Hann v. Kahkeshani ( 2023 )

Case: 22-20407 Document: 00516932153 Page: 1 Date Filed: 10/16/2023
United States Court of Appeals United States Court of Appeals
Fifth Circuit
for the Fifth Circuit FILED
October 16, 2023
____________
Lyle W. Cayce
No. 22-20407 Clerk
____________
In the Matter of Stephen Hann, doing business as Trinity
Custom Builders, doing business as Christian Builders, doing
business as Hann Builders, doing business as Beta Investments
Limited, doing business as SKH 2000, Incorporated, doing business
as Hann and Associates,
Debtor,
Saeed Kahkeshani,
Appellee,
versus
Stephen K. Hann, doing business as Trinity Custom Builders,
doing business as Christian Builders, doing business as Hann
Builders, doing business as Beta Investments Limited, doing
business as SKH 2000, Incorporated, doing business as Hann and
Associates,
Appellant.
______________________________
Appeal from the United States District Court
for the Southern District of Texas
USDC No. 4:16-CV-230
______________________________
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Before Wiener, Stewart, and Engelhardt, Circuit Judges.
Per Curiam: *
Appellant, Debtor Stephen K. Hann, appeals the district court’s
judgment, on appeal from the bankruptcy court, concluding that his debt to
Saeed Kahkeshani, relating to a breached residential construction contract,
is excepted from discharge by 11 U.S.C. §§ 523(a)(2)(A) and (a)(4). The
district court judgment reversed the bankruptcy court’s summary judgment
determination in Hann’s favor. Having carefully considered the applicable
law, the parties’ arguments, and the record herein, we are not convinced that
the district court erred in its resolution of the issues presented in this
bankruptcy appeal. Thus, we AFFIRM the district court’s determination
that Hann’s debt to Kahkeshani is rendered nondischargeable by 11 U.S.C.
§§ 523(a)(2)(A) and (a)(4).
I.
On or about May 18, 2010, Kahkeshani entered into a residential
construction contract with SKH 2000, Inc. d/b/a Hann Builders (“SKH”)
for a home to be built in Houston, Texas. Hann was the sole officer, director
and shareholder of SKH. Kahkeshani paid for the construction with funds
loaned by Bank of River Oaks. As work progressed on the project, an
employee of SKH submitted “draw requests” to the bank for payments
under the contract. The draw requests state: “Contractor hereby requests
the below itemized funds from lender for contractor to pay for the listed
items, all of which are a part of the construction project at the above
referenced Property.” The draw requests also contained descriptions of the
work (e.g., framing, windows, etc.) and included a representation by SKH
that the specific dollar amounts for specific work described in the draw
_____________________
*
This opinion is not designated for publication. See 5th Cir. R. 47.5.
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request “[w]ill be paid for.” Hann did not sign the draw requests. Nor,
apparently, were they sent to him.
Notwithstanding the language included in SKH’s draw requests,
Hann directed that some of the funds received from Kahkeshani’s bank
instead be used to pay for expenses on other SKH projects, as well as Hann’s
personal expenses and debts, and debts owed by Hann’s prior business, Hann
Builders, Ltd. (“HBL”), which had ceased operation in 2007 or 2008
because it could not generate sufficient revenue. When SKH failed to pay a
number of the subcontractors working on the Kahkeshani construction
project, liens were filed against Kahkeshani’s property. Kahkeshani
ultimately discovered that only approximately $193,000 (of the
approximately $761,000 he had paid SKH) was used to pay the construction
costs for his house.
In February 2011, Kahkeshani sued Hann and SKH in Texas state
court, asserting claims for breach of contract, violations of the Texas
Construction Trust Fund Act, Tex. Prop. Code, § 162.001, et seq.,
breach of express trust, common law and statutory fraud, alter ego, piercing
the corporate veil, single business enterprise, fraudulent transfer, unjust
enrichment, money had and received, constructive trust, and theft. A year
later, Hann commenced his Chapter 7 bankruptcy proceeding and removed
Kahkeshani’s state court suit to the bankruptcy court. See Adv. No. 12-
03196. In May 2012, Kahkeshani commenced the adversary proceeding
underlying this appeal (Adv. No. 12-03256), asserting that his state-law
claims resulted in nondischargeable liability against Hann under 11 U.S.C. §
523(a).
