Bankruptcy Law

James Cole, Esquire

Bankruptcy court erred in finding for defendants at close of plaintiffs’ evidence in action for nondischargeability of debt due to actual fraud. Bauer v. Gilmartin (In re Gilmartin), No. 11-6014 (B.A.P. 8th Cir., November 16, 2011).

Debtors-Defendants Gilmartin and Plaintiffs Bauer formed an LLC to buy and rebuild real estate. Each couple made an initial contribution to capital, but thereafter the Gilmartins did not contribute anything. James Gilmartin operated the business from its inception in 2006 through the end of 2008, when the Bauers learned that Gilmartin had taken over $200,000 from the LLC for his personal expenses, allegedly without authorization. In the meantime, James Gilmartin had persuaded the Bauers to inject capital into the LLC at various times in 2007 and 2008, culminating in contributions from August through December, 2008, totaling over $330,000.

The LLC had attempted to complete two projects. One was sold at a loss; the other was foreclosed upon by a bank. The Gilmartins and Bauers had personally guaranteed the LLC’s debts.

The Gilmartins filed for Chapter 7 relief in March 2010. The Bauers timely filed an adversary proceeding against them alleging actual fraud and contesting the dischargeability of the damages owed as a result of that fraud. At trial, after presentation of plaintiffs’ evidence, the court ruled for the defendants pursuant to Rule 52(c), Fed. R. Civ. P., applicable pursuant to Rule 7052, Fed. R. Bankr. P. The court found that plaintiffs had not demonstrated
that damages were caused by defendants’ fraud rather than by the failure of the projects. The court concluded that since the Bauers had failed to prove that the venture would have otherwise been successful absent the alleged misuse of funds, there were no damages resulting from such misuse.

The Bankruptcy Appellate Panel reversed the judgment and remanded the case. Rule 52(c) allows the court to issue what is often loosely called a directed verdict at the close of plaintiff’s evidence but is more accurately denominated a “judgment on partial findings.” The bankruptcy court, utilizing this procedure, erred in determining the appropriate rule for measuring Plaintiffs’ damages.

In finding that the Bauers had failed to prove that the alleged fraud caused damages, the bankruptcy court had considered only the “benefit of the bargain” rule, which is normally the measure of damages in a fraud case. However, there are circumstances in which other measures of damages are permitted. The plaintiffs had pleaded and had offered evidence on “out of pocket” damages, asserting that they would not have poured capital into the LLC had they known that James Gilmartin was withdrawing large sums from the LLC for personal expenses. The panel held that the bankruptcy court should have considered this alternative basis for proving damages and remanded the case.