UNITED STATES BANKRUPTCY COURT

IN RE: WARD HALE CASE NO. 95-51480

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

IN RE:

WARD HALE CASE NO. 95-51480

DEBTOR

KEITH OAKS

KAREN OAKS PLAINTIFFS

VS. ADVERSARY NO. 95-5102

WARD HALE DEFENDANT

MEMORANDUM OPINION

Following the trial of this matter on Count II of the complaint, as amended, the court took this matter under submission. By Count II of the amended complaint, the plaintiffs are asserting an unliquidated claim for damages which they allege is excepted from discharge under 11 U.S.C. § 523(a)(2)(A) as a debt obtained by false representations of the debtor concerning his qualifications, knowledge, and experience as a home builder.

FINDINGS OF FACT:

The defendant debtor filed a petition for relief under chapter 7 of the Bankruptcy Code on September 11, 1995.

The plaintiffs Keith and Karen Oaks are listed in Schedule F to the debtor's petition as creditors holding an unsecured, nonpriority claim in an unknown amount arising out of a disputed building contract.

The debtor has been employed for more than 18 years as a vascular technician at the Veterans Administration Hospital, Lexington, Kentucky. For the past few years he has engaged in the home building business as a sideline. He testified he had built houses similar to the one involved in this litigation in Harrison County, at Georgetown, Kentucky and in Palomar Hills subdivision in Lexington, Kentucky.

He testified he purchased the lot at 644 Reims Drive, Winchester, Kentucky in 1993 with money borrowed from his father. He obtained a construction loan of $80,000 to $90,000 from First National Bank of Georgetown and commenced building a home on the lot. The building permit which the debtor obtained on July 21, 1993 estimated the cost of construction as $80,000.

The debtor did very little of the construction work himself, other than the electrical work. A person from Richmond, Kentucky did the footers and basement. A plumber from Cynthiana, Kentucky did the plumbing work. Morgan & Whitehead did the framing and put the vinyl on the outside walls. Ed Andress also did some of the framing and the roof. The drywall installer was a person from Paris, Kentucky. Insulation was installed by Reliable of Lexington. The heating and air conditioning system was installed by Climate Control of Lexington. Cabinets were installed by Danny Denhart of Winchester, Kentucky. Trim work was done by an employee of Morgan & Whitehead. Painting was done by Raymond Sheppard. The plaintiffs herein, the Oaks, picked out the carpet and the debtor paid for the installation.

According to the debtor, he commenced building the home for himself. He had recently gone through a divorce and expected a daughter to live with him in the house. After the house was about one-half finished he realized he could not pay for the house and decided to sell it. He put up a "For Sale by Owner" sign but also listed the house for sale with Coldwell Banker Realty.

According to the testimony of Karen Oaks she and her husband were looking for a home when they saw the debtor's "For Sale" sign. On inquiry they learned the house was listed with Coldwell Banker Realty.

When she saw the house the drywall work was done, but needed finishing. The debtor told her he had built several homes; that he had built a similar home in Cynthiana. She testified the debtor spoke as if he were a knowledgeable home builder, and the realtor "backed up" this representation of the debtor.

The debtor denied that he held himself out to be a professional builder. He stated the plans for the house came from a book.

Mrs. Oaks and her husband asked about a support beam in the middle of the basement; they asked if the support beam could be moved. The debtor advised them that moving the beam might be a code violation, but he would check. The beam was moved or removed.

Because the drywall was up the Oaks could not see the construction underneath the drywall.

On December 14, 1993 the Oaks agreed to purchase the home for $116,500, subject to an inspection.

A notation at the bottom of the building permit issued by the Winchester/Clark County Department of Inspection indicates the house was inspected on February 22, 1994. The City of Winchester Building Inspection certificate indicates the house was inspected on February 22, 1994. The City of Winchester Building Inspection and Code Enforcement Division granted a Certificate of Occupancy on that date. On February 23, 1994 Inspector Larry Disney issued a Satisfactory Completion Certificate stating that all items were complete, except landscaping, sod, planting grass, trees and shrubs.

Tracy Puckett, the building inspector for the City of Winchester who issued the building permit for the house at 644 Reims Road, testified he had been a building inspector for the City of Winchester for the previous seven years; that he had worked in construction most of his life.

He stated he performed three periodic inspections on the house, on the footers, the framing, and when the house was complete and ready for occupancy.

Larry Disney is the chairman of the City of Winchester Planning Commission. Puckett is an adviser to the Commission.

Disney testified the City of Winchester adheres to the Kentucky Building Code for one and two family residences. He stated the electrical and plumbing systems were inspected by others. He found the basement tile was properly installed and did not notice any improper structural supports when he made his final inspection on February 23, 1994 and issued a satisfactory completion certificate on March 18, 1994. He had not revisited the house after the date of his final inspection.

With respect to the fireplace he testified that cultured marble is not considered a combustible and is permissible around a fireplace.

