BFR's contract provided that BFR would be held harmless regarding the consequences arising out of the quantity or quality of water produced by the well. The altered contract also removed this provision.

Neither Van Sergae nor the Harrisons disclosed to BFR the Harrisons' Chapter 11 filing. Unaware of the material alterations to the BFR contract as well as the Chapter 11 filing, BFR's representative signed the contract committing to drill a water well to a depth of three hundred feet.

On October 7, 1991, BFR completed a well to a depth of four hundred and thirty feet. Despite the fact that the contract required modifications to be in writing, the Harrisons orally authorized a change order to drill beyond three hundred feet and use a more expensive casing material. This well did not produce water sufficient to support the planned development. When the Harrisons came to inspect the first well with Van Sergae, they authorized BFR to cap this well and drill a second one. On October 18, 1991, after work on the second well began, BFR learned of the Harrisons' bankruptcy filing. Thereafter, Van Sergae orally assured a representative of BFR that it would be paid and authorized drilling the second well to a depth of five hundred and fifty feet. BFR completed the second well on October 22, 1991. This well also failed to produce sufficient water to support the planned development. When the Harrisons were unable to locate water to support a subdivision, the project failed.

A chapter 11 trustee was appointed for the estate on June 5, 1992. The trustee abandoned Chualar Canyon on September 17, 1993 before the property was foreclosed by a secured creditor.

The procedural posture of the case arrives after a litigious history. On February 6, 1992, BFR filed a complaint against the Harrisons in the Superior Court for Monterey County to foreclose on its two mechanic's liens in the amount of $30,698.62. The Harrisons filed a counterclaim alleging BFR failed to complete a water-producing well and failed to seal the drilled wells. The Harrisons stipulated to relief from the automatic stay to liquidate BFR's claim in Superior Court. However, BFR removed the Superior Court action to this Court. Trial of the removed action was held on July 28, 1993. Although the Harrisons were served with and answered the complaint, they failed to appear at the time of the trial, only sending Anna Van Sergae as their attorney-in-fact.

The Court found that the Harrisons' contract with BFR was made in the ordinary course of business but did not benefit the estate. Judgment was entered against the Harrisons for breach of contract in the amount of $30,693.62 plus pre-judgment interest, attorneys' fees and costs amounting to $22,198.72. Shortly thereafter, the case was converted to chapter 7, resulting in this proceeding for non-dischargeability.

The issue before the Court is whether, by their silence regarding the alterations to the contract and their ability to pay, the Harrisons materially misrepresented their intent in contracting for services from BFR.

Section 523(a)(2)(A) of the Bankruptcy Code provides that an individual debtor is not discharged from any debt for services to the extent obtained by false pretense, false representation, or actual fraud. To succeed in its claim, BFR must prove the following by a preponderance of the evidence: (1) the Harrisons made representations; (2) that they knew to be false, or that they acted with reckless indifference to the truth; (3) the representations were made with the intent and purpose of deceiving BFR; (4) BFR justifiably relied on the representations; and (5) BFR sustained damages as a proximate result of the representations. Field v. Mans, __ U.S. __, 95 C.D.O.S. 8949;8951 (1995); In re Britton, 950 F.2d 602, 604 (9th Cir. 1991); Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); In re Rubin, 875 F.2d 755, 759 (9th Cir.1989).

At the crux of this proceeding is the court's determination that the Harrisons' negotiations with BFR contained implied representations and conduct intended to create and foster a false impression regarding the contract and payment. The Court reaches this result for the following reasons. The Harrisons' previous negotiations with other drilling contractors failed due to the Harrisons' financial problems. Yet, despite preparation of a chapter 11 petition, the Harrisons never disclosed their financial situation. Only hours after filing the chapter 11 case, the Harrisons advised a BFR representative that the contract "was acceptable." Clearly, however, BFR's standard contract was not acceptable to the Harrisons because the contract was redrafted such that (1) the Harrisons would receive the drilling reports before payment to BFR was due; (2) no lien could be placed against Chualar Canyon; and (3) BFR would not be held harmless regarding the results of the drilling. These revisions were sandwiched in the middle of BFR's contract. By advising the BFR representative that the contract "was acceptable," the Harrisons misrepresented their intentions. Thereafter, the Harrisons maintained silence regarding these material alterations as well as their bankruptcy filing.

