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Eighth Circuit Resurrects Action to Find Debt Nondischargeable Due to Fraud - Bauer v. Gilmartin

November 18, 2011

As Chino Hills consumer bankruptcy attorneys, we were interested to read about an unusual reversal of a court decision protecting a bankruptcy debtor from creditors. In Bauer v. Gilmartin, the Bankruptcy Appellate Panel of the Eighth U.S. Circuit Court of Appeals found that James Gilmartin's debt to Larry and Cheryl Bauer should be nondischargeable because of Gilmartin's fraud in a real estate matter. The two couples had formed a real estate company together and agreed to share payments and profits equally, but the Bauers said Gilmartin began taking money from the company without authorization. The bankruptcy court had held a partial hearing on the issues, but found that the Bauers had not proven they were damaged by the fraud. On appeal, the BAP reversed this, finding the bankruptcy court hadn't considered all arguments.

The Gilmartins and Bauers had no formal written agreements for their business, but agreed orally that they would contribute equal money and share profits equally. They agreed that Gilmartin, as day-to-day manager of the company, would get monthly compensation, but disagreed at the hearing about the terms. The Bauers contend that Gilmartin was taking money out of the company to deal with his personal financial troubles. The Bauers loaned them $30,000, and Gilmartin also repeatedly asked them for additional capital for the real estate company for cost overruns. The Bauers took out a second mortgage to achieve this. Eventually, one project was sold at a loss and the other was foreclosed. After the Gilmartins' bankruptcy, the Bauers filed an adversary complaint arguing that the debt to them should be nondischargeable because of fraud. The bankruptcy court ultimately made partial findings for the Gilmartins.

The bankruptcy appellate panel reversed. In order to prove nondischargeability, it said, the Bauers must prove that Gilmartin knowingly made false representations in order to deceive them, and that they suffered losses and damages because they relied on those representations. The bankruptcy court found that the Bauers could demonstrate no loss as a proximate cause of the misrepresentations, although it did not dispute that they suffered losses. In essence, the court found no evidence that the company would have been profitable if it weren't for James Gilmartin's alleged misuse of the money. The Bauers argued on appeal that the court failed to consider their alternative argument -- that they wouldn't have put money into it in the first place if they had known about the alleged fraud. The BAP noted that the bankruptcy court applied the "benefit of the bargain" as the measure of damages, but in cases like this, it may also consider "out of pocket" damages. Ultimately, it reversed the lower court and remanded for consideration of those damages.

As Seal Beach personal bankruptcy lawyers, we'd like to remind clients and potential clients that this is one area where a normally dischargeable bankruptcy debt becomes nondischargeable. The goal of bankruptcy is to allow filers to settle their debts without becoming enslaved to those debts, which is why most debts are dischargeable (with specific exceptions for tax debt, child support and others). However, the bankruptcy code does not allow filers to escape responsibility for debts when they arise from their own bad actions, and fraud is one such exception. This reversal does not necessarily mean Gilmartin's debt to the Bauers will be declared nondischargeable, but it does mean there's still a chance. Our Los Angeles County individual bankruptcy attorneys work carefully with clients to identify this kind of potential challenge and neutralize it when possible so there are no complications on the way to a new financial start.

If you feel like you're drowning in debt and you don't see how you can reasonably pay it back, you should call Howard Law, P.C., to discuss the possibility of a bankruptcy. For a consultation or more information, send us an email or call1 1-800-872-5925.

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