In March 2013, Hann invoked the arbitration clause in the
construction contract with Kahkeshani and moved to compel arbitration of
Kahkeshani’s claims. The bankruptcy court ordered arbitration of the claims
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in the removed action and the adversary proceeding, and authorized the
arbitrator to make findings of fact and conclusions of law on all claims in those
cases, but reserved the ability to make the ultimate determination of
dischargeability.
During the four-day arbitration hearing, twelve witnesses testified,
including Hann and other SKH personnel, and almost sixty exhibits were
admitted into evidence. Thereafter, the arbitrator rendered a “Final Arbitral
Award on Liability, Damages & Attorneys’ Fees[,]” with detailed findings of
fact and conclusions of law. The arbitrator concluded that SKH was liable
for breach of the construction contract, violating the Texas Construction
Trust Fund Act, Tex. Prop. Code, §§ 162.005(1)(A), 162.031, and
fraudulent misrepresentation.
The arbitrator additionally determined that Hann had also violated
§ 162.005(1)(A) but found insufficient evidence demonstrating that he had
personally made any fraudulent misrepresentations to Kahkeshani.
Nevertheless, the arbitrator concluded that Hann was liable for SKH’s
fraudulent misrepresentations as its alter ego. The arbitrator awarded
damages of $371,972.13, attorney’s fees of $200,000, and post-award interest
at a rate of 5% in Kahkeshani’s favor. 1 The bankruptcy court confirmed the
arbitration award in December 2015.
In mid-2015, the parties submitted cross-motions for summary
judgment regarding dischargeability to the bankruptcy court. The only
evidence offered in support of Kahkeshani’s motion was the arbitrator’s
award. Hann additionally submitted his own declaration, dated July 21, 2015.
_____________________
1
The arbitrator concluded that no violations of the Texas Theft Liability Act, Tex.
Civ. Prac. & Rem. Code § 134.001, et seq., or the Texas Fraudulent Transfer Act, Tex.
Bus. & Com. Code § 24.001, et seq., had occurred.
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The bankruptcy court denied Kahkeshani’s motion and granted Hann’s
cross-motion regarding dischargeability. Kahkeshani appealed to the district
court.
On July 7, 2022, the district court entered its Opinion on Appeal and
Final Judgment. Reversing the bankruptcy court, the district court concluded
Kahkeshani’s debt was nondischargeable under 11 U.S.C. § 523(a)(2)(A) and
§ 523(a)(4). 2 Hann’s appeal to this court followed.
II.
When reviewing the decision of a district court acting as an appellate
court, we “apply[] the same standard of review to the bankruptcy court’s
conclusions of law and findings of fact that the district court applied.” In re
JFK Capital Holdings, L.L.C., 880 F.3d 747, 751 (5th Cir. 2018) (quoting
Barron & Newburger, P.C. v. Tex. Skyline, Ltd. (In re Woerner), 783 F.3d 266,
270 (5th Cir. 2015) (en banc)). Accordingly, questions of fact are reviewed
for clear error and conclusions of law de novo. Matter of Cowin, 864 F.3d 344,
349 (5th Cir. 2017). Mixed questions of law and fact also are reviewed de
novo. Id. A factual finding is clearly erroneous “when, although there is
evidence to support it, the reviewing court on the entire evidence is left with
a firm and definite conviction that a mistake has been committed.” Matter of
Missionary Baptist Found. of Am. Inc., 712 F.2d 206, 209 (5th Cir. 1983)
(quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948)).
_____________________
2
The district court also remanded the case to the bankruptcy court for further
discovery on Kahkeshani’s claim seeking to bar Hann’s discharge under 11 U.S.C. § 727(a).
During the course of this appeal, the parties agreed to “dispose” of the claims asserted
regarding the bar to discharge set forth in 11 U.S.C. § 727(a). Thus, only the applicability
of the exceptions to discharge provided by 11 U.S.C. § 523(a) remain in dispute.
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III.
Section 727 of Title 11 of the United States Code provides for a
debtor’s discharge of debt, pursuant to Chapter 7 of that title, unless one of
several specified exceptions are met. See 11 U.S.C. § 727(a). Regarding 11
U.S.C. § 523, subsections 523(a)(2)(A) and 523(a)(4) preclude a discharge
“under section 727 . . . from any debt”:
(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;
[or]
(4) for fraud or defalcation while acting in a
fiduciary capacity, embezzlement, or larceny.
