IN THE UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
MURRAY D. KATZ and No. 1-89-00156
v. A.P. No. 1-89-0114
MURRAY D. KATZ,
Memorandum of Decision
Plaintiff Stanley Blumenfeld is a retired attorney and a successful real estate investor. At
the request of a friend, in March, 1985, he became involved with and purchased an interest in
a closely held corporation known as Hi Line Paint Company.
Bloomenfeld regretted becoming involved in Hi Line almost from the moment he made the
purchase. He soon discovered that the business was being poorly managed and needed repeated
infusions of cash just to keep the doors open. There was also a significant toxic waste problem.
Blumenfeld considered several options to extricate himself from Hi Line, including shutting its
doors and liquidating, and determined that the best way to get out was to find a buyer for the
In the Spring of 1986, a business broker put Blumenfeld in contact with James Zetz, who
owned a business called Ryan Paint Company. Blumenfeld and the other owners of Hi Line
agreed to sell their shares Zetz and his partner. The ageement they negotiated was somewhat
unusual; not only was no cash down payment required of the buyers, but Blumenfeld agreed
to loan Zetz $110,000.00. Thus Blumenfeld, as a seller, was actually paying out $110,000.00
in cash in order to make the sale work.
Even though Blumenfeld agreed to part with $110,000.00 in cash, his incentives for entering
into the agreement are clear. He was personally liable to the former owner of Hi Line for
$144,000.00 in promissory notes; one of the conditions of the sale to Zetz was that Zetz would
obtain Blumenfeld's release on these notes. Thus, for a cash outlay of $110,000.00 Blumenfeld
got rid of a cash-draining albatross from around his neck, was released from $144,000.00 in
personal liability, and was promised $66,667.00 plus a right to buy back into Hi LIne if Zetz
made it profitable. The transaction therefore made economic sense even though the only cash
which changed hands went from sellers to buyers.
Defendant Murray Katz was the attorney who represented Zetz in the transaction. However,
there was considerably more than a normal attorney-client relationship between Katz and Zetz.
Zetz and his enterprises were Katz' primary, if not only, clients. Katz worked out of Zetz'
business premises, kept all his business records with Zetz' records, and drove a car supplied by
Zetz. It is very clear that Katz totally depended on Zetz for his livelihood.
As part of the transaction, Blumenfeld was to review Zetz' personal financial statement.
Zetz produced a financial statementwhich contained several outright lies. It stated that one of
his projects had an appraised value of $660,000.00, when in fact the appraisal was for
developed property and the property was in fact undeveloped. It stated that one project had a
significant equity when in fact Zetz did not even own the projecty and had never owned it. It
stated that Zetz had two college degrees when if fact he had none.
Katz knew that some of the information in the financial statement was false. However, he
personally represented to Blumenfeld and his attorney that the financial statement was truthful
and accurate and that Zetz was worth the $1 million it stated. As anxious as Blumenfeld was
to sell Hi Line, he would not have done so if he had known the truth. While his reliance on
Katz' representations was not very smart, it was reasonable under the circumstances, as Katz
was an attorney and his representations gave the financial statement more credibility than it
would have otherwise had.
The court accordingly finds that Katz owes Blumenfeld a nondischargeable debt due to his
misrepresentations, pursuant to section 523(a)(2) of the Bankruptcy Code. It is not necessary
to determine if an insider relationship existed between Katz and Zetz, as there is liability under
section 523(a)(2)(A) if there was no such relationship and liability under section 523(a)(2)(B)
if there was an insider relationship. Moreover, although the court finds that Katz knew that the
financial statement contained false information, his representations to Blumenfeld were so
reckless that he would still be liable for making them even if he did not specifically know of
the falsity. In re Houtman
(9th Cir.1978) 568 F.2d 651, 656.
However, even with a finding of fraud, Blumenfeld is not entitled to anything near the
damages he seeks. Under section 523(a)(2), not all damages flowing from fraudulent conduct
are nondischargeable. The language of that section specifically limits nondischargeable debts
to debts for money or property to the extent
such was obtained by fraud. This limiting language
means that damages not actually based on out-of-pocket losses, such as benefit of the bargain
damages or punitive damages, are not allowed even if such items could be included in a fraud
award under state law. In re Ellwanger
(9th Cir.BAP 1989) 105 B.R. 551, 555; In re Anguiano
(9th Cir.BAP 1989) 99 B.R. 436. The evidence clearly established that
Blumenfeld's primary motivation in entering into the agreement to sell his interest in Hi Line
was to get out from further involvement in that corporation. Both the Bankruptcy Code and
principles of equity require the court to consider the benefits Blumenfeld actually got from the
transaction in determining the net amount of his damages.
Blumenfeld was induced to part with his shares of stock and $110,000.00 in cash. The only
evidence of the value of the stock is the contract price of $66,667.00; while the court has its
doubts that the stock was actually worth this much, it gives Blumenfeld the benefit of the doubt
in the absence of evidence to the contrary. Thus, at most Blumenfeld was induced to part with
money or property having a value of $176,667.00.
In return, Blumenfeld got released from liability on two of his notes, totalling $144,100.00,
given to the former owner when he purchased Hi Line. He also got $13,352.27 in payments
which Blumenfeld concedes are a proper credit, was repaid $10,156.69 owed to him by Hi
Line, and was released from $1,020.00 in liability for Hi Line's delinquent rent, as he had
personally guaranteed Hi Line's lease. Thus, Blumenfeld actually got $168,628.96 in benefits
from the sale to Zetz.
The court notes that Katz has a tenable argument that Blumenfeld's benefits exceeded his
losses because Blumenfeld was also released from liability under Hi Line's long-term lease.
However, the court accepts Blumenfeld's uncontested assertion that the lease was below market
and had a value of $300,000.00, so that he had no real exposure on account of it. Why
Blumenfeld did not seek to become whole by taking over the lease is a question the court
declines to grapple with.
The court rejects entirely Blumenfeld's assertion that he is entitled to an additional
$150,000.00 which he paid pursuant to a term in his contract with Zetz making him responsible
for certain Hi Line notes. There was no evidence presented that Blumenfeld was personally
liable on those notes, and it is abundantly clear that he made the payments because he felt
personally responsible for getting the note holders into the Hi Line mess and not because he was
obligated to pay under the contract.
The court declines to give Katz a credit for the $18,000.00 broker's commission.
Blumenfeld was out these funds regardless of how they were applied, and would not have
incurred the fee but for Katz' misrepresentations.
For the foregoing reasons, Blumenfeld is entitled to a nondischargeable judgment in the
amount of $8,038.04. He shall also recover his costs of suit.
Blumenfeld shall submit an appropriate form of judgment, which counsel for Katz has
approved as conforming to this decision. This memorandum constitutes findings and
conclusions pursuant to FRCP 52(a).
Dated: February 1, 1990 _______________________