id.
The DeWitts appealed to the BAP on September 1, 2017.
They argued that the bankruptcy court's factual findings were
riddled with "critical clear errors," including "crediting
Stewart's self-serving testimony," and that the court had ignored
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well-settled law when it failed to find false representations,
false pretenses, actual fraud, or willful and malicious injury.
For the most part, the BAP agreed with the DeWitts.
According to the BAP, on appeal, Stewart did not meaningfully
challenge the DeWitts' arguments, except as to whether Stewart had
made express misrepresentations. Dewitt v. Stewart (In re
Stewart), 592 B.R. 414, 434 (B.A.P. 1st Cir. 2018). Departing
from the bankruptcy court's reasoning, the BAP found that Stewart
made at least three sets of express misrepresentations and that
many of the bankruptcy court's factual findings were "contrary to
the testimony of the DeWitts, Lessard, Pike, Traffie, and Stewart,
himself." Id. at 437. Additionally, the BAP decided the bankruptcy
court had erred by not addressing implied misrepresentations under
the theory of false pretenses and that "the record, viewed as a
whole, supports a conclusion that [Stewart] impliedly made such
false representations." Id. at 439. The BAP next found that
Stewart had acted with the intent to deceive. Id. It considered
any challenge to the DeWitts' contention that they had relied on
Stewart's false representations as waived by Stewart on appeal,
and in any event, that the record demonstrated that the DeWitts
had satisfied their burden to show actual and justifiable reliance.
Id. at 349-40, 440 n.17. Finally, the BAP deemed that the DeWitts
had suffered harm, the final piece of the puzzle allowing Stewart's
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liability to the DeWitts to be excepted from discharge under §
523(a)(2)(A). Id. at 440. Having reached the opposite conclusion
as the bankruptcy court with respect to the dischargeability of
the debt, the BAP proceeded to find that "the record shows that
Stewart used [BN]'s corporate form to promote an injustice against
the DeWitts," which it found sufficient to pierce the corporate
veil under New Hampshire law. Id. at 441. The result was a
reversal of Counts I and VIII and remand for the bankruptcy court
to determine damages. Id. at 442. Now, Stewart appeals.
II.
A. Section 523(a)(2)(A): False Pretenses, False
Representation, and Actual Fraud
We review "the bankruptcy court's findings of fact for
clear error and afford[] de novo review to its conclusions of law."
Smith v. Pritchett (In re Smith), 586 F.3d 69, 73 (1st Cir. 2009)
(quoting Werthen v. Werthen (In re Werthen), 329 F.3d 269, 272
(1st Cir. 2003)). Because we owe no formal deference to the BAP
decision, "we look through that decision and directly review the
bankruptcy court's findings" ourselves. de Benedictis v. Brady-
Zell (In re Brady-Zell), 756 F.3d 69, 72 n.2 (1st Cir. 2014)
(citing In re Smith, 586 F.3d at 73); Privitera v. Curran (In re
Curran), 855 F.3d 19, 24 (1st Cir. 2017). The clear error standard
of review "plainly does not entitle a reviewing court to reverse
the finding of the trier of fact simply because it is convinced
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that it would have decided the case differently." Dev.
Specialists, Inc. v. Kaplan (In re Irving Tanning Co.), 876 F.3d
384, 389 (1st Cir. 2017) (quoting Anderson v. City of Bessemer
City, 470 U.S. 564, 573 (1985)). A finding of fact is only clearly
erroneous when "the reviewing court on the entire evidence is left
with the definite and firm conviction that a mistake has been
committed." Id. (quoting Anderson, 470 U.S. at 573); see Toye v.
O'Donnell (In re O'Donnell), 728 F.3d 41, 46 (1st Cir. 2013)
(declining to find clear error where the judge's view was "not
'wrong with the force of a 5 week old, unrefrigerated, dead fish'"
(quoting S Indus., Inc. v. Centra 2000, Inc., 249 F.3d 625, 627
(7th Cir. 2001))). "Deference to the findings of the bankruptcy
court is especially appropriate where a determination depends upon
an assessment of credibility" and the assignment of weight to the
witness's testimony. In re Irving Tanning Co., 876 F.3d at 389
(citing Palmacci, 121 F.3d at 785).
Section 523(a)(2)(A) of the Bankruptcy Code states that
a debt will be excepted from discharge:
(2) for money, property, services, or an extension,
renewal, or refinancing of credit, to the extent
obtained by—
(A) false pretenses, a false representation, or actual
fraud, other than a statement respecting the debtor's
or an insider's financial condition.
