Roe et al v. Rule Sale & Service Inc et al

MEMORANDUM OF DECISION - 1
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF IDAHO
______________________________________________________
In Re:
Bankruptcy Case
STEVEN J. RULE, 	No. 04-01799
Debtor.
______________________________________________________
NANCY ROE, DIANE
JOHNSON and WALLY
OLSON, AS PERSONAL
REPRESENTATIVES FOR THE
ESTATE OF JO ANN OLSON
AND OLSON & OLSON, LLC.,
Plaintiffs, 	Adv. Proceeding No. 04-6190
vs.
RULE SALES & SERVICES,
INC., an Idaho corporation, and
STEVEN RULE, an individual,
Defendants.
_______________________________________________________
MEMORANDUM OF DECISION
___________________________________________________________
Appearances:
Scott D. Hess and Terri R. Yost, JONES GLEDHILL HESS FUHRMAN
& EIDEN, Boise, Idaho, Attorneys for Plaintiffs.
William A. McCurdy, Boise, Idaho, Attorney for Defendant.
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1 These findings include both disputed and undisputed facts. In deciding
disputed issues of fact, the Court carefully considered the testimony of the witnesses, and
based upon its opportunity to observe them testify, assessed their credibility. The Court’s
findings reflect its judgment on the weight to be given to that testimony.
MEMORANDUM OF DECISION - 2
In this adversary proceeding, Plaintiffs contend that a $400,000 state
court judgment entered in their favor against Defendant Steven Rule, a Chapter 7
debtor, should be excepted from discharge in bankruptcy. The Court conducted a
three-day trial at which the parties presented the testimony of several witnesses
and submitted dozens of documentary exhibits. At the conclusion of the trial, the
parties submitted written closing arguments. Docket Nos. 46–49. The Court has
reviewed and considered all the evidence, testimony and the arguments of the
parties, and the issues are now ripe for disposition. The following constitutes the
Court’s findings of fact and conclusions of law, and decision. Fed. R. Bankr. P.
7052.
Findings of Fact1
The Agreements.
Plaintiffs Nancy Roe, Diane Johnson, and Wally Olson are the
children of the late Jo Ann Olson. The children prosecute this adversary
proceeding on behalf of their deceased mother’s probate estate. In addition, the
various family members conducted business via Olson & Olson, LLC (sometimes
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2 Except where significant, the Court will refer to the Plaintiffs collectively.
3 John Frye did not testify. Plaintiffs did not call him as a witness. Defendants
were not allowed to call him as a sanction for their unjustified failure to comply with the
Court’s Pre-Trial Order requiring disclosure of witnesses prior to trial. See Docket No.
9. Defendants did not disclose any intent to call Mr. Frye.
4 Plaintiffs named Rule Sales & Service as a defendant in this action. However,
because the issue here is the dischargability of the money judgment Plaintiffs hold
against Defendants, and because Rule Sales & Service is not a debtor in bankruptcy, the
Court’s determination will have no effect upon the liability of Rule Sales & Service, Inc.
For convenience, when the Court refers to the Defendant, it includes those instances
where Rule was acting through and on behalf of the corporation.
5 Apparently, Rule was another accounting client of Mr. Frye.
MEMORANDUM OF DECISION - 3
referred to as “the company”), which entity has joined as a plaintiff in this action.2
Plaintiffs have owned a parcel of real properly located on Centennial
Way in Caldwell, Idaho for the past twenty years. Jo Ann Olson, acting through
the company, decided to develop the property by building an automated car wash
on the site. Jo Ann Olson came to this conclusion after consultation with her
accountant and advisor, John Frye,3 as well as after several discussions with her
children about the development possibilities. Mr. Frye recommended that
Plaintiffs consider asking Defendant Steven Rule, who did business as Rule Sales
& Service, Inc.,4 to serve as the contractor for the project. 5 Defendant had been in
business for several years selling and installing car wash equipment as a local
distributor for at least two different manufacturers. In addition, Defendant had
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MEMORANDUM OF DECISION - 4
undertaken several comprehensive car wash construction projects for clients in the
Treasure Valley.
When Plaintiff Nancy Roe and Jo Ann Olson first met with
Defendant and his salesman in 1997 or 1998 to discuss a possible car wash
project, they did not particularly like either man. As a result, planning the project
was abandoned for a time. 	However, in July 2000, Jo Ann Olson decided to
proceed with the development. Jo Ann Olson, John Frye, Diane Johnson and her
husband again met with Defendant in August. Defendant gave them literature
about the kinds of equipment he sold. On September 28 and 29, 2000, Olson,
acting on behalf of the company, entered into two agreements with Defendant to
purchase the automated car wash equipment. 	See Exs. 13 and 14. In addition, the
next day, she signed an agreement Defendant had prepared (the “Management
Agreement”) providing that he would manage and supervise all aspects of the
construction of the car wash. See Ex. 1.
Plaintiffs expressed their desire to Defendant to build a “top-of-the-
line” car wash and believed Defendant’s ideas would accomplish this goal.
Originally, Plaintiffs contemplated building a facility with one automatic car wash
bay and three self-service bays. However, during construction, Plaintiffs decided
to replace one bay with a coffee shop.
