A couple (the “creditors”) desired to renovate a historic building on their property and hired a construction company (the “company”), an entity wholly owned by the debtor. The debtor represented to the creditors that he was a licensed general contractor despite the fact that neither the company nor the debtor were licensed. The parties signed a construction contract, and the creditors paid the company a large, refundable deposit for use in the renovation project. However, after significant delays due to the company’s failure to secure permits for the renovations (because it did not have the required contractor’s license), the creditors and the company mutually agreed to terminate the contract. The company failed to return the deposit to the creditors and, in fact, at the direction of the debtor, had spent the entirety of the deposit before completing any renovation work. Bank statements revealed that the debtor had paid numerous personal debts using the company’s assets, including the deposit. After a lengthy back-and-forth, in which the company continually changed its position and failed to provide documentation to the creditors of expenses incurred and therefore retained from the deposit, the creditors sued the company in state court for the company’s misappropriation of the deposit. The state court entered judgment in favor of the creditors for the entirety of the deposit, costs, and pre-judgment interest. The debtor filed for Chapter 13 bankruptcy, and the company went out of business. The debtor’s confirmed Chapter 13 plan (the “plan”) provided that the debtor would pay “a 100% payout to all timely filed Class Four Claims.” The creditors filed a proof of claim for the deposit amount but then amended their claim to reflect the state court judgment amount, treble damages, interest, and attorney’s fees and costs. The debtor did not object to the amended proof of claim. The creditors then filed a complaint seeking to have the full debt deemed nondischargeable against the debtor under “Sections 523(a)(2)(A) (‘false pretenses, false representations, and actual fraud’), 523(a)(4) (‘embezzlement’), and/or 523(a)(6) (‘willful and malicious injury’) of the bankruptcy code,” and seeking additional damages (as reflected in their amended proof of claim) for civil theft under Colo. Rev. Stat. § 18-4-405. The debtor contested the nondischargeability.
In McNulty v. Palecki (In Re Palecki), 667 B.R. 581 (Bankr. D. Colo. 2025), the bankruptcy court held that the debt owed by the debtor was valid and nondischargeable under Sections 523(a)(2)(A), (a)(4), and (a)(6), and that the creditors were entitled to mandatory enhanced damages under the Colorado civil theft statute. First, the court set forth the standards and analysis required for nondischargeability claims. The court explained that creditors bear the burden of establishing a debt is nondischargeable under Section 523(a) and that if there is any doubt as to the nondischargeability, it should be resolved in the debtor’s favor because “exceptions to discharge under Section 523(a) ‘are to be narrowly construed . . . because of the fresh start objectives of bankruptcy.’” Bellco First Fed. Credit Union v. Kaspar (In re Kaspar), 125 F.3d 1358 (10th Cir. 1997). To determine nondischargeability claims under Section 523(a) a two-part analysis is required: (1) “‘[f]irst, the bankruptcy court must determine the validity of the debt under applicable law’” (the claim on the debt component) and (2) “‘[s]econd, if there is a valid debt, ‘the bankruptcy court must determine the dischargeability of the debt under Section 523’” (the dischargeability component). Hatfield v. Thompson (In re Thompson), 555 B.R. 1 (10th Cir. BAP 2016). Therefore, the court first addressed whether a valid debt existed and found that one did (excluding any treble damages, attorney’s fees, and costs for civil theft, which the court later addressed). The court carefully considered this finding because the debtor had already agreed with the creditor that he owed the amount of the state court judgment. However, the court found that certain amounts should be deducted to account for expenses incurred by the debtor in attempting to get permits for the renovation and payments already made to the creditor under the plan, making the debt owed by the debtor slightly less than the state court judgment amount.