11 U.S.C. § 523(a)(2)(A). In keeping with the Bankruptcy Code's
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"fresh start" policy, the "[e]xceptions to discharge are narrowly
construed[,] . . . and, for that reason, the claimant must show
that his 'claim comes squarely within an exception enumerated in
Bankruptcy Code § 523(a).'" Palmacci, 121 F.3d at 786 (quoting
Century 21 Balfour Real Estate v. Menna (In re Menna), 16 F.3d 7,
9 (1st Cir. 1994)); see also McCoy v. Spigel (In re Spigel), 260
F.3d 27, 35 (1st Cir. 2001) (explaining that the narrow exceptions
to discharge do not always protect the inculpable creditor).
Although sharing certain elements, false pretenses, false
representation, and actual fraud form "three distinct categories
of misconduct," and by proving any of the three, the claimant will
stave off discharge of a particular debt. Privitera v. Curran (In
re Curran), 554 B.R. 272, 284-85 (B.A.P. 1st Cir. 2016), aff'd,
855 F.3d 19 (1st Cir. 2017); see McGuinness v. Gannon (In re
Gannon), 598 B.R. 72, 82-83 (Bankr. D. Mass. 2019).
To make out a claim for false representation, the
plaintiff must prove by a preponderance of the evidence that:
1) the debtor made a knowingly false representation
or one made in reckless disregard of the truth, 2)
the debtor intended to deceive, 3) the debtor intended
to induce the creditor to rely upon the false
statement, 4) the creditor actually relied upon the
false statement, 5) the creditor's reliance was
justifiable, and 6) the reliance upon the false
statement caused damage.
Sharfarz v. Goguen (In re Goguen), 691 F.3d 62, 66 (1st Cir. 2012)
(quoting In re Spigel, 260 F.3d at 32); Grogan v. Garner, 498 U.S.
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279, 291 (1991) (holding that standard of proof for
dischargeability exceptions is by a preponderance of the
evidence). Each of the six elements constitutes a finding of
fact, and failure to prove any one of them defeats the claim.
Palmacci, 121 F.3d at 787-88 (citing Commerce Bank & Tr. Co. v.
Burgess (In re Burgess), 955 F.2d 134, 139 (1st Cir. 1992)). "The
requirements for false pretenses 'are largely the same, except
that requirement of a false representation is replaced by a
requirement of a false pretense, which is an implied
misrepresentation or a false impression created by conduct of the
debtor.'" Curran, 554 B.R. at 285 (quoting Meads v. Ribeiro (In
re Ribeiro), Adv. No. 11–1188, 2014 WL 2780027, at *9 (Bankr. D.
Mass. June 19, 2014)). False pretenses may "arise when the
circumstances 'imply a particular set of facts, and one party knows
the facts to be otherwise' but does not correct the counter-party's
false impression." In re Curran, 855 F.3d at 28-29 (quoting Old
Republic Nat'l Title Ins. Co. v. Levasseur (In re Levasseur), 737
F.3d 814, 818 (1st Cir. 2013)) (affirming a denial of the
plaintiff's motion to amend her complaint to add claims under §
523(a)(2)(A) when she had failed to plead facts sufficient to show
false pretenses or a false representation).
Actual fraud, understood in light of the common law
definition found in the Restatement (Second) of Torts (Am. Law
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Inst. 1977), is broader than misrepresentation. Sauer Inc. v.
Lawson (In re Lawson), 791 F.3d 214, 219-20 (1st Cir. 2015)
(holding that "actual fraud" as used in § 523(a)(2)(A) does not
require a misrepresentation and includes the knowing receipt of
fraudulent conveyances). It "consists of any deceit, artifice,
trick, or design involving direct and active operation of the mind,
used to circumvent and cheat another." Id. at 219 (quoting 4
Collier on Bankruptcy ¶ 523.08[1][e] (A.N. Resnick & H.J. Sommer
eds., 16th ed. 2015)). Actual fraud, compared to merely
constructive fraud, requires wrongful intent and cannot be implied
by law. Id. at 220; see Husky Int'l Elecs., Inc. v. Ritz, 136 S.
Ct. 1581, 1586-87 (2016).