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MEMORANDUM OF DECISION - 5
As previously noted, Plaintiffs entered into separate agreements with
Defendant to purchase the essential equipment to wash cars. In one of these
purchase agreements, Plaintiffs agreed to buy a Vector Rapid Wash System from
Defendant for use in the automatic car wash bay. The total price Plaintiffs agreed
to pay Defendant for this system, including a $6,000.00 installation fee, was
$126,122.00. Ex. 13. For the three self-service bays, Plaintiffs agreed to buy the
GinSan Ultimate System from Defendant. The total price for this equipment was
$88,341.26, which included $4,900.00 for “labor to erect equipment.” Ex. 14.
The Airlift Door Package for the car wash was purchased for a total price of
$11,970.80. Ex. 15
As an equipment dealer, Defendant sold the equipment to Plaintiffs
at a substantial markup over his cost. Defendant’s cost for the Vector Rapid Wash
System was $72,500.00, Ex. 16; $39,220.00 for the GinSan equipment Ex. 17; and
$6,934.68 for the Airlift Doors, Ex. 18. But, the total cost Plaintiffs agreed to pay
Defendant for the car wash equipment was $226,434.14.
Plaintiffs Nancy Roe and Diane Johnson testified that at no time
during the negotiations and discussions concerning the project did Defendant
disclose to them that he would be making a profit on the sale of the equipment.
By the same token, there is no evidence, either in the written purchase orders or
otherwise, that Defendant agreed to sell the equipment to Plaintiffs at his cost, or
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MEMORANDUM OF DECISION - 6
at some other discount. Moreover, as noted above, Plaintiffs agreed to purchase
the equipment from Defendant before retaining him to manage the construction of
the car wash.
In the Management Agreement, Defendant committed to supervise
the construction of the car wash, including selecting, negotiating contracts with,
and supervising the work of all subcontractors and vendors. For his efforts, the
agreement provided that Plaintiffs would pay Defendant a management fee. In
particular, the Agreement provided that “Rule is [to be] paid 8% of total project
cost, (est. total cost $500,000.00) or an estimated management cost of $40,000.00.
50% ($20,000.00) paid upfront [sic], 50% ($20,000) paid on job start up.” Ex. 1.
The Business Relationship Deteriorates.
A considerable delay preceded the commencement of construction.
And, unfortunately, the car wash project did not progress as quickly as the parties
hoped. 	Indeed, several practical and legal challenges to prompt completion of the
car wash developed.
For example, with Defendant’s support, Plaintiffs decided it would
be beneficial to expand access to the property by adding a second entrance off of
Centennial Way. Defendant endeavored to secure the approval of the local
authorities for such a change, including hiring engineers to design the access, but
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MEMORANDUM OF DECISION - 7
there were complications. Attempts to resolve these problems took considerable
time and generated expense before the idea was ultimately abandoned due to cost.
In addition, subcontractors encountered issues with the presence of underground
utilities and easements in excavating for the project. Finally, as noted above,
Plaintiffs decided to modify the construction plans to include the coffee shop
which, while not an unexpected decision, resulted in additional delay and expense.
During construction in the late summer and early fall of 2001, the
business relationship between Plaintiffs and Defendant became strained. Jo Ann
Olson became very ill. When Defendant asked Plaintiffs for additional funds that
would exceed the estimated $500,000 cost referred to in the Management
Agreement, Plaintiffs refused to advance them without a detailed accounting of
how the $470,000 they had already paid had been spent. 	More particularly, the
following occurred.
In July 2001, Defendant met with Plaintiffs Diane Johnson and
Nancy Roe, along with Nancy Roe’s husband, at Jo Ann Olson’s home to discuss
the progress of the project. Jo Ann Olson was not in attendance at the meeting due
to illness, and it was around this time that Jo Ann Olson turned over supervision of
the project to her daughters. During this meeting Plaintiffs asked Defendant if the
project would be completed for $500,000. Defendant indicated he thought that it
would. Defendant testified that by saying this, he meant the cost for the car wash
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MEMORANDUM OF DECISION - 8
building would amount to about $500,000. However, he felt the family members
understood that this figure did not include the cost of the car wash equipment of
over $200,000. To support his conclusion, Defendant testified that John Frye,
who was coordinating discussions and dealings during construction between Jo
Ann Olson and Defendant, was always aware that the cost of the car wash project
would be around $750,000. However, both Jo Ann Olson and her daughters
testified that at all times they believed the car wash project, including the
equipment, would cost $500,000.
By August 2001, Plaintiffs had paid Defendant $470,000 towards
the completion of the car wash. It was not finished. By this time, Jo Ann Olson
was no longer involved and her daughters had stepped in to handle the car wash
construction project for the family. On August 13, 2001, Defendant produced and
sent Jo Ann Olson a document described as a “construction project statement
delivered to Western Bank as per John Frye.” Ex. 3. The statement indicated the
“estimated project total costs of $500,000.00" and that a “progress payment of
30% of estimated project costs $150,000.00" was due. Ex. 3. Defendant sent
Plaintiffs a similar statement again on September 7, 2001, also indicating an
estimated total project cost of $500,000.00. Ex. 4.
