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NDNY: Claim against contractor not discharged if trust fund was diverted

In re: Henderson (NDNY Chap. 7 Bk 08-60255; AP 09-80035 (Hon. Diane Davis; decision Jan. 27, 2010):

Motion for summary judgment in an adversary proceeding to deny discharge or accepted that this charge. The debtor is a home improvement contractor in the creditor is a dissatisfied customer. The case was originally filed in chapter 13 but converted to chapter 7. The creditor is litigating the dischargeability issues pro se (without an attorney), and the court concluded the pleadings were a mass. However, the court reorganized the pleadings in order to address specific discharge issues.

The court dismissed all the motions for denial of discharge. The court concluded that the debtor maintained adequate records, and so dismissed a discharge challenge under the bankruptcy code section 727(a)(3).

The court dismissed the challenge to discharge based on the debtor allegedly making a false oath or statement, as described in section 727(a)(4). The false statements alleged by the creditor were either failure to list a Workers Compensation claim, and listing as an asset and alleged claim against the creditor is for work performed but not yet paid for. The court concluded that the statements were either appropriate or not material (that is to say, pertinent to the discovery of assets that can be distributed to creditors.)

The court also dismissed a challenge to discharge for making a "false claim" under section 727(a)(4)(B). The creditor claimed that by falsely stating they owed the debtor money, the debtor was filing a false claim. However, this rarely-used section applies where the debtor has scheduled fictitious claims, not disputed debts.

The court also rejected a challenge to discharge based on willful failure to obey a court order, under section 727(a)(6). The various orders in question were various discovery orders associated with the discharge adversary proceeding, and the court found no willful violations.

The court then addressed request to have the creditor's debt excepted from discharge under section 523. First, the creditor claimed that the debt was incurred on the basis of fraud, as described in section 523(a)(2)(A). The court concluded that the debtor had not overstated his qualifications or intentions to complete the job, and so the deposit money was not obtained on the basis of fraud. Failure to perform a contract is not, by itself, fraud.

The creditor also lost on the issue of whether the debt was incurred basis of embezzlement or larceny (523(a)(4)) or willful or malicious injury (523(a)(6)), again as the matter appears to be just a contract dispute. However, the court did allow one exception to discharge issue to continue, on the grounds of alleged defalcation by a fiduciary under section 523(a)(4). Under New York Lien Law Article 3-A, a home improvement contractor is required to escrow deposits on home improvement projects (or provide other safeguards) until the project is substantially complete. The contractor, therefore, acts as a fiduciary for the homeowner's deposit. On that cause of action, the creditor could proceed.

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