Bankruptcy Court sets high bar for recovering debt owed by home improvement contractor: A cautionary tale for when home improvement projects go bad

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Too often parties to a construction dispute do not focus on the importance of proving and recovering damages until the later stages of the case.  A recent bankruptcy case, In re Patrick Gannon, shows why an analysis of damages and recoverability should be the highest priority when a home improvement project turns into a nightmare.  


In In re Patrick Gannon, a couple hired Gannon Construction, Inc. to build an attached garage and home office.  The project started out well, but deteriorated due to flooding, drainage, and other problems caused by shoddy work.  As the project spiraled out of control, Gannon demanded payment up front to keep working and repeatedly attempted to double-bill the homeowners for work that was never finished.  After numerous problems, delays, and multiple payments, Gannon abandoned the project.


The homeowners sued Gannon in state court for more than $160,000 on theories of breach of contract, negligence, fraud, and misrepresentation.  Although there was clear evidence of construction defects and unfinished work, the homeowners were left out in the cold because Gannon had filed for Chapter 7 bankruptcy protection.  Under the Bankruptcy Code, certain debts, such as student loans and alimony, may not be discharged by the bankruptcy court.  The debt owed by Gannon to the homeowners, however, was not recoverable by the homeowners unless they could show the amount owed had been obtained by "false pretenses, a false representation, or actual fraud," or for "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny; . . ."  11 U.S.C. § 523(a)(2)(A) and (4). 


Although the bankruptcy court found there was clear evidence that Gannon's work was "rife with building code violations," the bankruptcy court denied the homeowners' claim for relief.  First, there was not enough evidence that Gannon's promises to do a good job were false when they were made at the start of the project.  Likewise, Gannon's failure to maintain insurance was not fraudulent because he had not lied when he told the homeowners that he had insurance at the start of the project.  


Nor were Gannon's misleading billing practices and attempts to double-bill the homeowners sufficient to render Gannon's debt nondischargeable.  Instead, the bankruptcy court held that because there were multiple "red flags", such as the poor work and shady billing practices, the homeowners could not have reasonably relied on any misrepresentations by Gannon when they continued to pay him.  


This case shows the remarkably high threshold a creditor homeowner must show to recover on a claim against a home improvement contractor that files for bankruptcy protection.  To avoid this nightmare scenario and the possibility of being left with a claim against a judgment proof contractor, homeowners must protect themselves when problems develop at a project.  In particular, payments to a contractor should only be made according to a schedule of values and should be documented in billing forms, such as American Institute of Architect ("AIA") payment form or an equivalent that links payment amounts to percentage completion.  When problems arise at a project as a result of poor work or other defects caused by the contractor, the reality of the situation is that most contractors will want an opportunity to fix the problem themselves. Homeowners should consult with an attorney as soon as a dispute arises--particularly when there are concerns about the reputation or viability of a contractor.  This may prevent the situation from deteriorating any further and, if litigation is unavoidable, it could be the difference between a successful lawsuit and recovering nothing.


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