On September 18, 2001, after Defendant had requested two more
progress payments, Plaintiffs sent a letter to Defendant requesting a full
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MEMORANDUM OF DECISION - 9
accounting for the car wash project. Ex. 5. In his September 21, 2001, response
to this letter, Defendant indicated he was offended by the request for information
supporting his request because providing such an accounting was not included in
the parties’ agreement. Ex. 6. Even so, Defendant partially accounted for the
project’s costs by indicating,
To date Olsons have paid Rule thru [sic] deposits and
progress payments $470,000.00 dollars. Rule has
provided equipment, site work, building costs,
permitting fees, archectic [sic] & engineering fees
totaling $368,838.33. That leaves a $132,000.00
balance of the $500,000.00 projected costs. Costs for
lanscaping [sic], asphalt, roofing, painting, signage
should total about $130,000.00 as I had projected.
Additional costs ordered by Jo Ann Olson and John
Frye not included in the original estimates are the
coffee shop costs ($42,918,39) water and sewer line
repairs ($6,748,30), permits and fees ($41,895.80).
Total Project Costs to Date:
Car Wash Equipment 	$226,434.05
Site Work and Car Wash Building 	$142,404.05
Trailer Court Sewer and Water Repairs 	$ 	6,748.30
Permits and Fees 	$ 41,895.80
Coffee Shop Construction to Date [ ] 	$ 42,918.39
To continue the car wash project Olsons will need a
progress payment of $130,000.00 to the Rules [sic]
construction account. As I stated before the car wash
is built with the customers [sic] money, not Rules [sic]
money.
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6 Obviously, Defendant’s reasoning, as well as his math, is difficult to follow. In
one paragraph of his response, Defendant seems to imply the project cost is in line with
the original $500,000 estimate. Even so, he asks for an additional $130,000.00 payment
in order to continue the project.
MEMORANDUM OF DECISION - 10
Ex. 6.6
Plaintiffs refused to make the $130,000 payment. After additional
meetings with Plaintiffs Diane Johnson and Nancy Roe regarding the progress of
the project, Defendant walked off the job on September 29, 2001. Plaintiffs took
over management of the project and finally finished the car wash in March or
April of 2002. The total cost of the project paid by Plaintiffs was between
$810,000 and $820,000.
While It is Disputed, the Car Wash Equipment was Included in the
Estimated Total Project Cost.
Defendant plausibly testified that he was asked to draft a
Management Agreement containing an estimate of the total cost of the project to
allow Plaintiffs to arrange their financing for the project. He did so.
One of the critical factual controversies in this action concerns
whether the estimated $500,000 “total project cost” included by Defendant in the
Management Agreement signed by the parties was intended to include the cost of
the automated car wash equipment sold by Defendant to Plaintiffs. Defendant
testified the $500,000 figure was intended as an estimate for the building, and that
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MEMORANDUM OF DECISION - 11
the contracts to purchase the car wash equipment represented separate, additional
costs. The record belies Defendant’s position. While Rule’s testimony on this
point provides a simplistic method of reconciling his otherwise inconsistent
accountings for the costs of this project, the Court finds, based largely upon the
information Defendant himself provided concerning the cost of the project,
together with the plain meaning of the language employed in the Management
Agreement, that the parties intended the cost estimate in the Management
Agreement to include the cost of car wash equipment.
Even so, while the $500,000 figure in the Management Agreement
was intended by the parties to reflect the total project cost, the Court also finds,
consistent with Defendant’s position, that this number constituted, at best, an
educated guess of the cost of this project. And as things turned out, it was a poor
guess at that.
On the other hand, the Court believes Rule when he testified that,
from very early on, “everyone” involved in the project appreciated the total cost
would greatly exceed $500,000. Clearly, it would have been impossible for the
parties to precisely predict months in advance all the conceivable costs for a
project such as the construction of a commercial facility. 	The Agreement itself
correctly labels this number an “estimate.” 	At the time the Agreement was inked,
no car wash construction plans had been drawn, no permits had been issued, and
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MEMORANDUM OF DECISION - 12
the scope of the project had not yet been completely defined. The testimony of the
parties was consistent that there were discussions regarding the challenges incident
to the addition of a second “curb-cut” and “deceleration lane” to provide another
street access to the car wash. Ultimately, it was decided that such an addition was
cost prohibitive, but clearly time and effort was expended to look into this issue.
There were also additional unforseen issues such as the unanticipated presence of
active sewer lines on the property relating to its former use as a mobile home park.
All things considered, there is no doubt that when the Management
Agreement was signed and the project was first begun, the full scope of the work
necessary to build this car wash was not known by the parties to any significant
degree of certainty. 	It is therefore clear that while the $500,000 figure inserted by
Defendant in the Management Agreement was intended to reflect “total project
costs,” including the equipment, that number was, as it turned out, merely an
overly optimistic guess.
The Documents Also Show the Project Would Inevitably Cost More
than $500,000.
While Plaintiffs maintain they did not know the project would cost
more than $500,000 until the late summer of 2001, very early on Defendants gave
Plaintiffs a breakdown of the anticipated construction costs indicating that
construction of the building would cost approximately $308,663.52, to which
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MEMORANDUM OF DECISION - 13
additional expenses such as $42,918 for the coffee shop and $41,895 for some
utilities and permits, would have to be added. Ex. 2. Nancy Roe testified she
understood that the addition of a coffee shop in place of one of the bays would
cost an additional $43,000 over the estimated cost of $500,000. In addition, since
the purchase orders for the equipment were executed before the Management
Agreement, Plaintiffs were also aware that the price of the equipment was
$226,434.14.