See 11 U.S.C. §§ 523(a)(2)(A), (a)(4). 3
The Texas Construction Trust Fund Act (“TCTFA”), Tex. Prop.
Code, § 162.001, et seq., is relevant to § 523(a)(4)’s discharge exception.
The TCTFA provides in pertinent part:
§ 162.001. Construction Payments and Loan Receipts as
Trust Funds
(a) Construction payments are trust funds under this chapter if
the payments are made to a contractor or subcontractor or to
an officer, director, or agent of a contractor or subcontractor,
_____________________
3
11 U.S.C. §§ 523(a)(2)(A), (a)(4). Subsection 523(a)(6) also precludes discharge
of debt for “willful or malicious injury by the debtor to another entity or to the property of
another entity[.]” Having concluded that §§ 523(a)(2)(A) and (a)(4) preclude discharge
here, the district court did not review the bankruptcy court’s contrary determination
regarding § 523(a)(6). Given our agreement with the district court’s assessment of
§§ 523(a)(2)(A) and (a)(4), we likewise do the same.
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under a construction contract for the improvement of specific
real property in this state.
§ 162.002. Contractors as Trustees
A contractor, subcontractor, or owner or an officer, director,
or agent of a contractor, subcontractor, or owner, who receives
trust funds or who has control or direction of trust funds, is a
trustee of the trust funds.
§ 162.003. Beneficiaries of Trust Funds
(a) An artisan, laborer, mechanic, contractor, subcontractor, or
materialman who labors or who furnishes labor or material for
the construction or repair of an improvement on specific real
property in this state is a beneficiary of any trust funds paid or
received in connection with the improvement.
(b) A property owner is a beneficiary of trust funds described
by Section 162.001 in connection with a residential
construction contract, including funds deposited into a
construction account described by Section 162.006.
§ 162.005. Definitions
In this chapter:
(1) A trustee acts with “intent to defraud” when the trustee:
(A) retains, uses, disburses, or diverts trust funds with the
intent to deprive the beneficiaries of the trust funds;
(B) retains, uses, disburses, or diverts trust funds and fails
to establish or maintain a construction account as required
by Section 162.006 or fails to establish or maintain an
account record for the construction account as required
by Section 162.007; or
(C) uses, disburses, or diverts trust funds that were paid to
the trustee in reliance on an affidavit furnished by the
trustee under Section 53.085 if the affidavit contains false
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information relating to the trustee’s payment of current or
past due obligations.
(2) “Current or past due obligations” are those obligations
incurred or owed by the trustee for labor or materials furnished
in the direct prosecution of the work under the construction
contract prior to the receipt of the trust funds and which are
due and payable by the trustee no later than 30 days following
receipt of the trust funds.
(3) “Direct cost” means a cost included under a construction
contract that is specific to the construction of the improvement
that is the subject of the contract.
(4) “Indirect cost” means a cost included under a construction
contract that is not specific to the construction of the
improvement that is the subject of the contract.
(5) “Financial institution” means a bank, savings association,
savings bank, credit union, or savings and loan association
authorized to do business in the state.
(6) “Construction account” means an account in a financial
institution into which only trust funds and funds deposited by
the contractor that are necessary to pay charges imposed on the
account by the financial institution may be maintained.
§ 162.031. Misapplication of Trust Funds
(a) A trustee who, intentionally or knowingly or with intent to
defraud, directly or indirectly retains, uses, disburses, or
otherwise diverts trust funds without first fully paying all
current or past due obligations incurred by the trustee to the
beneficiaries of the trust funds, has misapplied the trust funds.
(b) It is an affirmative defense to prosecution or other action
brought under Subsection (a) that the trust funds not paid to
the beneficiaries of the trust were used by the trustee to pay the
trustee’s actual expenses directly related to the construction or
repair of the improvement[,] or have been retained by the
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trustee, after notice to the beneficiary who has made a request
for payment, as a result of the trustee’s reasonable belief that
the beneficiary is not entitled to such funds or have been
retained as authorized or required by Chapter 53.
(c) It is also an affirmative defense to prosecution or other
action brought under Subsection (a) that the trustee paid the
beneficiaries all trust funds which they are entitled to receive
no later than 30 days following written notice to the trustee of
the filing of a criminal complaint or other notice of a pending
criminal investigation.
(d) A trustee who commingles trust funds with other funds in
the trustee’s possession does not defeat a trust created by this
chapter.
