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In Re John Richards Homes Building Co., L.L.C., Debtor. Kevin Adell v. John Richards Homes Building Co., L.L.C.
Citations: 439 F.3d 248; 2006 U.S. App. LEXIS 8831; 46 Bankr. Ct. Dec. (CRR) 35Docket: 04-2154
Court: Court of Appeals for the Sixth Circuit; March 1, 2006; Federal Appellate Court
The United States Court of Appeals for the Sixth Circuit affirmed the bankruptcy court's dismissal of an involuntary bankruptcy petition filed by Kevin Adell against John Richards Homes Building Co. L.L.C. (JRH), determining that the petition was made in bad faith. The bankruptcy court awarded JRH costs, attorneys' fees, compensatory damages, and punitive damages pursuant to 11 U.S.C. § 303(i), a decision that the district court upheld. The background involves a Residential Building and Purchase Agreement between Adell and JRH, where JRH agreed to sell Adell a property and construct a home for $3,030,000. The deal closed on February 28, 2002, with $1,750,000 allocated for the land. Following the closing, Adell's relationship with JRH deteriorated due to dissatisfaction with construction delays and disputes over the property's value. Adell filed a civil suit against JRH and its principal, John Shekerjian, alleging misrepresentation regarding the property's worth and the timeline for construction, claiming that JRH had falsely stated the land was worth $1,000,000 and the house would be valued at $2,000,000, in contradiction to the sale documents. The court found sufficient evidence of bad faith in Adell's actions leading up to the bankruptcy petition. On June 18, 2002, JRH and Shekerjian filed an answer denying Adell's claims and included a verified counter-complaint. Prior to this, Adell attempted to persuade two of JRH's contractors to support an involuntary bankruptcy petition against JRH, but both refused. On June 24, 2002, Adell filed such a petition as the sole petitioning creditor under 11 U.S.C. § 303(b)(2), claiming $800,000 for fraud and breach of contract. He also employed a public relations firm to publicize JRH's alleged financial issues. JRH moved to dismiss the petition on July 1, 2002, arguing that Adell's claim was subject to a bona fide dispute and that at least three petitioning creditors were required due to JRH having 12 or more creditors. On July 12, 2002, Adell added three creditors to the petition. However, on July 15, 2002, the bankruptcy court granted JRH's motion to dismiss, determining that Adell's claim was disputed and significant factual issues existed, preventing him from serving as a valid petitioning creditor. The court denied the addition of other creditors and Adell did not appeal the dismissal. Following discovery and a two-day hearing, the bankruptcy court awarded JRH $4,100,000 in compensatory damages, $2,000,000 in punitive damages, and $313,230.68 in attorney's fees on April 25, 2003, finding that Adell acted in bad faith. The district court upheld this ruling on August 5, 2004, after which Adell filed the current appeal. Section 303(i) of the Bankruptcy Code allows the court to grant judgment against petitioners who file an involuntary bankruptcy petition in bad faith. In this case, the bankruptcy court found that Adell filed such a petition against JRH in bad faith, resulting in an award of $4.1 million in compensatory damages, $2 million in punitive damages, and costs and attorney's fees to JRH. Adell appealed, challenging the bankruptcy court's findings, including the determination of bad faith and the awarded damages. The appellate review of the bankruptcy court's findings is based on a clear error standard for factual determinations and de novo for legal conclusions. Both the bankruptcy and district courts concluded that assessing bad faith involves considering the totality of circumstances, with a presumption of good faith favoring the petitioning creditor. JRH provided evidence supporting the claim of bad faith, including Adell's quick escalation of disputes over construction issues and threats of criminal prosecution against JRH, despite attempts by JRH to resolve the issues amicably. Adell's claims about the property value and his refusal to accept buyback offers further indicated potential bad faith in his actions prior to filing the petition. JRH maintained that Adell was in breach of their construction agreement and disputed his claims throughout the process. Adell, while his state court lawsuit against JRH was ongoing, attempted to rally JRH's contractors to file an involuntary bankruptcy petition against JRH, knowing he needed an undisputed claim exceeding $12,000. His bankruptcy attorneys filed the petition without obtaining documents that would have indicated JRH disputed all of Adell's claims. Adell aimed to publicize the bankruptcy