In re Stewart

948 F.3d 509

Edward T. STEWART, Jr., Debtor.

Sheila Dewitt and Joseph Dewitt, Plaintiffs/Creditors, Appellees,

v.Edward T. Stewart, Jr., Defendant/Debtor, Appellant.

No. 18-9007

United States Court of Appeals, First Circuit.

February 3, 2020

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.

Before Howard, Chief Judge, Torruella and Selya, Circuit Judges.

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 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.

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 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 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 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 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 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...