§ 162.032. Penalties
(a) A trustee who misapplies trust funds amounting to $500 or
more in violation of this chapter commits a Class A
misdemeanor.
(b) A trustee who misapplies trust funds amounting to $500 or
more in violation of this chapter, with intent to defraud,
commits a felony of the third degree.
(c) A trustee who fails to establish or maintain a construction
account in violation of Section 162.006 or fails to establish or
maintain an account record for the construction account in
violation of Section 162.007 commits a Class A misdemeanor.
See Tex. Prop. Code §§ 162.001–007, 162.031–032.
Although the TCTFA does not expressly create a civil remedy, Texas
courts have recognized a private cause of action in favor of the statutory
beneficiaries against a person who has misapplied trust funds with the
requisite scienter. Dealers Elec. Supply Co. v. Scroggins Const. Co., 292 S.W.3d
650, 657 (Tex. 2009); Young v. Bella Palma, LLC, No. 14-17-00040-CV, 2022
WL 578442, at *9 (Tex. App. Feb. 25, 2022); IBEW-NECA Sw. Health &
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Ben. Fund v. Fairbairn Elec., Inc., No. 3:07-CV-0376-D, 2008 WL 4488970,
at *3 (N.D. Tex. Oct. 7, 2008); Mesa S. CWS Acquisition, LP v. Deep Energy
Expl. Partners, LLC, No. 14-18-00708-CV, 2019 WL 6210213, at *3 (Tex.
App. Nov. 21, 2019). This civil liability includes personal liability against a
company’s principal, officer, or director with the requisite control over
funds. See, e.g., Choy v. Graziano Roofing of Tex., Inc., 322 S.W.3d 276, 289–
94 (Tex. App. 2009); C & G, Inc. v. Jones, 165 S.W.3d 450, 453 (Tex. App.
2005); Holladay v. CW & A, Inc., 60 S.W.3d 243, 245–46 (Tex. App. 2001);
see also Lively v. Carpet Servs., Inc., 904 S.W.2d 868, 873–74 (Tex. App.
1995), writ denied (Feb. 9, 1996) (TCTFA provides for individual liability
based on the fiduciary relationship, not on an implied alter ego status of the
trustee).
IV.
The district court concluded that discharge of the debt that Hann
owes Kahkeshani in connection with a breached residential construction
contract is precluded by two provisions of the bankruptcy code, specifically
11 U.S.C. §§ 523(a)(2)(A) and (a)(4). We agree that both provisions apply
and preclude discharge of Hann’s debt to Kahkeshani.
A. 11 U.S.C. § 523 (a)(2)(A)
Section 523(a)(2)(A) of Chapter 11 of the United States Code pre-
cludes discharge of a debt for money that was obtained by “false pretenses, a
false representation, or actual fraud.” The arbitrator concluded that SKH
was liable for fraudulent misrepresentation. However, because another SKH
representative, Karen Travelstead, a sales agent, signed the draw requests
that SKH submitted for Kahkeshani’s funds, and there was no evidence that
the draw requests were sent to Hann, the arbitrator found there to be “insuf-
ficient record evidence to prove that [] Hann (as opposed to other SKH em-
ployees) was directly and personally responsible for the misrepresentations
in the draw requests.” Id. Thus, the arbitrator was “unable to conclude that
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Stephen Hann, individually, made fraudulent misrepresentations to [Kahke-
shani].” Nevertheless, the arbitrator concluded that Hann, as SKH’s alter
ego, is personally liable to Kahkeshani for the misrepresentations in the draw
requests that Travelstead signed on SKH’s behalf.
The arbitrator additionally explained, in paragraph 27 of the award:
The record evidence is sufficient to establish that
Stephen Hann should be held personally liable for the
misrepresentations of SKH pursuant to a piercing the
corporate veil or alter ego theory. The evidence was clear that
Stephen Hann diverted trust funds deposited with SKH by
[Kahkeshani] (and other homeowners); Mr. Hann used those
funds to pay creditors of HBL and to pay his own creditors.
Stephen Hann treated SKH’s funds as if they were his own; he
directed that the funds be used in whatever manner he
personally desired. There was no economic benefit to SKH
from paying the creditors of HBL, supposedly a separate
corporation, or from paying Stephen Hann’s own creditors.
