FOR THE NORTHERN DISTRICT OF CALIFORNIA In re JOHN B. HYDE,                                                         No. 1-88-01384      Debtor. ___________________________/ MODERN PIONEERS' LIFE INSURANCE COMPANY,      Plaintiff,     v.                                                                              A.P. No. 1-88-0185 JOHN B. HYDE,      Defendant. ______________________________/ Memorandum of Decision I. Introduction
     Prior to his bankruptcy, debtor John B. Hyde controlled an insurance brokerage, a company which administered insurance claims, and a reinsurance company. All he needed to fully insure and administer a large block of insurance sold by the brokerage was an outside insurance company to act as the primary insurer.      During 1985, Hyde used Coastal Life Insurance Company as the primary insurer. However, plaintiff Modern Pioneer Life Insurance Company ("MPL") had also been involved in a minor way. In late 1985, Hyde approached MPL with the proposal that it replace Coastal as the primary insurer. MPL agreed to the proposal, at first informally by a brief telegram dated December 31, 1985, and later by formal agreements dated March 26, 1986.      MPL was the primary insurer for about ten months of 1986, commencing on January 1. Theoretically, this should have been easy money for MPL, as the premiums were supposed to be sufficient to cover the claims and the risk of loss was supposed to be borne by Hyde's reinsurance company. However, the premiums were not sufficient and the reinsurance company proved to be insolvent; as a result MPL actually had to pay a considerable sum to claimants. This lawsuit seeks to have MPL's losses declared a nondischargeable debt of Hyde.      MPL asserts nondischargeable liability on three grounds. First, it alleges that it was induced to enter into the situation in the first place by misrepresentations knowingly and fraudulently made by Hyde, and the debt is therefore nondischargeable pursuant to section 523(a)(2)(A) of the Bankruptcy Code. Second, it alleges that Hyde filed a false financial statement with the State of Arizona regarding the affairs of his reinsurance company and gave MPL a false written financial statement regarding his personal affairs, thereby rendering the debt nondischargeable pursuant to section 523(a)(2)(B). Third, MPL alleges that Hyde diverted funds from MPL-controlled bank accounts to accounts he controlled, that Hyde was a fiduciary in relation to the accounts, and the debt is therefore nondischargeable pursuant to section 523(a)(4).
II. Fraudulent Oral Statements

     It is clear from the testimony that MPL agreed to be the primary insurer in 1986 only because Hyde lied to its president concerning the status of the bank accounts relating to activity insured by Coastal. Hyde told MPL' president that there was sufficient cash in these accounts to cover all anticipated claims, plus checks which had been issued but had not yet cleared the bank. However, Hyde knew that as a result of excessive salaries and draws taken by himself and the other principals of his companies there was insufficient cash in the accounts to terminate his relationship with Coastal cleanly, and in fact there was a shortfall of several hundred thousand dollars. Hyde knew that the only way he could meet his financial obligations to Coastal was to use premiums earned after MPL became the primary insurer.      MPL wanted to insure that its business dealings with Hyde were risk free. It could do this by controlling the bank accounts into which premiums were deposited, which Hyde agreed to, and by assuring that the funds on hand when they took over the role of primary insurer were sufficient to cover all prior activity. MPL's fatal error was taking Hyde's word for the latter, rather than insisting on an audit before agreeing to be the insurer. The primary issue of law now before the court is whether a nondischargeable judgment can be based on Hyde's misrepresentations.      Section 523(a)(2)(A), which excepts a debt from discharge to the extent it was incurred by a false representation, specifically excludes statements regarding the financial condition of the debtor or a company he controls. Section 523(a)(2)(B) excepts debts from discharge due to false statements regarding such financial conditions, but only if the statements are in writing. Thus, a false statement regarding financial condition which is not in writing cannot be the basis for finding a debt nondischargeable. Engler v. Van Steinburg (4th Cir.1984) 744 F.2d 1060; In re Cook (Bkrtcy.E.D.Va.1985) 46 B.R. 959, 961. Moreover, what constitutes a "statement respecting a financial condition" is to be broadly interpreted. Blackwell v. Dabney (4th Cir.1983) 702 F.2d 490, 491.      Notwithstanding Engler and Blackwell, the Court does not believe that Hyde should escape liability because his misrepresentations were oral. They were not misrepresentations as to the general creditworthiness of his company, but rather were misrepresentations as to specific conditions which existed at the time. It is clear that regardless of the overall financial condition of Hyde and his companies, MPL would not have agreed to become the primary insurer if it knew that Hyde had misrepresented the status of the bank accounts. While MPL's reliance on the oral representations was certainly not good business, it was not so far out of the realm of normal business relations as to be unreasonable, given a prior history with Hyde. Accordingly, the Court will find a nondischargeable debt based on the misrepresentations.      In so ruling, the Court recognizes that it must decline to follow Engler. The Court believes that the Fourth Circuit in that case failed to distinguish between a representation that a certain asset has so much equity which might be available to creditors to satisfy their claims and a representation that an asset is encumbered in a specific manner made to induce a creditor to become a lienholder on that property. While the former is a representation as to financial condition which must be in writing to be actionable in a dischargeability proceeding, the latter should not be considered such a representation where the effect is to insulate the debtor from liability for a knowingly fraudulent statement upon which a creditor reasonably relied. In the absence of Ninth Circuit authority, the Court declines to apply Engler to these facts.