filing and spread misinformation about JRH's customer satisfaction, falsely claiming there were nine dissatisfied customers, although at least two had no issues. He testified that he learned from two former JRH employees about JRH's alleged financial troubles and believed he had a claim of at least $133,000 based on his payments for home construction. Adell was unaware that JRH had responded to his civil complaint, denying all claims. Although Shekerjian admitted to owing Adell money, he claimed he couldn't pay it back, and Adell denied malicious intent or threats toward other creditors. In contrast, JRH presented evidence disputing Adell's claims, asserting they were financially stable and that the former employees who testified for Adell had personal grievances, undermining their credibility. The bankruptcy court found overwhelming evidence of bad faith in Adell's petition, concluding he did not honestly believe he was entitled to bankruptcy relief but instead intended to intimidate Shekerjian into settlement or harm his business. The court supported its finding with seven specific points. Adell's subsequent challenge to the bankruptcy court's findings claimed they were erroneous or immaterial, or argued that evidence of good faith outweighed the bad faith evidence, which will be addressed further. Adell was found by the bankruptcy court to have known or should have known that his claims were disputed when he filed an involuntary bankruptcy petition on July 15, 2002. The court noted that JRH had already filed substantial defenses and counterclaims against Adell's state court complaint. Adell's argument, based on his own testimony and a claim that a third party acknowledged some funds were for construction costs, was deemed not credible. The bankruptcy court identified several issues with Adell's position: (1) His attorneys were aware of JRH's pleadings before the petition was filed, and their failure to inform him was not a valid defense. (2) The nature of Adell's claims indicated that he would understand the existence of real disputes without needing legal advice. (3) JRH's attorneys had informed Adell's attorneys that they would contest the claims, highlighting that an involuntary petition was improper. (4) Adell failed to withdraw the petition once he became aware of JRH's responses. Adell's second argument, asserting there was no bona fide dispute regarding at least $133,000, was also rejected. Even if there was a trust acknowledgment, it did not imply that his claim was undisputed. The bankruptcy court's earlier dismissal of Adell's petition, which he did not appeal, resolved the question of whether a bona fide dispute existed. The district court characterized Adell’s belief that the funds were undisputed as retroactively constructed, unsupported by his attorneys during the dismissal hearing. Ultimately, both of Adell's challenges to the bankruptcy court's findings were deemed meritless, confirming that he was aware that his claim was subject to a bona fide dispute at the time of filing. Adell was found to have knowingly intended harm to JRH through his actions related to an involuntary bankruptcy filing. The bankruptcy court determined that Adell was aware of the serious consequences for JRH and that he intended to inflict such harm. Adell's claim that he reasonably believed JRH belonged in bankruptcy was rejected, as the court established that his claims were subject to a bona fide dispute, indicating he should have known JRH did not belong in bankruptcy. Adell's testimony denying any threats of bankruptcy and his rationale for hiring a public relations firm was deemed not credible by the court, which provided extensive reasoning supported by substantial evidence. Additionally, the court found that Adell's attorney had threatened Shekerjian with criminal prosecution regarding related civil matters, a finding that Adell did not contest but deemed irrelevant. However, the bankruptcy court considered this threatening behavior relevant under the totality of circumstances regarding bad faith. Lastly, the court concluded that Adell could not adequately explain how he arrived at the $800,000 figure included in the bankruptcy petition. Although Adell cited his own testimony and that of his attorney to justify the figure, the court relied on Adell's earlier deposition where he admitted uncertainty about the calculation, thereby finding him not credible. This credibility determination led to the court's rejection of Adell's challenge to the finding regarding the $800,000 debt's basis. Adell's actions during the bankruptcy proceedings were scrutinized by the court, which found he displayed his wealth and used threats to persuade creditors to support his petition. The court credited the testimonies of two creditors, Cynthia Weaver