The Court may infer an intent to deceive from a misrepresentation. In re Rubin, 875 F.2d at 759. Where the debtor perpetrates the misrepresentation through silence or nondisclosure, intent to deceive may be inferred from the fact that the debtor received some benefit that he would not have obtained absent his silence, and remained silent despite the knowledge that the creditor would bear any resulting loss. In re Demarest, 176 B.R. 917, 920 (Bankr. 9th Cir. 1995).

The Harrisons knew their misrepresentation would mislead BFR into believing the Harrisons signed BFR's standard contract and that the Harrisons would pay for services rendered under that contract. However, the Harrisons were insolvent, and the contract alterations appear to have been intended to shift the cost of drilling to BFR in the event that a sufficient water supply was not found. Thus, the Harrisons gained the benefit of the water reports that determined the viability of further development and shifted the risk of loss to BFR.

The Harrisons assert that they intended to pay BFR both when they entered the contract and when they authorized the change orders. However, it appears, at best, that the Harrisons' only intended to pay BFR if BFR found water sufficient to allow development of the parcel. Although all acts giving rise to the inference of intent to deceive are attributable to Van Sergae, those acts were originally authorized by, and subsequently ratified by, the Harrisons.

The intent to deceive required for a finding of non-dischargeability can be inferred from surrounding circumstances or a false representation. In re Hultquist, 101 B.R. 180, 183 (Bankr. 9th Cir. 1989); In re Rubin 875 F.2d at 759. The Harrisons intent to deceive BFR can be inferred from the Harrisons' alteration of the material terms in the contract, their continued silence regarding these terms and their financial insolvency.

At trial BFR's principal testified that he would not have signed the contract had he known the Harrisons had included material alterations between the pages of BFR's standard contract. The requisite level of reliance under §523(a)(s)(A) is justifiable reliance. Field v. Mans, 95 C.D.O.S. at 8951. One is "justified in relying on a representation of fact 'although he might have ascertained the falsity of the representation had he made an investigation.'" Id. (quoting Restatement (Second) of Torts (1976)). BFR relied upon the Harrisons' representations that the contract "was acceptable" and that they would compensate BFR for its services. BFR was not obliged to investigate the veracity of the Harrisons' representations. Field v. Mans, 95 C.D.O.S. at 8951; In re Apte, 180 B.R. 223 (9th Cir. BAP 1995); In re Ashley, 903 F.2d 599, 604-05 (9th Cir. 1989).

Unaware of the Harrisons misrepresentations, BFR performed services worth $30,693.62 and incurred a further loss of $22,198.72 for interest, attorneys' fees and costs. There can be no question that the damages suffered by BFR to the extent of $30,693.62, the amount owed BFR on the drilling contract, were a direct consequence of the Harrisons representations.

A bankruptcy court has authority to apply state or federal substantive law, depending on the nature of the action. Where state law governs the substantive issues in an action, the bankruptcy court is required to look to state law to determine whether attorney's fees should be awarded. In re Johnson, 756 F.2d 738, 740-41 (9th Cir. 1985); In re Ashley, 903 F.2d at 605 n. 7 (9th Cir. 1990).

California law provides that attorney's fees shall be granted where the contract so provides. Cal.Civ.Code §1717. Thus, attorney's fees, costs and interest of $22,198.72 are held non-dischargeable under Section 523(a)(2)(A). There has been no further request for attorney fees and the Bankruptcy Code does not provide for allowance of attorney's fees and costs in connection with a dischargeability action except as provided in §523(d).

For the reasons stated, the the Harrisons debt to BFR in the amount of $52,892.34 is non-dischargeable.

Accordingly, IT IS SO ORDERED.

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