Had Plaintiffs reviewed the documents they were provided, they
would that have known that, even before construction commenced, the costs to
build the type of car wash they wanted would likely run at least $619,910.66,
without any allowance for Defendant’s management fee, and assuming no
unforseen complications occurred. Nancy Roe testified she had not seen the
estimated building cost until she was going through Jo Ann Olson’s files after the
project was turned over to her. However, it is clear that at least Jo Ann Olson had
been given this document. And even if the handwritten numbers appearing on this
document are not included in the estimate, the cost to build the car wash building
plus the equipment cost significantly exceeded $500,000.
In short, from the inception of the project, and more so as time
passed, Plaintiffs knew, or should have known, that the cost of the car wash
would be more than Defendant’s estimate of $500,000.
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MEMORANDUM OF DECISION - 14
Plaintiffs Relied on the Advice of Others.
Through the testimony of Plaintiffs Nancy Roe and Diane Johnson it
was obvious that Plaintiffs, and especially Jo Ann Olson, relied heavily on the
advice of others in connection with making decisions about the car wash project.
As noted, John Frye apparently recommended that Plaintiffs hire Defendant for
this job, even though they did not initially care for him or his salesman. Mr. Frye
also acted as a go-between during the project for communications between
Defendant and Jo Ann Olson. Diane Johnson testified that Plaintiffs did no
independent research regarding this project, secured no other bids for any aspect
of the project, and only looked at the brochures Defendant provided for the
equipment he sold before purchasing the equipment from Defendant. Plaintiffs
had nothing with which to compare Defendant’s prices and cost estimate, nor did
they endeavor to gather any such information.
The Lien.
After ceasing work, on October 5, 2001, Defendant, with the advice
and assistance of his attorney, signed and caused to be recorded a statutory Claim
of Lien against the car wash property. In this lien claim, Defendant asserted he
was owed $168,342.72. Ex. 22. Defendant testified that this amount was
calculated by Rule Sales & Service’s bookkeeper/office manager as that needed to
pay off all the outstanding claims of subcontractors for work performed on the
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MEMORANDUM OF DECISION - 15
property, together with his accrued management fee. Plaintiffs testified that, after
taking over the project, they paid subcontractors over $100,000 for goods and
services provided before Defendant walked off the job. That they did pay this
amount actually supports the credibility of the amount due stated in Defendant’s
lien claim.
One year later, Debtor amended his Claim of Lien to $16,315.66.
Ex. 23. Debtor testified this amendment reflected payments made by Plaintiffs to
subcontractors, leaving only Debtor’s management fee outstanding.
The State Court Action.
Plaintiffs sued Defendant and his company in state court claiming
breach of contract, breach of fiduciary duty, fraud and slander of title. The parties
tentatively settled the issues the day trial was to begin, and recited a stipulation on
the record. Apparently, as a result of their negotiations, Defendant agreed to pay
$30,000 to Plaintiffs, and to release the lien on the car wash property. However,
problems arose in documenting the deal. When Defendant would not sign
Plaintiffs’ version of the settlement documents, on September 4, 2003, at
Plaintiffs’ request and over Defendants’ objection, the state court entered a
judgment against Defendant in the amount of $400,000 and ordered the lien
released. In its judgment, the court awarded $100,000 to Plaintiffs for damages
arising out of their breach of contract claim; $200,000 for damages arising out of
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7 To the Court, the basis for the state court’s judgment is unclear. It seems to
represent a default judgment on the merits based upon Defendants’ failure to cooperate in
effectuating the terms of the settlement agreement. Because of the curious nature of the
proceedings below, this Court ruled that the state court judgment was not entitled to
preclusive effect to establish the elements of Plaintiffs’ nondischargeability claims. See
Memorandum Decision and Order, Docket Nos. 24 and 25.
8 Unless otherwise noted, all section and chapter references are to the
Bankruptcy Code, 11 U.S.C. §§101-1330, and all Rule references are to the Federal
Rules of Bankruptcy Procedure.
MEMORANDUM OF DECISION - 16
their breach of fiduciary duty, fraud, and slander of title claims; and $50,000 in
punitive damages. Ex. 26, 33. 7
Defendant filed for relief under Chapter 7 of the Bankruptcy Code on May
19, 2004. Plaintiffs timely commenced this adversary proceeding on August 24,
2004.
The Parties’ Arguments
Plaintiffs’ Amended Complaint seeks a declaration that the debt
Defendant owes them under the state court judgment is excepted from discharge in
bankruptcy under § § 523(a)(2)(A), (a)(2)(B), (a)(4) and (a)(6).8 Plaintiffs contend
Debtor defrauded them by representing at various times during his involvement in
the construction project that the car wash would cost $500,000 to complete, when
he knew the actual cost would be closer to $750,000. Plaintiffs also argue
Defendant willfully and maliciously damaged their property by recording an
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MEMORANDUM OF DECISION - 17
inflated Claim of Lien after walking off the job, preventing them from refinancing
their loan on the property.