and Robert Clark, over Adell's self-serving claims, concluding that Adell's behavior was relevant to the determination of bad faith in filing the petition. Furthermore, the court rejected Adell's defense that he relied on the advice of bankruptcy attorneys, noting his failure to disclose critical information to his counsel, which would have influenced the decision-making process. Adell did not dispute the legal principle that reliance on an attorney's advice requires full disclosure of pertinent facts, and his attorney confirmed reliance on Adell's misrepresentation regarding an undisputed claim. Consequently, the court deemed his reliance-on-counsel defense invalid, viewing his withholding of evidence as further evidence of bad faith. Additionally, the court found Adell's claim that he filed the petition out of concern for creditors to be false, noting his threats to creditors regarding payment contingent on their participation in the petition. Adell's challenge to this finding was unpersuasive as he failed to demonstrate clear error in the court’s preference for the testimonies of Weaver and Clark over those of his supporters. Adell contends that any statements he made were truthful and not threats, arguing that this should not factor into the assessment of bad faith regarding the involuntary bankruptcy petition. The bankruptcy court, however, maintains that it can consider any threats made by the petitioning creditor towards others as part of the overall circumstances. Adell further asserts that the court did not adequately consider evidence of his good faith, which he claims would outweigh the bad faith evidence. He cites testimony from Bjorkly and others regarding JRH’s financial issues, as well as advice from his bankruptcy counsel about the potential insolvency of JRH. Despite this, the bankruptcy court found much of the good faith testimony not credible and concluded that the evidence of bad faith was overwhelming. Consequently, the court's determination that Adell filed the petition in bad faith was upheld. Regarding compensatory damages, the bankruptcy court, under 11 U.S.C. § 303(i), is authorized to award damages resulting from the bad faith filing. The court found that JRH suffered significant damage to its reputation and projected future profits amounting to $4,100,000 due to the filing, estimating a loss of 20 home sales over five years. Adell challenges both the causation of damages and the damage amount, arguing that the bankruptcy court lacked sufficient evidence to link the filing to future lost profits, particularly noting the absence of expert testimony on the impact of negative publicity. The findings on these matters are reviewed for clear error. Shekerjian's testimony indicated significant negative impacts on JRH following the filing of the petition, noting that JRH was "totally devastated" and lost two high-end contracts shortly thereafter. In the six months between the petition filing and the bankruptcy court hearing, JRH did not sell any homes, and Shekerjian emphasized the critical importance of a builder's reputation in the high-end market. The bankruptcy court found his testimony credible, concluding that JRH's market competitiveness was severely affected by its reputation. Additionally, David Johnson, a local developer, corroborated that the petition harmed JRH's ability to sell homes and that concerns about JRH's financial stability were widely discussed in the real estate community during that period. The court determined that JRH was entitled to $4,100,000 in compensatory damages, relying on expert testimony from Frazee, who provided a credible calculation of lost profits. The court found Frazee's methodology reasonable and supported by evidence, attributing any remaining uncertainty to Adell's actions in filing the petition. Adell challenged the damages amount, specifically questioning the use of past profits from related entities to estimate JRH's future profits, the claimed historical profit margin, and assumptions regarding sales continuity and future sales losses. The court held that while JRH’s future lost profits were compensable, the past business records of the Affiliates were relevant for context, given that JRH was formed in 2001 to consolidate the previous operations of those entities. Testimony indicated that as part of JRH's formation, several Affiliates were phased out, with ongoing projects nearing completion. Frazee asserted that using historical sales data from the Affiliates was a reasonable basis for predicting JRH's future earnings, given the business was being transitioned to JRH. He argued that the best indicator of JRH's future profits was the past profitability of the Affiliates. The bankruptcy court accepted this approach, countering Adell's claim of clear error. Frazee