While "[t]he statutory requirements for a discharge are
'construed liberally in favor of the debtor,'" Palmacci, 121 F.3d
at 786 (quoting Boroff v. Tully (In re Tully), 818 F.2d 106, 110
(1st Cir. 1987)), the law limits discharge to "the honest but
unfortunate debtor," In re O'Donnell, 728 F.3d at 42 (quoting
Grogan, 498 U.S. at 286-87).
On appeal, Stewart defends the bankruptcy court's
opinion allowing the discharge of the DeWitts' claims and charges
that the BAP erred when it reweighed the evidence, decided
arguments not properly preserved below, and conducted its own fact-
finding. Meanwhile, the DeWitts present their position that the
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bankruptcy court's findings were clearly erroneous and its
interpretations of the evidence implausible. They posit that the
"uncontested" facts in evidence -- the false revenue numbers and
misrepresentation of subcontractor relationships, the
"misappropriation" of falsely induced deposit payments, and
finally, the project mis-sequencing aimed at eliciting additional
payments -- are sufficient to meet their burden of proof under
§ 523(a)(2)(A) and the BAP was correct in so concluding.
First, we address the issue of false pretenses or implied
misrepresentations, which Stewart claims was not properly before
the lower courts. The bankruptcy court acknowledged that the
DeWitts were seeking exception to discharge for either "false
pretenses or representations," but did not differentiate between
the two when laying out the legal framework or walking through its
analysis. In re Stewart, 2017 WL 3601196, at *10. The BAP found
that "[t]he bankruptcy court committed clear error when: (1) it
did not analyze whether Stewart obtained the DeWitts' money through
false pretenses; and (2) it did not find that the DeWitts proved
that Stewart obtained their money through false pretenses." In
re Stewart, 592 B.R. at 439. Stewart now argues on appeal that
the DeWitts did not clearly present this theory to the bankruptcy
court (or to the BAP for that matter), other than by citing the
entirety of § 523(a)(2)(A), and instead focused their arguments on
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false representations and actual fraud. Therefore, he claims the
BAP effectively decided an issue not before the bankruptcy court.
The DeWitts counter this waiver argument by pointing out that the
claim for false pretenses is nearly identical to that for false
representation, "lumped together" if you will, and "'mirrors' the
argument before the trial court."
We note that a "legal theory may not be preserved by
bare reference in a pleading if it is thereafter abandoned until,
freshly discovered on appeal, it is raised anew." Banco Bilbao
Vizcaya Argentaria v. Wiscovitch-Rentas (In re Net-Velázquez), 625
F.3d 34, 40 (1st Cir. 2010). Yet, having parsed the DeWitts'
closing brief submitted to the bankruptcy court, as well as their
brief to the BAP, we conclude that they did in fact preserve their
claim for false pretenses below, albeit not in the clearest of
terms. First, the theories of false pretenses and false
representation under § 523(a)(2)(A) overlap almost completely.
See Kosilek v. Spencer, 774 F.3d 63, 91 n.13 (1st Cir. 2014) (en
banc) (declining to find waiver where the issue significantly
overlapped with the argument raised by the party). On several
occasions, we have suggested that the two theories require a
showing of the same elements. See, e.g., In re Goguen, 691 F.3d
at 66; In re Spigel, 260 F.3d at 32. Other times, we have treated
false pretenses as a subset of false representations. See, e.g.,
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In re Curran, 855 F.3d at 28; In re Levasseur, 737 F.3d at 817-
18. The DeWitts' briefs below contain several references to
"false pretenses," and while these references are rather
conclusory, the DeWitts did explicitly state that they were
advancing a false pretenses argument. In addition, the DeWitts
cited and discussed many cases that found both false pretenses
and/or false representations that reflect the overlap of these
arguments. See, e.g., Fornet v. Miller (In re Miller), 5 B.R.