The court then addressed the nondischargeability issue, beginning with the Section 523(a)(2)(A) claim. The creditors asserted all three subparts of § 523(a)(2)(A) applied – “(1) false representations; (2) false pretenses; [and] (3) actual fraud.” Each subpart contains its own elements, but overall, they require that a debtor intended to defraud a creditor. To establish nondischargeability due to false representations, the creditor must prove “(1) the debtor made a false representation” other than a statement respecting the debtor’s or an insider’s financial condition; “(2) the debtor made the representation with the intent to deceive the creditor; (3) the creditor relied on the false representation; (4) the creditor’s reliance was [justifiable]; and (5) the false representation resulted in damages to the creditor.” The court found that the debtor clearly made “several false representations,” notably, the debtor repeatedly represented himself as a licensed general contractor to the creditors and as such would be able to get the necessary permits and effectively complete the renovation. The court then looked to the totality of the circumstances and inferred that the debtor intended to deceive the creditors because he knew the creditors wanted to work only with a licensed general contractor and that he would not be able to get the necessary permits to do the renovations because he was not licensed. The court also found that the creditors relied on the false representations because the creditors “absolutely would not have entered into the [c]ontract if they had known [ ] the [d]ebtor was not a licensed general contractor. And, finally, the court found that the creditors’ reliance was justifiable. “In order for [a] [p]laintiff to have justifiable reliance on a representation under [Section] 523(a)(2)(A), the [p]laintiff need only perform a cursory inspection of the representation to the extent that it should be very obvious that the representation is fraudulent.” Adamas Cnty. Dept. Social Servs. V. Sutherland-Minor (In re Sutherland-Minor), 345 B.R. 248 (Bankr. D. Colo. 2006). The debtor argued that the creditors failed on the reliance element because they did not make direct inquiries to the City Planning Office (by website, phone, in person, etc.) or demand a copy of the debtor’s license to verify. However, the court emphasized that all that is required under the Bankruptcy Code is justifiable reliance (as opposed to reasonable reliance), and the creditors had at least made a “cursory examination or investigation” of the representations made by the debtor by asking on numerous occasions if he was licensed and contacting all of his references to confirm. Further, the debtor had previously engaged in construction projects in the city, for which he would have needed a permit, so the creditors justifiably assumed that the debtor must have been licensed because a license is required to obtain such permits. Finally, the court found that the false representation did result in damages in the form of the deposit. Therefore, because the creditors proved all elements of Section 523(a)(2)(A) for false representation, they were “entitled to a nondischargeable judgment in their favor.”
The court then found the creditors established nondischargeability under Section 523(a)(2)(A) for false pretenses based largely on the same evidence as above. “‘Unlike false representations, which are express misrepresentations, false pretenses include conduct and material omissions.’” Bank of Cordell v. Sturgeon (In re Sturgeon), 496 B.R. 215 (10th Cir. BAP 2013). The court explained that the debtor’s omission (that he was not a licensed contractor and that he would have to find a real licensed general contractor to help him perform under the contract) led the creditors to believe that he was a licensed contractor that would be able to obtain permits from the city, which led them to enter into a contract with the debtor and pay the deposit. The court found the debtor’s omissions were “intentional and done with reckless disregard.” The court also found the creditors successfully proved all elements required to get nondischargeability under subsection three of § 523(a)(2)(A) – actual fraud. The court explained that “anything that counts as ‘fraud,’” which generally “connotes deception or trickery…and is done with wrongful intent is ‘actual fraud.’” Husky Int’l Elecs., Inc. v. Ritz, 578 U.S. 355 (2016). The debtor used “deception or trickery” in his engagement with the creditors by making “intentional false representation” to induce the creditor to enter a contract with them. Additionally, the debtor intentionally used the deposit for personal means within a month of receiving it, which he knew (and admitted) was to be used only for the renovation project.
Next, the court addressed the nondischargeability under Section 523(a)(4) claim for embezzlement, finding that the creditors proved all elements required and were entitled to a nondischargeable judgment on embezzlement grounds. Embezzlement under § 523(a)(4) requires “(1) entrustment (property lawfully obtained originally); (2) of property; (3) of another; (4) that is misappropriated (used or consumed for a purpose other than that for which it was entrusted); (5) with fraudulent intent.” Alternity Cap. Offering 2, LLC v. Ghaemi (In re Ghaemi), 492 B.R. 321, 325 (Bankr. D. Colo. 2013). The court found the creditors “easily” proved the first three elements – at the debtor’s request, the creditors entrusted the deposit (the creditor’s property) to the debtor’s control (as the debtor had control of the company). The fourth element was also met, as the debtor caused the deposit to be made. The debtor testified at trial that there was an understanding that the purpose of the deposit was restricted to only work done for the renovations. Regardless, the debtor spent the deposit on general operating expenses, other projects, and payments of personal expenses. Lastly, for the § 523(a)(4) embezzlement claim, the court determined that the debtor did misappropriate “with fraudulent intent.” The “fraudulent intent” element “requires a heightened mens rea of ‘intent to permanently deprive,’ which is more than mere conversion. Ghaemi, 492 B.R. at 327. Here, it was clear that there was not simply passive fraud, where an error or unclear mistake occurred; instead, the debtor intentionally used the deposit for prohibited purposes. The debtor argued that he did not commit embezzlement because he intended to return the deposit, however, the court noted that he used the deposit in order to keep the company afloat and “there is no exception…excusing defendants who misuse the entrusted property of the solvent in order to save a poor company.” Sherman v. Potapoy (In re Sherman), 603 F.3d 11 (1st Cir. 2010). Additionally, there is no “intent to return” defense to embezzlement. U.S. v. Young, 955 F.2d 99, 104 (1st Cir. 1992).