The debtor testified that during the nine weeks between the execution of the purchase contract by the Oaks on December 14, 1993 and the closing on the sale of the house to the Oaks on February 28, 1994 he talked to Mrs. Oaks daily. He checked on the house before and after work and saw Mrs. Oaks there daily. At the Oaks' request he put in extra electrical outlets, and extra drywall in the basement.

At a meeting at Coldwell Banker Realty about two weeks before closing the Oaks wanted to change a counter top that was scratched. The record is unclear as to whether the counter was changed.

L. E. Kirkwood, who had been a real estate agent for Coldwell Banker for 102 years, was the listing agent and salesman that handled the sale of the property to the Oaks. He testified that at closing there was a discussion of some work remaining to be done. He testified the debtor told the Oaks if they wanted to back out of the sale he would keep the property.

Debtor testified that at closing he did not want to sign a warranty, but did. According to the closing statement approximately $65,000 was disbursed to pay off the construction loan to First National Bank of Georgetown; the debtor received, or was to receive, approximately $42,000, although apparently $1,300 of this sum was held in escrow pending the completion of landscaping, sodding and seeding of the lot.

According to the testimony of Mrs. Oaks the basement flooded approximately two days after they moved into the house. The debtor told them this was due to the fact windows needed sealing. After caulking was added to the windows they moved some of their belongings into the basement and the basement flooded again.

The debtor testified that each time the Oaks complained he tried to take care of the matter. Shortly after closing they complained about a basement door; he sent a painter over to fix the door.

According to Mrs. Oaks the landscaping was not finished; the contractor the debtor hired did not properly landscape the property. They refused to release the $1,300 that had been placed in escrow at closing.

On July 8, 1994, the debtor, by counsel, offered to pay the Oaks $2,000 more than they had paid for the house if they would deed the house back to him. See Defendant's Exhibits No. 9 and 10. At trial, counsel for the Oaks objected to the admissibility of these exhibits as constituting evidence of an offer of compromise or settlement, proof of which is precluded by Rule 408, Federal Rules of Evidence. The court sustained this objection.

However, Rule 408 excludes these exhibits only to the extent they relate to either the validity or amount of the claim of the debtor against the Oaks or their claim against him. Rule 408 does not preclude consideration of these exhibits by the court when they are offered as in this instance as bearing on the question of the intent of the debtor to defraud the Oaks, the key issue in this case. The court believes it may and should consider Defendant's Exhibits No. 9 and 10 in determining whether the debtor made false representations considering his qualifications as a builder with intent to deceive the Oaks.

A compromise and settlement between the parties did not materialize and on July 16, 1994 the debtor filed suit against the Oaks in the Small Claims Division of the Clark County District Court to recover the $1,300 placed in escrow at closing. Case No. 94-500122. On August 11, 1994 the Oaks, by counsel, filed an answer alleging the complaint should be dismissed. They also filed a counterclaim for damages in excess of the jurisdictional amount required to confer jurisdiction on the Clark Circuit Court. The action was thereafter transferred to the Clark Circuit Court where it is now designated as 95-CI-00042.

Robert L. Rose, the attorney for the debtor in the Clark Circuit Court litigation, employed Stephen D. Adams, a real estate appraiser with offices in Winchester, Clark County, Kentucky, to appraise the house and lot occupied by the Oaks at 644 Reims Court, Winchester, Kentucky. Mr. Adams appraised the property on September 9, 1995. He fixed the value of the property as of that date at $106,000. Defendant's Exhibit No. 8. According to his report the appraiser took into account the discrepancies reported by the property owners -- dampness in the basement, the fact that some of the basement area was unfinished, a leak in the air conditioning condensation line in the attic that had damaged the second floor foyer ceiling, an inoperative electrical circuit, leaks under the doors that access the deck, plumbing defects involving the second floor public and master bathrooms, including the fact the whirlpool was not level and one of the bathroom doors was difficult to open and close because it made contact with the foyer hardwood floor. He also noted the property owners reported structural integrity problems associated with the second floor joists. He further noted defects on the exterior of the home related to trim items and caulking. The report does not note any defects in landscaping or the yard area.

The litigation in the Clark Circuit Court with respect to the counterclaim of the Oaks was stayed by the intervention of bankruptcy on September 11, 1995.

On December 9, 1995, the Oaks timely filed their complaint to except the debt owed to them from discharge under 11 U.S.C. § 523(a)(2)(A) and to deny the debtor a discharge under 11 U.S.C. § 727(a)(2)(A). By agreement of the parties the only issue tried thus far is the question of whether the debt owed to the Oaks should be excepted from discharge under 11 U.S.C. § 523(a)(2)(A).

The question of whether the debtor should be denied a discharge under 11 U.S.C. § 727(a)(2)(A) is to be tried later possibly in conjunction with an adversary proceeding by the trustee to set aside as fraudulent and recover for the estate a transfer of property by the debtor to his ex-wife, Sandra Edwards. The trustee has not instituted such an adversary proceeding as of this date.