determined a 17% profit margin for estimating future lost profits based on the historical margins of the Affiliates for high-end home construction over the past five years. Adell challenged the bankruptcy court's reliance on this testimony, arguing the absence of direct evidence of Affiliates' past profits. However, the court maintained that the expert's use of historical data to inform projections was valid and within the framework of Federal Rule of Evidence 705, which allows experts to provide opinions without disclosing all underlying facts first, placing the burden of challenging this testimony on opposing counsel during cross-examination. Frazee also assumed that sales would continue at the same rate for the next five years, which Adell contested by pointing to testimonies indicating declining sales prior to the petition. However, the bankruptcy court found Adell's argument unpersuasive. The bankruptcy court found the testimonies of Bjorkly and Seklar to be not credible, supported by Shekerjian's assertion that JRH's sales had not declined. Despite JRH lacking a market expert, both Shekerjian and Johnson indicated that luxury home sales were not impacted by the broader market downturn. This evidence justifies the court's acceptance of the expert's assumption of steady sales, which is not clearly erroneous. Adell argued against JRH's expert's assumption of losing four home sales annually for five years, but this assumption was supported by Shekerjian's testimony, which regarded it as "extremely conservative" in light of the high-end home market dynamics. Shekerjian noted that JRH had not sold any homes since filing for bankruptcy, although permits for high-end homes were issued during that period. He emphasized the negative impact of the bankruptcy filing on JRH's sales due to the "ripple effect" in the luxury market and the significant negative publicity surrounding JRH. Shekerjian's future plans for JRH involved a substantial investment in land with the aim of doubling sales, while Johnson corroborated that JRH's sales capability had been adversely affected by the bankruptcy petition. The court acknowledged that estimating future lost profits is inherently imprecise but found sufficient evidence for the assumption of lost sales. Even if the assumption were incorrect, the damages awarded could still be conservative as they did not account for ongoing expenses related to reputation repair or investments in land development. Adell also sought to overturn the bankruptcy court's $2,000,000 punitive damages award, challenging it on both constitutional and non-constitutional grounds, with constitutional issues reviewed de novo and other aspects for abuse of discretion. A district court abuses its discretion by relying on clearly erroneous factual findings or by misapplying the law. For due process compliance in punitive damages, the Supreme Court mandates the consideration of three factors: (1) the degree of reprehensibility of the defendant's misconduct, (2) the disparity between the plaintiff's harm and the punitive damages, and (3) the comparison between the jury's punitive damages and civil penalties in similar cases. The bankruptcy court in this case evaluated these factors in determining a $2,000,000 punitive damage award, deeming the defendant Adell's conduct reprehensible and justifying the amount based on permissible ratios and comparable penalties. The court concluded that this award serves the purposes of deterrence and punishment, being half of the $4,100,000 compensatory damages and significantly below the suggested maximum limits. On appeal, Adell challenged the bankruptcy court's ruling on several grounds, including neglecting mitigating evidence, assessing the size of other awards, and misjudging the reprehensibility of his conduct. The appellate court found no merit in these arguments, affirming the bankruptcy court's findings regarding the bad faith of Adell's conduct and the credibility of evidence presented. The court upheld the compensatory damage award, thereby supporting the ratio of punitive to compensatory damages. Additionally, the appellate court rejected Adell's claim that the bankruptcy court failed to consider comparable civil or criminal penalties, noting that this assertion was incorrect. The only issue that warranted further discussion was whether the bankruptcy court should have compared its punitive damages award to other awards under section 303(i), which the court concluded was not required by the Supreme Court's framework. A bankruptcy court's decision to award punitive damages was upheld, as it adhered to applicable law and provided a clear rationale for the award. The court also granted attorneys' fees and costs to JRH, which Adell challenged on the grounds of his good faith in filing