424, 428 (Bankr. W.D. La. 1980) (finding "the debtor made a false
pretense or representation in order to obtain money to pay other
creditors" (emphasis added)). Perhaps most helpful for their
cause is their mention of Fensick v. Segala (In re Segala), 133
B.R. 261 (Bankr. D. Mass. 1991), where the bankruptcy court found
that when "funds are deemed to have been entrusted to the debtor
for a specific purpose, the debtor is regarded as impliedly
representing his intention to use the funds accordingly." Id. at
264. There, the plaintiffs had hired the debtor to update their
home, and despite no formal payment schedule, id. at 262, the
plaintiffs had made payments in response to the debtor's non-
specific assertion that he needed the funds to continue the job,
"impliedly represent[ing] that the funds would be used on the job,"
id. at 264. Although the court's conclusion in In re Segala did
not actually use the term "false pretenses," that was clearly its
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meaning.6 In light of the overlap between the theories of false
pretenses and false representation, the DeWitts' curt references
to false pretenses, along with their detailed discussion of various
false representations, sufficiently preserved the issue of implied
misrepresentation. Accordingly, we decline to find the false
pretenses argument waived and agree with the BAP that it was error
not to address whether Stewart obtained the DeWitts' money through
conduct amounting to implied misrepresentations. In re Stewart,
592 B.R. at 439.
This, however, is where our agreement with the BAP on
the issue of false pretenses ends. After drawing this conclusion,
the BAP proceeded to find that "the record, viewed as a whole,
supports a conclusion that [Stewart] impliedly made such false
representations." Id. Given the complexity of the record and the
contested nature of the testimony, we leave this sort of fact-
finding to the trier of fact. See In re Irving Tanning Co., 876
F.3d at 389-90 ("If a trial court's findings are too meager to
allow review, the decision has run afoul of [Federal Rule of Civil
Procedure] 52(a), and the appropriate remedy is a remand for
further fact-finding." (citing Supermercados Econo, Inc. v.
6 On appeal, Stewart argues why the facts of In re Segala are
distinguishable. Without deciding the merits of these arguments,
we cite this case only to illustrate that the issue of false
pretenses was preserved below.
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Integrand Assurance Co., 375 F.3d 1, 5 (1st Cir. 2004))).
Therefore, we remand to the BAP with instructions to return the
case to the bankruptcy court for further findings on this issue.
Next, before weighing in on the court's fact-finding on
the elements of the false representation claims, we look to see
whether the bankruptcy court applied the correct legal standards,
an exercise we perform de novo. In re Goguen, 691 F.3d at 68.
Here, we find that the bankruptcy court erred when determining
what is required to prove a false representation. In particular,
the bankruptcy court took too narrow a view of what constitutes
intent to deceive. Intent to deceive may be found if any of the
following are true:
the maker of the misrepresentation "(a) knows or
believes that the matter is not as he represents it
to be; (b) does not have the confidence in the
accuracy of his representation that he states or
implies; or (c) knows that he does not have the basis
for his representation that he states or implies."
Palmacci, 121 F.3d at 787 (quoting Restatement (Second) of Torts
§ 526). A "false representation as to one's intention, such as a
promise to act," can qualify as a misrepresentation under
§ 523(a)(2)(A). Id. at 786. In the context of such a
misrepresentation, the question of fraudulent intent centers on
the debtor's state of mind with regard to his promise. See id.
at 788. The trier of fact must ask whether the representation was
made in bad faith, i.e., with either an "intention of reneging on
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his promise" or "recklessly disregarding whether or not he would
keep his promise." Id. at 789. Simply breaking one's contractual
obligations does not, therefore, evidence such fraudulent intent.
See id. at 787. Nevertheless, the trier of fact may infer the
requisite intent or recklessness if the debtor knew or should have
known that he could not keep his promise. See id. at 788-89. And
this inference may be derived from the totality of circumstances,
including from circumstantial facts and post-transaction conduct.
Id. at 789, 792-93.
On appeal to the BAP, the DeWitts -- then appellants,
now appellees -- focused their arguments on Stewart's
representations regarding the use of their payments which would go
to "fund their project" and "leverage subcontractors." Thus, we
limit our ensuing analysis to those representations.7
7 In this appeal, the DeWitts, as appellees, have renewed their
arguments regarding Stewart's misrepresentations of BN's finances
and subcontractor relations, which were not clearly presented as
arguments to the BAP. We recently noted in Popular Auto, Inc. v.
Reyes-Colón (In re Reyes-Colón) that "[a]t least two circuits have
held that the losing party in the bankruptcy court cannot raise on
appeal to the circuit court arguments not presented to the district
court on intermediate review." 922 F.3d 13, 18 (1st Cir. 2019)
(citing Bradley v. Ingalls (In re Bradley), 501 F.3d 421, 433 (5th
Cir. 2007); United States v. Olson, 4 F.3d 562, 567 (8th Cir.