The evidence showed that, for the case at bar, there was such
unity between SKH and Stephen Hann that the separateness of
SKH should be ignored; holding only SKH liable for SKH’s
misrepresentations to [Kahkeshani] would result in an
injustice. The undersigned Arbitrator concludes that, as to the
acts and events involving [Kahkeshani], SKH was used as a
mere tool or business conduit of Stephen Hann.
In rejecting Kahkeshani’s assertion that § 523(a)(2)(A) precludes dis-
charge of Hann’s debt for the sums awarded by the arbitrator, the bankruptcy
court concluded that a debtor who did not personally make a false represen-
tation cannot be bound by the fraudulent actions or misrepresentations of an-
other person unless the other person is the debtor’s partner or agent. (citing
In re Quinlivan, 434 F.3d 314, 319 (5th Cir. 2005); RecoverEdge, L.P. v. Pente-
cost, 44 F.3d 1284, 1297 (5th Cir. 1995); Luce v. First Equip. Leasing Corp. (In
re Luce), 960 F.2d 1277, 1282 (5th Cir. 1992)).
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The district court, in contrast, viewed “the crux of the dischargeabil-
ity issue . . . to be whether Hann made a false misrepresentation—either his
own or as the alter ego of SKH.” Relying on the arbitrator’s findings that
“SKH made false representations in the draw requests by claiming it would
be used to pay subcontractors rather than Hann’s debts from his prior com-
pany,” and that “Hann was the alter-ego of SKH,” the district court deter-
mined that “SKH’s liability for false representations in the draw requests is
appropriately imputed against Hann, individually.” Finally, emphasizing
that Hann is the sole owner of SKH and had treated the construction funds
as his own, the district court concluded: “Hann is liable as an alter-ego of
SKH, and the debt is not dischargeable under Section 532(a)(2)(A).”
Our consideration of this issue is greatly assisted by the Supreme
Court’s recent decision in Bartenwerfer v. Buckley, 589 U.S. 69 (2023).
There, the Court confirmed that § 523(a)(2)(A) can extend to liability for
fraud that a debtor did not personally commit. In reaching this conclusion,
the Court reasoned that the provision, which is “written in the passive voice,
. . . turns on how the money was obtained, not who committed fraud to obtain
it.” Bartenwerfer, 598 U.S. at 72. The Court likewise rejected the notion that
the “fresh start” policy of modern bankruptcy law mandates limiting
§ 523(a)(2)(A) to the personal actions and statements of the “at fault”
debtor (rather than, for example, a faultless partner or associate), recognizing
that the bankruptcy code balances multiple interests and policies. Id. at 81.
The Court also clarified that Ҥ 523(a)(2)(A) does not define the scope of
one person’s liability for another’s fraud.” Id. Rather, “[t]hat is the function
of the underlying law,” which, in Bartenwerfer, was the law of California. Id.
at 81–82. Thus, the Court explained, “section 523(a)(2)(A) takes the debt as
it finds it, so if California did not extend the liability to honest partners,
§ 523(a)(2)(A) would have no role to play.” Id. at 82.
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Accordingly, Texas law determines the scope of Hann’s liability
relative to the misrepresentations in the draw requests that caused the bank
to release Kahkeshani’s funds to SKH. 4 Though narrowly applied, Texas
law does not limit the liability of a beneficial owner or affiliate of a corporation
for a contractual obligation of the corporation if that owner or affiliate has
“caused the corporation to be used for the purpose of perpetrating and did
perpetrate an actual fraud on the obligee primarily for the direct personal
benefit of the . . . beneficial owner . . . or affiliate.” See Tex. Bus. Org.
Code § 21.223 (b); see also Belliveau v. Barco, Inc. 987 F.3d 122 (5th Cir.
2021) (“actual fraud” involves “dishonesty of purpose or intent to deceive”
and is “characterized by deliberately misleading conduct”).
Here, as indicated, the parties agreed that the arbitrator would
determine Hann’s and SKH’s liability to Kahkeshani; only the issue of
discharge was reserved for the bankruptcy court. After a multi-day hearing,
the arbitrator determined that Hann is SKH’s alter ego, and “should be held
personally liable for the misrepresentations of SKH pursuant to a piercing the
corporate veil or alter ego theory.” 5 The district court agreed, concluding:
“Hann is liable as an alter-ego of SKH, and the debt is not dischargeable
under Section 532(a)(2)(A).”