Defendant characterizes this action as a business dispute, and insists
that even if he breached his contract with Plaintiffs, he committed no fraud.
Defendant contends the Plaintiffs always understood the total price of the project
would be closer to $750,000. Defendant argues that he recorded the lien claim
because he had not been paid money he believed in good faith he was owed
pursuant to the Management Agreement, and that he needed to pay subcontractors.
Conclusions of Law and Analysis
A. Debtor’s Rule 52(c) Motion
First, some housekeeping.
After Plaintiffs presented their case at trial, Defendant orally moved
for judgment on partial findings. Fed. R. Civ. P 52(c), which applies to adversary
proceedings by incorporation via Rule 7052, provides in part,
If during a trial without a jury a party has been fully
heard on an issue and the court finds against the party
on that issue, the court may enter judgment as a matter
of law against that party with respect to a claim or
defense that cannot under the controlling law be
maintained or defeated without a favorable finding on
that issue[.]
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MEMORANDUM OF DECISION - 18
Fed. R. Civ. P. 52(c). After argument by the parties, the Court orally granted
Defendant’s motion as to Plaintiffs’ § 523(a)(2)(B) and § 523(a)(4) claims. The
Court takes this opportunity to explain the reasons for its decision.
1. 	Plaintiffs Failed to Make a Prima Facie Case
Under § 523(a)(2)(B).
Section 523(a)(2)(B) prevents discharge of a debt in bankruptcy
when the debt was incurred by the
(B) use of a statement in writing–
(I) that is materially false;
(ii) respecting the debtor’s or an insider’s financial
condition;
(iii) on which the creditor to whom the debtor is liable
for such money, property, services, or credit
reasonably relied; and
(iv) that the debtor causes to be made or
published with intent to deceive[.]
Plaintiffs claimed an exception to discharge was proper under both § 523(a)(2)(A)
and § 523(a)(2)(B). The Ninth Circuit has held, “as a plain reading of the statute
shows, parts (A) and (B) are mutually exclusive, the former referring to
representations other than those respecting the debtor’s financial condition and the
latter referring specifically to written statements of financial condition.” In re
Kirsh, 973 F.2d 1454, 1457 (9th Cir. 1992).
Section 523(a)(2)(B) requires that any allegedly fraudulent statement
be in writing and be materially false in regard to the debtor’s financial situation.
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MEMORANDUM OF DECISION - 19
None of the documents involved in the transaction such as the Management
Agreement or the equipment contracts, or even the “statements” about project
costs sent by Defendant to Plaintiffs during construction, constitute a statement
respecting Defendant’s financial affairs. Whether those written documents were
fraudulent or not, Plaintiffs’ claim under § 523(a)(2)(B) fails, and so the Court
dismissed it.
2. 	Plaintiffs Did Not Meet the Requirements for an
Exception from Discharge under § 523(a)(4).
Plaintiffs abandoned their claim that Defendant committed fraud as a
fiduciary during presentation of their case in chief. The Court agreed with
Plaintiffs’ decision, and so dismissed the claim on Defendant’s Rule 52(c) motion.
To support an exception to discharge under § 523(a)(4), Plaintiffs
must show: “(1) an express trust existed, (2) the debt was caused by fraud or
defalcation, and (3) the debtor acted as a fiduciary to the creditor at the time the
debt was created.” Banks v. Gill Distribution Centers, Inc. (In re Banks), 263 F.3d
862, 870 (9th Cir. 2001) (citing Otto v. Niles (In re Niles), 106 F.3d 1456, 1459
(9th Cir. 1997)). Plaintiffs failed to establish the existence of any trust, or that
Defendant was ever acting as a fiduciary at the time the debt arose.
B. Plaintiffs’ § 523(a)(2)(A) Claim.
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MEMORANDUM OF DECISION - 20
To except a debt from discharge under § 523(a)(2)(A) Plaintiffs
must prove by a preponderance of the evidence that “(1) [Debtor] made
representations; (2) which at the time [Debtor] knew were false; (3) [Debtor] made
the representations with the intention of deceiving Plaintiff; (4) Plaintiff relied on
such representations; and (5) Plaintiff sustained the alleged loss as the proximate
result of the representations.” Bell, et al. v. Smith (In re Smith), 98.4 I.B.C.R. 119,
120 (Bankr. D. Idaho 1998) (citing American Express v. Hashemi (In re Hashemi),
104 F.3d 1122, 1125 (9th Cir. 1996)). “Intent to deceive is a question of fact
which may be inferred from the surrounding circumstances of the case.” Farmers
& Merchants State Bank v. Cracchiolo (In re Cracchiolo), 00.2 I.B.C.R. 84, 86
(Bankr. D. Idaho 2000) (citing Cowen v. Kennedy (In re Kennedy), 108 F.3d 1015,
1018 (9th Cir. 1997)).
For a debt to be excepted for fraud, the creditor’s reliance upon the
false statement need only be justified; reasonable reliance is not required. Field v.