1993)). And we accept this non-extraordinary position, at least
as it applies here to the facts of this case. Also, on the subject
of waiver, while the BAP found that Stewart made express
misrepresentations related to BN's ability to complete the
DeWitts' renovation within budget and as to the purposes of the
first and second deposits, In re Stewart, 592 B.R. at 434-35, the
DeWitts do not stress these arguments on appeal before us. Thus,
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The bankruptcy court dealt with the DeWitts' claims that
Stewart misrepresented the milestone payment structure to "fund
their project" and that BN would use these advance payments to
"leverage subcontractors" as distinct issues. In re Stewart, 2017
WL 3601196, at *14. As to the first issue, the court rejected
that Stewart "either intended to convey false information to the
DeWitts or to deceive them." Id. It proceeded to find the
representations too general to be false and accepted as plausible
Stewart's explanation that Stewart only meant that BN would not be
able to perform the project without the milestone payment scheme.
Id.
Next, the court turned to statements about "leveraging
subcontractors," finding no actual reliance by the DeWitts and
insufficient evidence of an intent to mislead because Stewart "was
simply providing an explanation of why BN was offering the
discount," which the DeWitts ended up receiving. Id. The problem
with the court's reasoning that Stewart lacked the intent to
deceive because these statements were merely explanations of a
discount is that it fails to consider whether Stewart actually
although the DeWitts have waived any argument that these sets of
representations were fraudulent, we recognize that they may be
relevant in a totality of the circumstances analysis of Stewart's
fraudulent intent with regard to the promise that he would use
milestone payments to leverage subcontractors.
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planned to keep his promise to invest the milestone payments to
the benefit of the DeWitts' project. For all its thoroughness,
the bankruptcy court failed to take into consideration whether
Stewart recklessly disregarded the truth of these representations.
And the correct analysis to answer this question would focus on
the totality of the circumstances surrounding these statements,
particularly in tandem with testimony from the DeWitts that Stewart
represented that the payments would be used "to fund [their]
project," along with other evidence that the funds were being spent
elsewhere. Palmacci, 121 F.3d at 789 ("Among the circumstances
from which scienter may be inferred are: the defendant's insolvency
or some other reason to know that he cannot pay, his repudiation
of the promise soon after made, or his failure even to attempt any
performance."). In addition, the accusations that the project was
mis-sequenced for the purposes of generating milestone payments
might serve as helpful context that bear on these alleged
misstatements.8
As for what the court found Stewart meant when he said
the payment scheme was to "fund your own project" (i.e., provide
8 To be sure, later in its opinion, the bankruptcy court did offer
an overview of the entire course of dealing, but only in the
context of whether Stewart had committed actual fraud by way of a
complex scheme against the DeWitts. In re Stewart, 2017 WL 3601196,
at *16-20.
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cash flow to the company), we doubt this reading squares with our
analysis of what constitutes a misrepresentation in Palmacci. Id.
at 788 (finding an express misrepresentation because "[a]n
ordinary lay person like [the creditor] would not think, nor would
it be reasonable to expect him to think, that [the debtor's]
representation that he would invest 'his own personal funds' in
the . . . project could be read to include funds he borrowed from
a bank secured by a mortgage on the project property itself"). We
wager that a lay person presented with a payment scheme, whereby
payments are triggered at the start of certain construction
milestones so as to "fund your own project," would not think that
this instead means that the money would be used to pay off a
company's old debts and extraneous expenses. However, we do not
belabor this point. Instead, we hold that, while the "fund your
own project" statements might not amount to express
misrepresentations in their own right, as the bankruptcy court
found, they still might serve to elucidate Stewart's intent when
assuring the DeWitts that the advance payments were being used to
leverage subcontractors. Finally, while perhaps the initial
representation about the goals of the milestone payments to
leverage subcontractors may have been a theoretical explanation of
the payment plan's goals, as Lessard and Stewart testified, BN's
subsequent requests for early milestone payments, and the
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specificity offered by Lessard as to how the DeWitts' money would
then be leveraged in his March 6 email (i.e., to the benefit of
the DeWitts' project), should be considered by the bankruptcy court
in light of the context at the time these representations were
made.