_____________________
4
We also note that the cases cited by the bankruptcy court and Hann have simply
recognized that partner or agent status—if established—is a legally permissible basis on
which one person can bear responsibility for another’s statements and/or conduct. In other
words, they do not establish an exclusive means. In re Quinlivan, 434 F.3d 314, 319 (5th
Cir. 2005); RecoverEdge, L.P. v. Pentecost, 44 F.3d 1284, 1297 (5th Cir. 1995); Luce v. First
Equip. Leasing Corp. (In re Luce). Indeed, RecoverEdge, L.P. v. Pentecost also recognized the
possible use of alter ego status, but concluded that it had not been alleged or found there.
44 F.3d at 1296.
5
The arbitration award reflects that these issues were among those that the parties
had agreed would be decided by the arbitrator.
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Considering the arbitrator’s determinations regarding SKH’s
fraudulent misrepresentations and Hann’s liability therefor, together with
the arbitrator’s extensive factual findings regarding Hann’s role at SKH and
control over when and how the funds received from Kahkeshani were used,
the district court’s determination that § 523(a)(2)(A) applies to SKH’s
representations to Kahkeshani, even if not personally made by Hann, is well-
founded. Indeed, in the absence of facts indicating that SKH did not usually
obtain funds from its clients via draw requests, or that the representations
made in the draw requests submitted to Kahkeshani’s bank were atypical, it
is unlikely that Hann, as the sole officer, director, and shareholder of SKH,
the past owner of “several corporations that built high-valued homes,” and
a general contractor working on similar projects since 1993, was unaware that
SKH’s draw requests included the representations regarding payment that
are at issue here.
This is especially so since the draw requests were prepared by SKH’s
office manager, who was responsible for accounting at SKH and HBL, and
who worked directly with Hann in handling SKH’s payables, i.e., she issued
payments, on Hann’s instructions to do so, for SKH’s unpaid bills, as well as
HBL’s debts and Hann’s own debts, using funds that SKH received from
ongoing projects. Furthermore, the draw requests were based on completion
percentages provided by the project managers, which Hann approved.
In any event, given the arbitrator’s determination of Hann’s liability
for SKH’s misrepresentations, Bartenwerfer supports § 523(a)(2)(A)’s
application here. Thus, we conclude that § 523(a)(2)(A) precludes discharge
of Hann’s debt.
B. 11 U.S.C. § 523 (a)(4)
Pursuant to 11 U.S.C. § 523(a)(4), any debt for fraud or defalcation
while acting in a fiduciary capacity, embezzlement, or larceny is not
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discharged under 11 U.S.C. § 727(a). “Defalcation includes the failure to
produce funds entrusted to a fiduciary, even where such conduct does not
reach the level of fraud.” In re Pledger, 592 F. App’x 296, 299 (5th Cir. 2015)
(quoting In re Swor, 347 F. App’x 113, 116 (5th Cir. 2009)). And, for purposes
of 11 U.S.C. § 523(a)(4), the term “defalcation” includes a culpable state of
mind requirement that, in the absence of conduct involving “bad faith, moral
turpitude, or other immoral conduct, requires an intentional wrong.” Bullock
v. BankChampaign, N.A., 569 U.S. 267, 273–74 (2013).
“Intentional” includes “conduct that the fiduciary knows is improper
[and] reckless conduct of the kind that the criminal law often treats as the
equivalent.” Id. at 274. Thus, “[w]here actual knowledge of wrongdoing is
lacking,” conduct is considered equivalent “if the fiduciary ‘consciously
disregards’ (or is willfully blind to) ‘a substantial and unjustifiable risk’ that
his conduct will turn out to violate a fiduciary duty.” Id. (quoting Model
Penal Code, § 2.02 (2)(c), p. 226 (1985)). “That risk ‘must be of such a
nature and degree that, considering the nature and purpose of the actor’s
conduct and the circumstances known to him, its disregard involves a gross
deviation from the standard of conduct that a law-abiding person would
observe in the actor’s situation.’” Id.
