Court Opinion

ID: 9890873
Source: CourtListenerOpinion
Date Created: 2023-10-16 18:00:36.575004+00
Date Added: 2024-06-11T07:50:02.616242
License: Public Domain

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
                 ______________________________
Case: 22-20407         Document: 00516932153             Page: 2      Date Filed: 10/16/2023

                                          No. 22-20407

   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.

                                                     2
Case: 22-20407      Document: 00516932153         Page: 3   Date Filed: 10/16/2023

                                   No. 22-20407

   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

                                            3
Case: 22-20407         Document: 00516932153            Page: 4      Date Filed: 10/16/2023

                                        No. 22-20407

   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.

                                                  4
Case: 22-20407           Document: 00516932153           Page: 5       Date Filed: 10/16/2023

                                         No. 22-20407

   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.

                                                     5
Case: 22-20407         Document: 00516932153               Page: 6      Date Filed: 10/16/2023

                                          No. 22-20407

                                                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.

                                                       6
Case: 22-20407     Document: 00516932153          Page: 7    Date Filed: 10/16/2023

                                   No. 22-20407

         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

                                             7
Case: 22-20407     Document: 00516932153          Page: 8    Date Filed: 10/16/2023

                                   No. 22-20407

             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

                                             8
Case: 22-20407      Document: 00516932153          Page: 9    Date Filed: 10/16/2023

                                    No. 22-20407

          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 &

                                              9
Case: 22-20407     Document: 00516932153           Page: 10   Date Filed: 10/16/2023

                                    No. 22-20407

   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

                                              10
Case: 22-20407     Document: 00516932153           Page: 11    Date Filed: 10/16/2023

                                    No. 22-20407

   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)).

                                             11
Case: 22-20407     Document: 00516932153           Page: 12    Date Filed: 10/16/2023

                                    No. 22-20407

          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 “§ 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.

                                             12
Case: 22-20407        Document: 00516932153              Page: 13       Date Filed: 10/16/2023

                                          No. 22-20407

              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.

                                                    13
Case: 22-20407       Document: 00516932153        Page: 14   Date Filed: 10/16/2023

                                   No. 22-20407

          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

                                            14
Case: 22-20407     Document: 00516932153            Page: 15    Date Filed: 10/16/2023

                                     No. 22-20407

   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);

                                              15
Case: 22-20407     Document: 00516932153           Page: 16    Date Filed: 10/16/2023

                                    No. 22-20407

   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

                                             16
Case: 22-20407     Document: 00516932153            Page: 17    Date Filed: 10/16/2023

                                     No. 22-20407

   “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

                                              17
Case: 22-20407    Document: 00516932153            Page: 18   Date Filed: 10/16/2023

                                   No. 22-20407

   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

                                              18
Case: 22-20407        Document: 00516932153             Page: 19      Date Filed: 10/16/2023

                                         No. 22-20407

              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.

                                                  19
Case: 22-20407     Document: 00516932153          Page: 20   Date Filed: 10/16/2023

                                   No. 22-20407

          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.

                                             20