the petition and the absence of a bona fide dispute regarding his claim. Both arguments were rejected; the court found no error in the bankruptcy court's bad faith ruling, and Adell did not appeal the dismissal of his claim, which had already been determined to involve a bona fide dispute. The case involved a Residential Building and Purchase Agreement between Adell and JRH dated December 28, 2001, where JRH agreed to sell a 1.8-acre parcel of land in Bloomfield Hills, Michigan, and construct a home for Adell for $3,030,000. The allocation of funds between the land purchase and construction was not specified in the Agreement, although JRH's cost for the land exceeded $1.7 million. Construction was to begin within a reasonable time after the agreement was signed and permits were issued. The sale closed on February 28, 2002, with $1,750,000 allocated for the land and $1,280,000 for construction. In March-April 2002, Adell expressed concerns about construction delays related to dewatering on the site, which JRH had temporarily halted pending a permit. After obtaining the permit, Adell requested a different builder for his home. He also recounted a prior permitting dispute with another town, revealing a retaliatory mindset towards construction projects. In May 2002, Adell contacted a former JRH employee, who indicated that the presence of water on the property was widely known and mentioned JRH's financial difficulties. The district court's decisions affirming the bankruptcy court's rulings were ultimately upheld. Testimony revealed that in late 2001, the office environment was tense due to financial issues, with delays in trades and payments affecting employees and customers. One employee requested a desk move to avoid seeing the ongoing trades, and the construction manager expressed frustration over unpaid trades. Customers felt their projects were stalled due to these delays. Adell later contacted Bjorkly for a list of vendors owed money by JRH, leading to litigation where JRH accused Bjorkly of revealing confidential information. Adell also reached out to William Seklar, a former JRH employee, who confirmed JRH's financial troubles and difficulties in completing home projects due to issues with trades and existing liens on properties. Upon learning of Adell's contacts with JRH contractors, Shekerjian's attorney warned Adell's attorney that such actions were deemed improper. Following this, Adell's attorney sent a letter to Shekerjian, demanding the removal of any liens against Adell's property and suggesting restitution for damages, with a deadline for response. When no response was received, a meeting occurred on June 3, 2002, where Adell claimed he had overpaid for the property, asserting it was worth $1 million rather than the $1.75 million he paid. Adell was advised to review local property prices to understand the value of his purchase better. Adell signed both the Settlement Agreement and the Warranty Deed for the property, valued at $1.75 million. During a June 3 meeting, Shekerjian proposed buying back the property, which Adell rejected, subsequently threatening to file an involuntary bankruptcy petition against JRH, prompting concern about the company's reputation. Morris advised Adell against filing such a petition and warned that any contact with JRH's vendors would be improper. Following this meeting, Morris sent three letters to Dlugokinski on June 5, 2002. The first letter addressed Adell's bankruptcy threat, reminding Dlugokinski that Adell had solicited a JRH contractor for the petition against prior warnings and warned of severe sanctions for filing a frivolous bankruptcy claim. The second letter contested the land's value, encouraging Dlugokinski to conduct independent research to confirm that the sales price was fair, emphasizing that Adell was advised by professionals throughout the transaction and was now the rightful owner of the property. Morris also noted that if Adell engaged another builder, it would breach the existing agreements, and he indicated JRH's intent to seek damages for this breach. The third letter, marked for settlement purposes, expressed readiness to discuss the matter and provide assurances regarding the ongoing construction plans for Adell's home. Common ground may be achievable in resolving the claims of Adell once the true market value of his purchased lot is established. On June 6, 2002, Dlugokinski, representing Adell, filed a lawsuit against JRH and Shekerjian in the Oakland County Circuit Court. The complaint included multiple allegations such as fraud, misrepresentation, breach of contract, and violations of the Builder's Trust Fund Act and the Construction Lien Act. The primary claims revolved around two points: 1) Adell alleged that Shekerjian and JRH falsely stated the land