We have determined that the TCTFA “creates fiduciary duties
encompassed by § 523(a)(4) to the extent that it defines wrongful conduct
under the statute.” In re Nicholas, 956 F.2d 110, 114 (5th Cir. 1992); Matter
of Boyle, 819 F.2d 583, 592 (5th Cir. 1987); see also Pledger, 592 F. App’x at
299 (“[f]or purposes of [§] 523(a)(4), a fiduciary duty only arises if there is a
simultaneous wrongful misapplication of funds”). “[U]nder Nicholas, a
creditor claiming Section 524(a)(4) nondischargeability through the TCTFA
must show that (1) the contractor intentionally, knowingly, or with intent to
defraud diverted trust funds and (2) the affirmative defenses in the statute do
not apply.” Pledger, 592 F. App’x at 301–02 (citing Nicholas, 945 F.2d at 114);
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see also Matter of Monaco, 839 F.3d 413, 418 (5th Cir. 2016) (beneficiary
seeking to avail itself of the § 523(a)(4) exception to discharge must show
that funds were misapplied under the TCTFA, which includes overcoming
the statute’s affirmative defenses).
Relevant here, an affirmative defense exists under the TCTFA for
“actual expenses directly related to the construction.” See Tex. Prop.
Code § 162.031(b). Disproving this requires showing that the payments in
question (a) were not made on the project or overhead, or (b) were made for
the debtor’s own uses rather than to benefit the health of his failing business.
Pledger, 592 F. App’x at 302 (citing Nicholas, 945 F.2d at 114); Monaco, 839
F.3d at 417 n. 1 (affirmative defense does not require that “‘funds be spent
only on the project for which they were received[;] they may be spent on
other projects or expenses related to general business overhead’”) (quoting
Swor, 347 F. Appx. at 116).
The arbitrator concluded that Hann and SKH misapplied trust funds
intentionally, knowingly, and with the intent to defraud, for purposes of
§§ 162.005(1)(A) and 162.031 of the TCTFA, and awarded damages and
attorneys’ fees and costs. The arbitrator found that Hann acted with an
“intent to defraud” by using trust funds with “the intent to deprive the
beneficiaries of the trust funds.”
The bankruptcy court thought that the arbitrator’s finding regarding
Hann’s scienter was sufficient to establish the state of mind necessary for a
violation of the TCTFA but not the level of mental culpability required by
Bullock for a debt to be nondischargeable defalcation under 11 U.S.C. §
523(a)(4). The bankruptcy court did not explain the basis for this
determination, however, and its rationale is not evident.
Regarding the necessary “defalcation of a fiduciary duty,” the district
court reasoned that Bullock’s scienter requirement was satisfied if Hann
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“intended to defraud” by using trust funds with “the intent to deprive the
beneficiaries of the trust funds” because “intent is a higher culpable state . . .
than knowing.” Recognizing that the arbitration award “is replete with
references to Hann’s personal awareness of where and how money was
spent,” the district court determined the necessary scienter was present.
To show that Hann did not have an affirmative defense, Kahkeshani
had to demonstrate that the funds at issue (a) were not used for expenses of
the project or overhead; or (b) were made for Hann’s personal use rather
than to benefit the health of this failing business. The district court concluded
that Kahkeshani had sufficiently established, as evidenced by the arbitrator’s
factual findings, that the money at issue was diverted for Hann’s personal use
and to pay the previously incurred debt of another company owned by
Hann—HBL.
Although acknowledging Hann’s belated efforts—submitting a
declaration almost two years after the 2013 arbitration hearing and more than
a year after the arbitration award was issued—to deny knowledge that the
funds received from Kahkeshani were not used for “actual expenses,” the
district court found the declaration insufficient to “counter the factual
findings by the arbitrator” who had “assessed the evidence of the overhead
costs and money paid to creditors.” Reasoning that it “can rely on the
abitrat[or]’s factual findings for support,” the district court decided that
“Kahkeshani has met his burden.” Thus, the district court ruled: “The debt
is nondischargeable because Hann knowingly misapplied the trust funds as a
fiduciary under Texas law.”
On this record, we agree with the district court’s determination that
Kahkeshani sufficiently established § 523(a)(4)’s application to Hann’s debt.
As the district court concluded, the arbitrator’s factual findings amply
demonstrate that Hann had the requisite scienter and that sums paid for
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HBL’s debts and Hann’s personal debts and expenses are not encompassed
by the TCTFA’s affirmative defense in § 162.031(b).
The record shows that Hann took an active and informed role in
SKH’s finances. Notably, the arbitration award reflects that Hann confirmed
that he was aware of the TCTFA’s existence; that he knew payments
received from Kahkeshani’s bank were supposed to be used to pay
subcontractors and suppliers who had furnished labor and materials for
Kahkeshani’s house, as described in the draw requests; and that he knew
payments from Kahkeshani’s bank were being made to his own creditors and
HBL’s creditors.