Mans, 516 U.S. 59, 74–75 (1995); see also Bell, et al. v. Smith (In re Smith), 98.4
I.B.C.R. 119, 121–22 (Bankr. D. Idaho 1998). “Justification 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.” Field, 516 U.S. at 71. However, significantly, “a person . . . cannot
recover if he blindly relies upon a misrepresentation the falsity of which would be
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MEMORANDUM OF DECISION - 21
patent to him if he had utilized his opportunity to make a cursory examination or
investigation.” Id.
Plaintiffs argue that Defendant’s sale of the equipment to them at a
price significantly in excess of Defendant’s cost amounted to fraud. Additionally,
Plaintiffs insist that Defendant fraudulently induced Plaintiffs to sign the
Management Agreement by representing the total cost of the project would not
exceed $500,000. Finally, Plaintiffs argue Defendant committed fraud by
continuing during the project to represent the cost of the project to be $500,000.
The Court disagrees in all respects.
1. 	That Defendant was to make a profit on the sale of
equipment is not fraud.
Despite Plaintiffs’ attempt to characterize them as fraudulent, there
is no indication in the purchase orders for the equipment signed by Jo Ann Olson
that the price represented Defendant’s cost. Defendant was a merchant and a
dealer in such equipment. He testified without contradiction that he both sells
equipment and builds car wash facilities. Presumably, absent some express
agreement to the contrary, Plaintiffs should have anticipated that Defendant would
expect to make a profit on the sale of the equipment to them, even separate and
apart from his agreement to serve as the construction manager. 	Defendant was
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MEMORANDUM OF DECISION - 22
under no legal duty to disclose his cost or proposed profit on the equipment sales
transactions.
Plaintiffs accepted the price for the equipment stated in the purchase
contracts. And no evidence was submitted showing that the price Defendant
charged Plaintiffs for the equipment was more than its fair retail value. Even if the
prices in the purchase orders could be characterized as “excessive,” such is no
reason to find Defendant guilty of fraud.
Plaintiffs contend that Defendant took advantage of a conflict of
interest he created by being both the construction manager and the equipment
salesman. Plaintiffs argue that Defendant, as the construction manager, had an
obligation to make sure all subcontractors properly performed and failed to do so
by allowing himself, as the equipment supplier, to charge an inflated price for the
equipment. But, Plaintiffs agreed to purchase the equipment from Defendant, at a
specific price, prior to contracting with Defendant to be the construction manager.
Such a situation does not amount to fraud.
Plaintiffs also contend that Defendant defrauded them by charging
an additional management fee on top of the equipment costs. The Management
Agreement allows Defendant a management fee calculated on the total costs of the
project. And Plaintiffs must admit that Defendant’s management fee was to be
assessed on top of the profit presumably included in all the various subcontractor
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MEMORANDUM OF DECISION - 23
contracts. At worst, Defendant may be accused of sharp dealing, and Plaintiffs
may be the victims of poor judgment and a bad business deal. That does not
amount to fraud.
2. 	Defendant’s estimates of the total cost of the project were
not fraudulent.
a. 	False Representation.
Defendant, in the Management Agreement he drafted, represented
that the estimated total project cost would be $500,000. Ex. 1. Plaintiffs allege
this statement was false because Defendant knew the project would require over
$700,000 to complete. While Defendant conceded he probably did realize it
would not be possible to build the total car wash for $500,000, he included that
figure in the Management Agreement as an initial estimate to get the project
started, to lower the amount of Plaintiffs’ down payment under the Agreement,
and to help Plaintiffs secure financing for the project.
By definition, an estimate is not intended to be exact. However,
because Defendant admitted that when he inserted the $500,000 figure in the
Management Agreement he knew it would not be possible to complete the car
wash for that amount, that statement was indeed false.
b. 	Intent to Deceive.
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MEMORANDUM OF DECISION - 24
Without doubt, Defendant’s $500,000 estimate of the total project
cost caused confusion. Plaintiffs contend they believed the project would not
exceed $500,000. But, as noted above, their testimony on this point is unrealistic
and ignores the plain meaning of the Management Agreement Plaintiffs signed,
which provides for “an estimated $500,000.00 total project cost.” Ex. 1. The
Management Agreement is not ambiguous. If Plaintiffs were truly opposed to
building the car wash if the cost was to exceed $500,000, as they testified,
presumably they would have insisted that the contract contain language clearly
limiting the project costs to that amount instead of allowing inclusion of an
“estimated” cost of $500,000. Obviously, the parties intended the $500,000 figure
in the Management Agreement as an approximation.
Plaintiffs failed to produce sufficient persuasive proof that
Defendant inserted the $500,000 estimate in the Management Agreement with the
intent to deceive Plaintiffs. 	As noted above, the parties understood the final cost
figure would likely exceed this amount, perhaps significantly.
Plaintiffs acknowledged that during construction, they made changes
to the car wash plans, such as adding a coffee shop into one of the car wash bays.
Defendant testified as to unforseen problems with the project, such as when a
subcontractor damaged a major sewer line that had not showed up on a Digline
report. 	The additional costs for the coffee shop, water and sewer line repairs, and
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MEMORANDUM OF DECISION - 25
permits and fees amounted to $91,562.49. Ex 6. There were also problems in
obtaining the necessary permits from the City of Caldwell.