was worth $1 million and that the home would be valued at $2 million, despite the sale documents indicating a $1.75 million valuation, and 2) they purportedly assured Adell that construction would start immediately after closing, despite knowing of "water problems" that would delay it unreasonably. On June 14, 2002, Adell contacted Cynthia Weaver from E.W. Kitchens, claiming issues with JRH, including a false assertion that Erb Lumber refused delivery due to JRH's debts. He stated he was wealthy and angry, seeking creditors to join him in forcing JRH into bankruptcy, although he later denied making these statements. The bankruptcy court found his denials unconvincing. Adell also provided Weaver with a lawyer's contact for verification, who corroborated his claims. Simultaneously, Adell communicated with Robert Clark from Motor City Stone, indicating that only those signing an involuntary petition would be paid and threatening non-signers with non-payment. Clark declined to join the petition based on his accountant's advice, while Adell again denied making the threats, which the bankruptcy court deemed not credible. Subsequently, JRH’s attorney sent a letter to Dlugokinski addressing Adell's communications with contractors, asserting that Adell claimed JRH was financially troubled and that he had grounds to initiate an involuntary bankruptcy. False statements were made intending to damage John Richards Homes' reputation among contractors and subcontractors, suggesting financial instability and insolvency. On June 18, 2002, John Richards Homes (JRH) and Shekerjian filed a civil suit denying Adell's claims, presenting affirmative defenses, and submitting a verified counter-complaint for breach of contract, defamation, tortious interference, and extortion. JRH sought a temporary restraining order to prevent Adell from communicating about JRH to its business associates while the case was pending. On the same day, JRH's attorney, Steven Howell, contacted Bob Carson, an attorney believed to be representing Adell, to explain JRH's position and advise against filing an involuntary bankruptcy petition, indicating that litigation was ongoing. Shortly thereafter, on June 24, 2002, Adell filed an involuntary bankruptcy petition against JRH, claiming JRH was not paying debts and asserting a fraud and breach of contract claim for $800,000. Adell had been advised by his bankruptcy attorney, Max Newman, to ensure he had an undisputed claim over $12,000 before filing. Believing JRH would admit to a claim of around $130,000 based on Adell's assurances, Newman used the higher figure to strengthen the petition. Adell failed to disclose JRH's indications of disputing any debt to him, which included prior communication rejecting claims. Newman also had concerns about JRH's operational legitimacy, noting a lack of a builder's license and multiple similarly named entities. Prior to filing, Adell contacted a public relations firm to publicize the bankruptcy filing, expressing dissatisfaction with his dealings with the bank and developer, but these claims were not substantiated in the bankruptcy court. Marx Layne, acting at Adell's request, contacted three newspapers—Detroit News, Detroit Free Press, and Crain's Detroit Business—regarding Adell's filing of an involuntary bankruptcy petition against JRH. On June 25, 2002, the day after the petition was filed, Marx Layne sent e-mails to reporters from the Detroit News and the Detroit Free Press, announcing the filing and claiming that JRH's recent payments to creditors were ineffective. The e-mails included a list of nine allegedly dissatisfied JRH customers, provided by Adell, none of whom had been directly contacted by either Adell or Marx Layne. Notably, two listed individuals, Jean McIntyre and Larry Gainer, reported being satisfied with JRH's work. Additionally, the e-mails falsely claimed exclusivity of the information and stated that a forthcoming civil suit hearing would be newsworthy. On July 1, 2002, Marx Layne sent a fax of the bankruptcy petition and the customer list to Crain's, which only published a brief notice of the filing. On June 26, 2002, JRH's attorney, Steven Howell, argued that the petition was improper due to ongoing litigation regarding Adell's claim. The bankruptcy court later agreed with JRH, determining that Adell's claim was genuinely disputed and dismissed the petition. Furthermore, the court found that Adell and his attorneys had failed to disclose critical documents, including letters indicating that Adell had agreed to the property purchase price and warnings against filing a frivolous bankruptcy petition, as well as JRH's response to Adell's state court complaint. McIntyre and Gainer both testified they had no complaints against JRH and had not interacted with Marx Layne.