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April 2010

Ghomeshi v. Sabban - Disgorgement Awards Against Unlicensed Contractors Dischargeable in Bankruptcy

Following in the recent line of cases regarding claims for disgorgement of compensation paid to unlicensed contractors in California under California Business & Professions Code § 7031(b), the Ninth Circuit has addressed whether such judgments are dischargeable pursuant to Section 523(a)(2)(A) of the United States Bankruptcy Code.

In the Gomeshi v. Sabban case, the Ninth Circuit concluded that awards made pursuant to Cal. Bus. & Prof. Code § 7310(b) are dischargeable in bankruptcy because § 7310 is not premised on a finding of either fraud or actual harm.  In Ghomeshi, Gomeshi hired Pacific Coast Creations ("Pacific"), to perform remodeling work at his home.  Sabban held the majority interest in Pacific and was a signatory to the contracts for services.  Sabban falsely represented that Pacific was a licensed contractor with the California Contractors State License Board.  Ghomeshi paid $123,000 to Pacific for the remodeling services.  Ghomeshi sued Sabban in state court for various causes of action, including violations of Cal. Bus. & Prof. Code § § 7160 and 7031(b).  The court found that Ghomeshi was induced to sign the contract in reliance upon false and fraudulent representations made by Sabban.

Cal. Bus. & Prof. Code § 7160 provides a cause of action for individuals who were induced to contract for home improvements in reliance of fraudulent statements.  If a party is successful on this claim, a $500 penalty may be recovered, as well as reasonable attorney's fees and any "damages sustained by him by reason of such statements or representations made by the contractor or solicitor."  The state court awarded the $500 penalty and attorney's fees, however they declined to award damages as they concluded "[t]echnically there are no damages."

Cal. Bus. & Prof. Code § 7031(b) allows a party who has used the services of an unlicensed contractor to recover all amounts paid to the contractor.  No showing of fraud of actual harm is required, just that the compensation was actually paid.  Hydrotech Sys. Ltd. V. Oasis Waterpark (1991) 52 Cal. 3d 988, 995, 997-98.  Pursuant to § 7031(b) the state court awarded Ghomeshi the amount he had paid to Sabban of $123,000.

Sabban subsequently filed for Chapter 7 bankruptcy protection.  Ghomeshi filed an adversary action to determine the dischargeability of his judgment.  The bankruptcy court found that the award under § 7160 was non-dischargeable, but that the award under § 7031(b) was dischargeable.  Ghomeshi appealed this finding to the Bankruptcy Appellate Panel who affirmed the finding.  Ghomeshi then appealed the BAP's holding to the Ninth Circuit.

The Ninth Circuit analyzed the basis for non-dischargement in addressing this issue.  Section 523(a)(2)(A) of the Bankruptcy Code excepts from discharge any debt for money, property, services, or credit that was obtained by fraud.  11 U.S.C. § 523(a)(2)(A).  In order to make a claim of non-dischargeability under this section, a creditor must demonstrate five elements:

 (1) the debtor made?representations;
 (2) that at the time he knew they were false;
 (3) that he made them with the intention and purpose of deceiving the  
 (4) that the creditor relied on such representations; and
 (5) that the creditor sustained the alleged loss and damage as the proximate 
      result of the misrepresentations having been made.

The court admitted that there was no question that Ghomeshi met the first four elements of this test.  However, the court concluded that for purposes of the award of $123,000 pursuant to Cal. Bus. & Prof. Code § 7031(b), Ghomeshi could not show that any actual loss or damage occurred as a result of the misrepresentation.  As the state court concluded, Ghomeshi had no actual damages as a result of the fraudulent statements by Sabban.  The award of $123,000 was based solely on the language of § 7031(b) which requires only that compensation was paid to an unlicensed contractor.  The court further justified its finding by noting that § 523(a)(2)(A) of the Bankruptcy Code deals only with debts based on actual fraud.  While Cal. Bus. & Prof. Code § 7160 actually addresses the issue of fraud, § 7031(b) is not premised on the commission of fraud.  It was this simple distinction in the language of the statutes themselves that led the court to conclude that an award made pursuant to § 7031(b) was dischargeable.

It is unknown what the practical result of this ruling will be.  It would appear that unlicensed contractors may have a safeguard should an owner ever seek disgorgement of compensation paid pursuant to § 7031(b).  However, this would not protect the contractor from penalty's and awards of attorney's fees under § 7160.  For owners, this may tighten the loophole provided by § 7031(b) by which an owner can recover all monies it paid for services rendered should it learn that the contractor, at any time during the work, was unlicensed.