Plaintiffs knew the price they had agreed to pay for the equipment
and had an estimate of what it could cost to construct the building. At the
beginning of the parties’ business relationship there were several “unknowns” that
would likely figure into the total cost of the project. While the $500,000 number
was an unrealistically low estimate, Plaintiffs failed to meet their burden to show
that Defendant intended to deceive them by using a fraudulent cost estimate.
c. Reliance.
Even if Defendant intended to deceive Plaintiffs by having them
sign an agreement projecting the total construction costs at $500,000, their
reliance on Defendants’ cost estimate, based upon other information available and
known to them, was not justifiable.
The documents offered in evidence, and presented by Defendant to
Plaintiffs before and during construction, show that the cost of the car wash would
exceed $500,000. These documents lend credibility to Debtor’s testimony that the
$500,000 number was merely inserted to get the project started. Plaintiffs argue
Exhibit 2, the Construction Oversight document, indicates it would cost
approximately $308,663.52 to construct the building. However, there are several
items and costs not included in that estimate. Two additional numbers are
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MEMORANDUM OF DECISION - 26
handwritten on the document: $42,918 for the coffee shop construction and
$41,895 for power, sewer and water hook up fees, and building permits. Plaintiffs
had already agreed to purchase equipment from Debtor in the amount of
$226,434.14. Had she reviewed these numbers, Jo Ann Olson and the others
would have understood the estimated costs were actually over $619,000 plus
Defendant’s 8% management fee. Defendant’s disclosure of this information to
Plaintiffs renders Plaintiffs’ alleged reliance on the $500,000 figure in the
Management Agreement and elsewhere unjustified.
Additionally, the testimony of both Nancy Roe and Diane Johnson
indicated Jo Ann Olson, who made the decisions concerning this project until she
became too ill to do so, relied heavily upon the advice of others. Diane Johnson
testified Jo Ann Olson relied upon John Frye for advice in undertaking and
building the car wash. When questioned why Plaintiffs borrowed $570,000 if they
believed the project was to cost no more than $500,000 it was explained by both
of these Plaintiffs that it was what they had been advised to do. The facts indicate
that Plaintiffs relied upon what was told them by others, including John Frye, as
opposed to using any independent judgment to see what was occurring with the
car wash project. Plaintiffs did not rely solely upon representations of Defendant
as to the costs of this project.
e. Plaintiffs Were Not Defrauded.
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9 The Court need not analyze Plaintiffs’ claim for damages and the corresponding
testimony of their expert. Even so, the Court notes Plaintiffs failed to produce evidence
showing they did not receive what they paid Defendant for in this transaction. Indeed,
there is nothing to suggest that the value of the car wash is not equivalent to its cost to
build. No mention of such an argument was made until Plaintiffs’ Response to
Defendants’ Closing Argument, Docket No. 48, was filed with the Court. The evidence
does not support such an argument. And the implications in Plaintiffs’ briefing that
Defendant may have diverted some of the funds they paid him for use on the project lack
any basis in the record.
MEMORANDUM OF DECISION - 27
Though the number he inserted in the Management Agreement was
indeed false, Plaintiffs failed to show Debtor acted with the intent to deceive them
when he used $500,000 as an estimate of the total project costs. Plaintiffs also
failed to show they were justified in their reliance on that projection. Plaintiffs
had other information available to them which showed the total cost of the project
would significantly exceed this sum. As a result, the Court concludes the debt
cannot be excepted from discharge under § 523(a)(2)(A) for fraud. 9
3. 	Defendant’s continued statements that the total project
cost would be $500,000 were not fraudulent.
As discussed above, Defendant’s estimate in the Management
Agreement that the total project costs would amount to $500,000 was incorrect,
something Defendant realized at the time. However, the evidence does not show
Defendant included an inaccurate estimate to defraud Plaintiffs.
Similarly, while Defendant continued to use the $500,000 number in
Exhibits 3 and 4 in calculating amounts due in the construction progress
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MEMORANDUM OF DECISION - 28
statements delivered to the Bank and in conversations with Plaintiffs, the evidence
fails to persuade the Court Defendant was attempting to deceive Plaintiffs. In
addition, by that time, Plaintiffs had access to documentation showing the cost of
the project would be well over $500,000. And Plaintiffs had authorized changes
to the project knowing the addition of the coffee shop would add additional cost to
the project.
Defendant deserves criticism for his cavalier approach to the
calculations he prepared during the construction project. Indeed, the Court found
the Defendant to be curiously disinterested in many of the details of the costs of
this project in his testimony at trial. In the Court’s opinion, Defendant was likely
negligent in his failure to be more cognizant of the accruing costs on this project,
and in his poor efforts at keeping Plaintiffs informed about those costs. Clearly,
Defendant’s various calculations of amounts expended and due from Plaintiffs on
the project are difficult to reconcile. Defendant’s lack of diligence in this regard
may have given Plaintiffs good cause to terminate his services for failure to
properly perform his duties under the Management Agreement. Even so, the
Court is not persuaded, in presenting cost information to Plaintiffs, Defendant
intended to defraud them.