Also relevant to this analysis, the bankruptcy court
separately addressed the DeWitts' arguments related to the
solicitation of payments at the end of the project. In re Stewart,
2017 WL 3601196, at *15-16. It concluded that the DeWitts'
evidence on this point, i.e., the amounts owed to vendors on the
DeWitts' project at the end of 2014 and exchanges between
subcontractors illustrating BN's inability to pay, was
"insufficient for the Court to conclude that Stewart either knew
that BN would not be able to complete the project or recklessly
disregarded the truth of that fact with an intent to deceive the
DeWitts." Id. at *16. However, rather than disposing of this
evidence as support for a stand-alone argument insufficient to
show fraudulent intent, this evidence should have been viewed as
context for the aforementioned misrepresentations. To be clear,
intent under § 523(a)(2)(A) does not require the intent to harm.
Cf. Printy v. Dean Witter Reynolds, Inc., 110 F.3d 853, 859 (1st
Cir. 1997) (finding that the malice element of a § 523(a)(6) claim,
in contrast, requires an intent to cause harm exceeding negligence
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and recklessness). And intentionally using deception to solicit
payments is not inconsistent with the court's other finding, based
on Stewart's testimony, that Stewart still believed he could
complete the project. In re Stewart, 2017 WL 3601196, at *16.
The latter may be true, but by misrepresenting how the milestone
payments were being used (to leverage subcontractors for the
benefit of the DeWitts' project), in light of BN's dire financial
situation, an inference of intent to deceive could very well
follow. We agree with the BAP's conclusion that "[i]t does not
necessarily follow from Stewart's attempt to rescue his own company
. . . that he had been honest in his dealings with the DeWitts."
In re Stewart, 592 B.R. at 438. While it may not have been
Stewart's intent to harm the DeWitts by not completing their
project, the right question is whether he intended to deceive them,
through recklessly made misrepresentations, in light of the
totality of the circumstances.
That still leaves us with the bankruptcy court's
alternative ground for finding no misrepresentation with respect
to the leveraging statements – i.e., that "there is no evidence
that the DeWitts actually relied on [them]." In re Stewart, 2017
WL 3601196, at *15; see Palmacci, 121 F.3d at 788 ("[A] factual
finding that negates one element of the plaintiff's prima facie
case renders findings concerning other elements unnecessary.").
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The court found that the DeWitts made the prepayments in order to
secure the discount that Stewart offered and ultimately provided
and that there was no evidence that the DeWitts believed that they
would receive an additional discount if BN could leverage its
subcontractors. In re Stewart, 2017 WL 3601196, at *15. In
reversing, the BAP found that Stewart had waived all arguments
with respect to actual and justifiable reliance by not countering
the DeWitts' argument on appeal that "the DeWitts actually did
rely on Stewart's representations."9 In re Stewart, 592 B.R. at
439-40. However, on appeal to the BAP, we find that Stewart did
in fact respond by citing and adopting the bankruptcy court's
reasoning that there was no reliance. Thus, we conclude it was
error to deem this argument waived, but nevertheless, agree with
the BAP's alternative suggestion that the bankruptcy court erred
by taking too narrow a view of reliance.
It is true that the DeWitts' claims must "arise[] as a
direct result of the debtor's misrepresentations or malice." In
re Spigel, 260 F.3d at 34 (quoting In re Menna, 16 F.3d at 10).
"[I]f a party has not in fact relied on the misrepresentation . . .
9 In their brief to the BAP, the DeWitts' entire argument on this
point is that they "testified that they never would have agreed to
make payments in advance of completion of different phases of the
project if they had known that BN was using these payments for the
general purposes of the business without reserving sufficient
funds to complete their project."
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in entering into a transaction in which he suffers pecuniary loss,
then the misrepresentation is not in fact a cause of the loss."
In re Goguen, 691 F.3d at 69 (second alteration in original)
(internal quotation marks omitted) (quoting Restatement (Second)
of Torts § 546 cmt. a) (holding that post-contract-formation
misrepresentations by the debtor that lead the creditor to "stay[]
the course" rather than opt out of the contract may constitute
cause-in-fact of the creditor's subsequent harm). Here, the
relevant transaction does not necessarily refer to the initial
ill-fated decision to contract with BN. The transaction could be
the DeWitts' continuing decision to prepay contract milestones
when the payments were being diverted elsewhere and not as
represented, i.e., to leverage subcontractors. For a "fraud that
induces the creditor not to exercise a right arising from the
contract may make the debtor's debt nondischargeable." Id. at 70
(citing Field v. Mans, 157 F.3d 35, 39, 42-46 (1st Cir. 1998)).
Therefore, the bankruptcy court erred by applying a standard of
reliance that overlooked the role those statements may have had in
continuing to string along the DeWitts.