It likewise is apparent that Hann had direct and exclusive control of
the funds of SKH, and that he decided which of SKH’s and HBL’s creditors
were to be paid each week. For this, Hann utilized weekly cash flow forecasts
for SKH and for HBL that showed—on separate spreadsheets—debts owed
by SKH and debts owed by HBL. Indeed, the arbitrator determined that it
was “Hann’s plan, intent, or method [] to use funds without regard to the
construction project(s) for which the payments had been made.”
Explaining the arbitrator’s determination that Hann and SKH had
misapplied trust funds knowingly, intentionally, or with intent to defraud,
paragraphs 11 and 12 of the award state:
[H]undreds of thousands of dollars were misapplied.
[Kahkeshani’s] funds were not used to pay the subcontractors,
vendors and/or suppliers that SKH represented in its draw
requests would be paid.
Stephen Hann used [Kahkeshani’s] funds for his own
personal use and benefit. While it is laudatory that Stephen
Hann made efforts to pay the past bills and expenses of HBL,
he was prohibited from doing so with trust funds that were paid
to him by customers for whom SKH was building homes or
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performing re-modeling work. The credible evidence in this
case proved that Stephen Hann knew what expenses (for both
SKH and HBL) accrued and were owed; what creditors of HBL
and SKH had been paid, in what amounts and when; and what
amounts would be paid to whom and when, on a weekly basis.
Regarding evidentiary support for his determination that Hann had
acted with “intent to defraud” by “using, disbursing or diverting trust funds
with the intent to deprive the beneficiaries of them,” the arbitrator
emphasized that Hann knew that SKH’s subcontractors and suppliers
working on [Kahkeshani’s] house were not being paid with the payments that
SKH received from [Kahkeshani’s] bank, 6 and that SKH did not otherwise
have enough money to pay them. Paragraph 22 of the award additionally
explains:
While Stephen Hann may have hoped to repay the
beneficiaries with other monies at some time in the future, the
evidence was conclusive that Mr. Hann knew that the
subcontractors and suppliers on [Kahkeshani’s] house were
not being paid with [Kahkeshani’s] money. Stephen Hann
knew SKH did not have sufficient funds to otherwise pay the
vendors who had provided labor and materials for
[Kahkeshani’s] house. Mr. Hann reviewed the expenses on a
weekly basis; he was the person who determined who would be
paid with the money in SKH’s bank accounts; he was the
person who used [Kahkeshani’s] funds to pay other
expenses—liabilities of HBL, liabilities of his own, and
_____________________
6
This is true even if Hann’s belated declaration is considered. Although he denies
“personally knowing that the subcontractors and suppliers on [Kahkeshani’s] project were
not being paid,” his explanation for that proposition is neither clear nor sufficient. In
contrast, the arbitrator made his determination after receiving documentary evidence and
hearing live testimony from Hann’s CPA (Carol Burke), the employee who did SKH’s and
HBL’s accounting (Jill Frey), the sales agent who prepared the draw requests for
Kahkeshani’s project (Karen Travelstead), and SKH project managers.
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liabilities of SKH unrelated to [Kahkeshani’s] house. No
payments were made without Stephen Hann’s knowledge and
approval. Clearly Mr. Hann had actual awareness of the
practice that was being perpetrated. He had to have known that
he was using [Kahkeshani’s] trust funds to pay expenses
unrelated to [Kahkeshani’s] house. No other conclusion is
reasonably inferable from the evidence.
We are cognizant that the arbitrator’s findings were made after a four-
day evidentiary hearing during which Hann certainly had the opportunity to
explain his actions and intentions. Considering those findings together with
the parties’ submissions to this court, we can find no fault in the district
court’s determination that “Hann knowingly misapplied [Kahkeshani’s]
trust funds as a fiduciary under Texas law”; thus, § 523(a)(4) also precludes
discharge of his debt.
V.
For the forgoing reasons, we agree with the district court’s determi-
nation that, pursuant to 11 U.S.C. §§ 523(a)(2)(A) and (a)(4), Stephen
Hann’s debt to Saeed Kahkeshani is nondischargeable. Accordingly, the
judgment of the district court is AFFIRMED.
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