Defendant plausibly testified that when he responded to Plaintiffs’
questions regarding project costs at the July 2001 meeting, he sincerely believed
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MEMORANDUM OF DECISION - 29
the eventual costs of constructing the car wash building would amount to about
$500,000. However, in making that representation, Defendant believed Plaintiffs
appreciated that this estimate no longer included the $200,000 cost of the
equipment. Defendant could have, indeed probably should have, been more
precise in his statements, which were likely confusing. But the Court is not
persuaded that Defendant made these statements with the intent to create a
misunderstanding by Plaintiffs. And again, at that point in the project, Plaintiffs
would not have been justified in treating Defendant’s statements as precise. 	At
best, the statements made by Defendant were approximations.
C. Plaintiffs’ § 523(a)(6) Claim.
Section 523(a)(6) excepts from discharge a debt “for willful and
malicious injury by the debtor to another entity or to the property of another
entity.” “To be considered willful, the debtor must commit an act akin to an
intentional tort under state law, and the debtor must intend the consequences or
injury resulting from the act rather than just the act itself.” Farmers & Merchants
State Bank v. Cracchiolo (In re Cracchiolo), 00.2 I.B.C.R. 84, 87 (Bankr. D.
Idaho 2000) (citing Kawaauhau v. Geiger, 523 U.S. 57, 61–62 (1998)); See also
Spokane Railway Credit Union v. Endicott (In re Endicott), 254 B.R. 471 (Bankr.
D. Idaho 2000). The act must be more than reckless or negligent. Cracchiolo,
00.2 I.B.C.R. at 87.
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In Idaho “[s]lander of title requires proof of four elements: (1)
publication of a slanderous statement; (2) its falsity; (3) malice; and (4) resulting
special damages.” McPheters v. Maile, 64 P.3d 317, 321 (Idaho 2003). Such a
showing is similar to what must be shown in the context of a § 523(a)(6)
nondischargeability action.
In a § 523(a)(6) action, the “willful injury requirement is met only
when the debtor has a subjective motive to inflict injury or when the debtor
believes that injury is substantially certain to result from his own conduct.”
Carrillo v. Su (In re Su), 290 F.3d 1140, 1142 (9th Cir. 2002); see also Dominguez
v. Elias (In re Elias), 03.4 I.B.C.R. 243, 245–46 (Bankr. D. Idaho 2003). “A
‘malicious’ injury involves ‘(1) a wrongful act, (2) done intentionally, (3) which
necessarily causes injury, and (4) is done without just cause or excuse.’” Su, 290
F.3d at 1146–47 (quoting In re Jercich, 238 F.3d 1202, 1209 (9th Cir. 2001));
Elias, 03.4 I.B.C.R. at 246.
1. 	Defendant’s Actions in Filing the Lien Claims were
Neither Willful nor Malicious.
Plaintiffs did not prove that Defendant, in filing his lien claims,
acted willfully and maliciously.
Defendant filed his original lien claim shortly after ceasing work
when Plaintiffs refused to further fund the project. Defendant may not have acted
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MEMORANDUM OF DECISION - 31
prudently in ceasing work. But the Court accepts Defendant’s explanation that he
filed the lien, not intending to in any way damage Plaintiffs, but in good faith to
protect his financial interests, and those of his subcontractors to whom he was
obligated. Moreover, given the amount Plaintiffs paid to subcontractors after they
took over the project, the amount of Defendant’s lien claim, while likely not
precisely correct, was not so excessive as to indicate the lien was asserted with a
bad motive. The same is true a year later when Defendant amended the lien claim.
While the presence of the liens may have prevented Plaintiffs from
refinancing the project as a practical matter, the Court is also not persuaded
Defendant acted maliciously. To the extent Defendant was owed money under the
Management Agreement to pay subcontractors and his management fees, he was
legally entitled to lien the property. 	See Idaho Code § 45-501 et seq.
The Idaho Supreme Court has instructed that “the fact that a lien
claimant claims a higher amount than is ultimately awarded does not require the
district court to invalidate the claimant’s entire lien.” Electrical Wholesale Supply
Co., Inc. v. Nielson, 41 P.3d 242, 253 (Idaho 2001) (citing Barber v. Honorof, 780
P.2d 89, 91 (Idaho 1989)) (Awarding only $1,069.12 when the amount originally
claimed was $51,571). In other words, under Idaho law, Defendant’s lien was not
invalid simply because the amount claimed proved to be different than the actual
amount owed absent a specific finding of abusive conduct “devoid of any good
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MEMORANDUM OF DECISION - 32
faith effort to comply with the lien statutes.” Id at 252. Similarly, even if the
original or subsequent lien claims may have exceeded the actual amounts due,
there is no indication that Defendant acted with malice in filing them. Asserting a
lawful lien, even if the amount claimed is inaccurate, is not the sort of wrongful
act targeted by the Bankruptcy Code as malicious.
No portion of Plaintiffs’ judgment debt against Defendant should be
excepted from discharge on the basis that the lien was asserted willfully and
maliciously.
Conclusion
Plaintiffs failed to prove that the debt owed to them by Defendant
under the state court judgment should be excepted from Defendant’s discharge in
bankruptcy pursuant to 11 U.S.C. § 523(a)(2)(A) or § 523(a)(6). A separate
judgment will be entered.
Dated: January 6, 2006
Honorable Jim D. Pappas
United States Bankruptcy Judge
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