Justifiable reliance, on the other hand, "is a matter of
the qualities and characteristics of the particular plaintiff, and
the circumstances of the particular case, rather than of the
application of a community standard of conduct to all cases."
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Field v. Mans, 516 U.S. 59, 71 (1995) (quoting Restatement (Second)
of Torts § 545A cmt. b). We acknowledge that the DeWitts testified
as to their reliance.10 But, as we have said before, "[a]t this
stage of bankruptcy litigation, the task of an appellate court is
not to find the facts anew, but, rather, to assay the bankruptcy
court's factfinding for clear error." In re Brady-Zell, 756 F.3d
at 72 (citing In re Tully, 818 F.2d at 109). Therefore, we agree
with Stewart that the BAP erred when it proceeded to reweigh the
10 The pertinent transcript of Sheila DeWitt's direct examination
reads:
Q: So he told you he would use your money in advance to leverage
subcontractors?
A: He did.
. . .
Q: And did you believe him?
A: Yes, we believed him.
Q: If the money wasn't going to your project would you have agreed
to pay everything in advance?
A: Never.
Trial Transcript 2/8/2017 70:9-20.
Q: Did you rely on Mr. Stewart's statement that you were, in fact,
funding your own project?
A: We did.
Q: Did you rely on that in terms of agreeing to this payment
schedule?
A: We did.
Q: Did you rely on that statement in terms of following the payment
schedule?
A: Yes.
Q: And you did follow it, didn't you?
A: Yes. We paid every milestone.
Trial Transcript 2/8/2017 77:10-20.
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evidence and announce its own findings of fact. Here, the BAP
found that the bankruptcy court had "excessively discounted the
testimony of the DeWitts, seemingly in favor of Stewart's testimony
that he transferred $50,000 in August 2014 from his 401(k)
retirement account to [BN]." In re Stewart, 592 B.R. at 438. It
is true that the bankruptcy court was swayed by Stewart's testimony
on the latter point, and had we been the trier of fact, we may
have assigned different weight to this evidence. However, because
we did not have the benefit of seeing Stewart or the DeWitts
testify, it is hard to know what the court was thinking, beyond of
course what it told us (which in fact is a lot). And while many
times the bankruptcy court explicitly explained the weight it was
assigning testimony, it did not give us a full read on the
credibility of the DeWitts, particularly with respect to these
statements on reliance. On appellate review, rather than
reassigning weight to witness testimony when it is apparent the
trier of fact considered it and chose to assign it little weight,
In re Stewart, 2017 WL 3601196, at *14, the proper remedy is to
remand to give the trial court the opportunity to explain its
rationale. Thus, rather than render the fact-based determination
as to actual and justifiable reliance, the latter of which we have
just explained is context-driven and plaintiff-specific, we remand
so the bankruptcy court may determine whether the DeWitts have
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proved, by a preponderance of the evidence, that they actually and
justifiably relied on BN's assurances.11
Therefore, in summary, we remand to the BAP with
instructions to return the case to the bankruptcy court to consider
only the statements pertaining to "leveraging subcontractors" as
express misrepresentations and to apply the aforementioned
standards for intentionality and actual and justifiable reliance.
In conducting the intent analysis, the bankruptcy court should
consider the totality of the circumstances, including Stewart's
nonactionable statements (e.g., "fund your own project"), BN's
dire financial situation, and evidence of mis-sequencing the
construction stages.
Lastly on the subject of § 523(a)(2)(A), the DeWitts
argue that the bankruptcy court clearly erred when it found that
Stewart's overall course of dealing did not amount to actual fraud.
The DeWitts point to Husky International Electronics, Inc. for the
proposition that even in the absence of a misrepresentation, the
court should find that Stewart's entire course of conduct
demonstrates an actually fraudulent scheme. Brief for Plaintiffs-
11 We leave also the sixth element -- the issue of harm –- and
any damages resulting from reliance to the bankruptcy court on
remand, as is our appellate prerogative. See In re Goguen, 691
F.3d at 72 (remanding the issue of damages to the bankruptcy court
when the bankruptcy court had not made specific findings on those
allegations).