The proof offered by the Oaks indicates there are major defects in the construction of the house which they purchased from the debtor.

Kenneth Wayne Mitchell, an independent inspector with American Property Inspection Company, Inc., at the request of the Oaks inspected their residence on several occasions. In his report dated June 24, 1994, which was immediately prior to commencement of the litigation in the state court, he notes numerous defects in the construction. He estimated the cost of repairs at $28,575.00. In a later report dated August 29, 1995, made after he revisited the property with a structural engineer, he estimated the total cost of repairing the property to be $109,069.00, plus other costs related to moving out and storing personal property while the home is being repaired.

Kourosh Marefat, a structural engineer licensed by the state of Kentucky, inspected the home on August 11, 1995 accompanied by Mr. Mitchell and Mr. Oaks.

Marefat found that due to the framing layout of the house the walls used as load bearing walls were not constructed as load bearing walls in that they were not properly supported.

He noted that, while the floor joists over the basement supporting the first floor of the house ran from the front to the back of the house, the floor joists supporting the second level spanned the entire length of the house, and obviously were not properly supported.

The roof trusses also span the entire length of the house, are attached to interior walls, which are not load bearing walls. He noted this is not an acceptable building practice.

Marefat used a carpenter's level to verify sloping of the floors on the second level of the house in the hallway and the master bathroom.

He found that the jack posts in the basement and garage were not anchored properly. In his view extensive work would be required to provide adequate support for load bearing walls and columns.

He found water problems with respect to the construction of the deck, the patio and landscaping; he found structural problems with the garage doors and the foundations under the deck, and numerous other problems.

Mrs. Oaks testified they cannot market the house without revealing all of these defects to the potential purchaser, which makes the house unsaleable.

Undoubtedly, the house was not constructed properly.

However, the question is whether the debtor knew the house was constructed improperly and knowingly concealed this fact from the Oaks.

The debtor was not an experienced builder even though he may have led the Oaks to believe he was. Most of the work on the house was done by subcontractors. The house was inspected and approved for occupancy by the City of Winchester Building Inspection and Code Enforcement Division.

The debtor testified the joists supporting the second floor were run the length of the house to accommodate the room arrangement on the second floor. There is no evidence he understood that interior walls supporting these joists were not support walls.

About two weeks prior to closing the debtor offered to release the Oaks from the purchase contract. After closing and prior to institution of the action in the Small Claims Court to collect the balance due on the purchase contract, the $1,300 placed in escrow until landscaping, sodding and seeding was completed, the debtor offered to purchase the house from the Oaks for $2,000 more than they had paid for it, an offer which the Oaks rejected.

Based on these findings the court is not persuaded that the debtor knew of and concealed from the Oaks the structural, plumbing, and landscaping, and other defects in the house prior to the closing of the sale to the Oaks.

CONCLUSIONS OF LAW:

The plaintiffs have failed to prove that the debtor obtained money (the purchase price of the house) from them by false pretenses or false representations.

The only representation, if any, the debtor made was that he was an experienced and knowledgeable builder. There is no evidence that the debtor made any specific representations concerning the structural integrity or the quality of the workmanship adhered to in constructing the house.

Unfortunately, the Oaks are saddled with a home that was not constructed in accordance with the applicable building codes. However, there is no evidence the building inspectors who visited the property on several occasions ever brought this to the attention of the debtor or that he knew the house was not in compliance with the building codes of the City of Winchester, which were in reality the state building codes.

The fact that prior to closing the debtor offered to release the Oaks from the purchase contract, and, after closing, offered to repurchase the house for $2,000 more than the Oaks had paid to him for the house rebuts any inference that the debtor knew the house was structurally defective.

Excepting the damage claim of the Oaks from discharge under title 11 U.S.C. § 523(a)(2)(A) is not an appropriate remedy on the facts of this case.

Accordingly, an order shall be entered dismissing Count II of the Second Amended Complaint and Count III of the Second Amended Complaint insofar as it seeks the alternative relief of excepting the damage claim of the Oaks from discharge.

Dated:

By the court -

______________________________

JOE LEE, CHIEF JUDGE

Copies to:

William A. Dykeman, Esq.

Barbara M. Griffin, Esq.

Lucinda Masterton, Esq.

U.S. Trustee

UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

IN RE:

WARD HALE CASE NO. 95-51480

DEBTOR

KEITH OAKS

KAREN OAKS PLAINTIFFS

VS. ADVERSARY NO. 95-5102

WARD HALE DEFENDANT

ORDER

In conformity with the memorandum opinion of the court this day entered, IT IS ORDERED that Count II of the Second Amended Complaint be and the same is hereby dismissed. It is further ordered that Count III of the Second Amended complaint is dismissed insofar as it seeks alternative relief of excepting the damage claim of plaintiffs Keith and Karen Oaks from discharge.