The court then addressed the nondischargeability under Section 523(a)(6) claim for “willful and malicious injury.” The Bankruptcy Code requires both “willful injury” and “malicious injury” as two distinct elements, or the claim must fail. The court first found that the debtor committed a willful injury. For willful injury under § 523(a)(6) the creditor must prove that “the debtor acted with the specific intent to harm a creditor or the creditor’s property, or…indirect evidence that the debtor desired to cause the injury or believed the injury was substantially certain to occur.” First Am. Title Ins. Co. v. Smith (In re Smith), 618 B.R. 901, 912 (10th Cir. BAP 2020). The court found indirect evidence that the debtor “knew and believed his actions with respect to the [d]eposit were ‘substantially certain’ to cause particularized injury to the [creditors].” The debtor knew (and admitted) to using the refundable deposit for unauthorized purposes, hid the company’s financial problems from the creditors, and then offered to return portions of the deposit despite having no means to do so. The debtor knew (or at least was substantially certain) that the creditors would be damaged by the company's failure, as their deposit would not be returned. The court then determined that the debtor committed a malicious injury. To prove malicious injury, the creditor must show the action was “‘wrongful and without just cause or excuse,’” which the court found the debtor’s actions to be. The debtor misappropriated the deposit, knowing “his conduct was wrongful and act[ing] with a culpable state of mind.” The court denied the debtor’s argument that he had “just cause or excuse” for misappropriating the funds to keep the company afloat. Because both elements – willful injury and malicious injury – were found, the court held the creditors proved the requirements necessary for a nondischargeability judgment under § 523(a)(6).
Finally, the court addressed the additional damages (treble damages, interests, and attorney’s fees and costs) the creditors sought under C.R.S. § 18-4-405 for civil theft. C.R.S. § 18-4-405 provides that “(1) a person commits theft when he or she knowingly obtains, retains, or exercises control over anything of value of another without authorization or by threat or deception…and: (a) intends to deprive the other person permanently of the use or benefit of the thing of value; [or] (b) knowingly uses, conceals, or abandons the thing of value in such manner as to deprive the other person permanently of its use or benefit.” Colo. Rev. Stat. § 18-4-401(1)(a)-(b). The creditors asserted civil theft under both (a) and (b), and the court found the creditors met their burden under both. The court explained that the intent to permanently deprive required for § 18-4-410(1)(a) was already proved to establish the creditors’ § 523(a)(4) and (a)(6) claims for nondischargeability. The creditors also proved civil theft under § 18-4-401(1)(b) because it was clear that the debtor “knowingly use[d]…the thing of value [the deposit]” since the deposit was actual used and gone. Section 18-4-405 provides a that civil theft is a basis for obtaining the additional damages sought by the creditors and the creditors were entitled to recover such because they met their burden of providing civil theft. Such damages are, in fact, “mandatory upon proof of all of the elements of civil theft.” In re Krupka, 317 B.R. 432, 439 (Bankr. D. Colo. 2004). The court also found that the creditors were entitled to post-judgment, but not pre-judgment interest under federal law. Pre-judgment interest generally may be awarded if it would “serve to compensate the injured party” or if it would be “otherwise equitable.” Diamond v. Bakay (In re Bakay), 454 Fed. Appx. 652, 654 (10th Cir. 2011). The court found that since the state court judgment amount (which it held was the amount of the debt less certain deduction) already included pre-judgment interest, no “principles of fundamental fairness” would be served for awarding pre-judgment interest on top of pre-judgment interest already awarded. However, as for post-judgment interest, “28 U.S.C. § 1961 sets the rate of interest ‘allowed on any money judgment,’” and the creditors are entitled to such.
By Kristin Meurer, [email protected]
Edited By Taylor O’Brien, [email protected]
Edited By Hayden Mariott, [email protected]