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Appellees at 41, DeWitt v. Stewart (In re Stewart), No. 18-9007
(1st Cir. Mar. 11, 2019) (citing 136 S. Ct. at 1587). For purposes
of nondischargeability based on actual fraud, the claimant must
demonstrate that the debtor's "underlying conduct . . . involve[d]
'moral turpitude or intentional wrong.'" 4 Collier on Bankruptcy
¶ 523.08[1][e] (Richard Levin & Henry J. Sommer eds., 16th ed.
2019) (quoting Husky Int'l Elecs., Inc., 136 S. Ct. at 1586). In
addition to the discrete alleged misrepresentations, the
bankruptcy court made a multitude of findings related to the
DeWitts' theory on actual fraud. For example, it found that the
Design Fee Purchase Agreement was not "the hook of some larger
fraudulent scheme," nor did Stewart attempt to mislead the DeWitts
into the Purchase Agreement by obscuring the true price of the
contract until after the DeWitts had made their first deposit. In
re Stewart, 2017 WL 3601196, at *17. The bankruptcy court also
rejected the argument that Stewart "viewed the DeWitts as a means
for his company to generate revenue with no real interest in
completing the project," id. at *20, and was "living high"
throughout at their expense, id. at *18. On appeal, the DeWitts
have failed to explain to us why these findings are clearly
erroneous. Notwithstanding our holding that the bankruptcy court
erred when it determined what was required to prove "intent to
deceive," the DeWitts do not explain how the court's additional
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findings negating the scheme they allege as "actual fraud" were
clearly erroneous. Because we find that the facts here can support
two plausible but conflicting interpretations of a body of
evidence, In re Brady-Zell, 756 F.3d at 72, we decline to find the
bankruptcy court's findings on the issue of actual fraud in clear
error and reserve our remand to the issues of false pretenses and
false representation.
B. Section 523(a)(6): Willful and Malicious Injury
The Bankruptcy Code also excepts from discharge any debt
that is "for willful and malicious injury by the debtor to another
entity or to the property of another entity." 11 U.S.C.
§ 523(a)(6). As referenced above, an exception to discharge under
§ 523(a)(6) requires more than negligence or recklessness. See
Printy, 110 F.3d at 859. Specifically, "[w]illfulness requires a
showing of intent to injure or at least of intent to do an act
which the debtor is substantially certain will lead to the injury
in question." In re Levasseur, 737 F.3d at 818 (internal quotation
marks omitted). While the BAP made no findings on the DeWitts' §
523(a)(6) claims, the DeWitts renew their argument that "Stewart's
actions were designed to commit injury." Convinced that the
bankruptcy court did in fact apply the correct standard in its
assessment of willful and malicious conduct, see In re Stewart,
2017 WL 3601196, at *20-21, we refuse to deem the court's finding
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that Stewart did not actually intend to cause the DeWitts harm as
clearly erroneous, remembering the burden of proof was again on
the DeWitts.
C. Piercing the Corporate Veil
Finally, Stewart points out on appeal that it was
inappropriate for the BAP to determine that the corporate veil
should be pierced without the bankruptcy court first having
conducted fact-finding on this issue. See In re Stewart, 592 B.R.
at 440-41. We agree that the appropriate remedy is remand for the
bankruptcy court to determine whether the corporate veil should be
pierced in accordance with New Hampshire state law. See In re
Irving Tanning Co., 876 F.3d at 389-90; see also Martínez v.
Petrenko, 792 F.3d 173, 181 (1st Cir. 2015) (explaining the
findings that New Hampshire state law requires for piercing the
corporate veil under Druding v. Allen, 451 A.2d 390, 393 (N.H.
1982)).
III.
In conclusion, we hold that the bankruptcy court erred
in three respects: (1) by failing to consider whether Stewart had
committed false pretenses through implied misrepresentation;
(2) by failing to consider whether Stewart was acting without
confidence in the accuracy of his representation or with knowledge
that he did not have the basis for his representation in its
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analysis of his intent to deceive, see Palmacci, 121 F.3d at 787;
and (3) by applying a standard of reliance that was too narrow and
did not take into consideration continuing transactions post-
contract-formation. As an appellate court, it is beyond our
purview to make factual determinations on the elements of a
§ 523(a)(2)(A) claim ourselves. The same goes for rendering
findings on the appropriateness of piercing the corporate veil.
Accordingly, we vacate the BAP's reversal of the bankruptcy court's
judgment and remand with instructions that the case be returned to
the bankruptcy court for further proceedings consistent with this
opinion. Each party shall bear their own cost of this appeal.
Reversed and Remanded.
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