III. False Financial Statements
     On April 1, 1986, Hyde submitted a written statement of the finances of his reinsurance company to the State Of Arizona. This statement, signed by Hyde, was knowingly false in that it represented that the company was solvent when it was not. Among other things, Hyde had falsely represent significant debt as equity, against the advice of his accountant. Moreover, the statement documented the oral misrepresentations Hyde had made concerning the bank accounts. Since the statement was delivered to MPL for filing, it is clear that Hyde meant for MPL to be influenced by it. However, liability for this statement is problematical, as it was delivered three months after MPL had been sucked into liability, and extrication would have taken several more months even if MPL had known the truth. Since the Court has already determined that Hyde is liable for the same misrepresentations when made earlier orally, it need not embark on the seemingly impossible task of determining what portion, if any, of MPL's damages was caused by the written statement of April 1.      On May 13, 1986, Hyde gave MPL a copy of his personal financial statement which had been prepared for Bank of America. However, Hyde told MPL's president that the income figures in the statement had been falsified to mislead the bank. While it may be that the statement to MPL's president was the false statement and that the income representations in the statement were true, one cannot reasonably rely on a financial statement which he has been told by the debtor contains false information. Accordingly, the Court finds no actionable fraud arising out of the personal financial statement.
IV. Diversion of Funds
     One of the original conditions MPL insisted upon in order for it to be the primary insurer was that MPL would have control of the bank accounts set up to handle the flow of premium payments. Even before the formal contracts were signed, Hyde and MPL's president visited the bank together to establish the accounts; the contract documents formalized the arrangement. By applicable state statutes, the money in the accounts is held in a fiduciary capacity. Cal.Ins.Code sec. 1759.6; Ariz.Ins.Code sec. 20-485.06. By May of 1986, MPL was not disbursing any funds to Hyde's businesses out of these accounts. Needing the cash and feeling that MPL was acting improperly in withholding disbursement, Hyde caused $885,922.01 to be diverted from these MPL-controlled accounts to accounts controlled by his company. He accomplished this first by sending a letter to the bank on May 19 directing diversion to his accounts, and then eleven days later by sending a letter to the policy holders redirecting the premiums. There is no question that this conduct violated the contracts between Hyde's companies and MPL; the issue is whether the conduct amounts to defalcation in a fiduciary capacity, embezzlement, or larceny, so as to render the debt nondischargeable pursuant to section 523(a)(4) of the Bankruptcy Code.      In order to establish defalcation in a fiduciary capacity, there must be an express trust. In re Pedrazzini (9th Cir.1981) 644 F.2D 756. However, the trust may be created either by agreement or by statute. In re Short (9th Cir.1987) 818 F.2d 693, 695. Here, there was a trust established by statute and governed by agreement. Hyde breached the terms of the trust by diverting the funds. It is no defense that Hyde placed the funds in a new trust account, as the new trust account did not have the safeguards which were part of the terms of the breached trust. Nor is it any defense that Hyde distributed the funds according to state insurance law, as the terms of the trust gave MPL something more than state law required, which was control of the bank accounts.
V. Damages
     Having determined that at least two grounds exist for finding a nondischargeable debt, the Court must proceed to determine damages. This is no easy task, since MPL has asked for a judgment in excess of $6.5 million, a figure it reached by totalling an incomprehensible array of figures, many of them based on conduct not related to dischargeability issues. Moreover, it appears that the figure was reached by seeking recovery of the same losses on each of several legal theories.      The Court begins its analysis by noting that a debt is nondischargeable pursuant to the provisions of section 523(a)(2) only to the extent that it was incurred by fraud. Thus, not all damages are nondischargeable merely because fraud is found. The creditor is entitled to be made whole for his out-of-pocket losses due to the fraud, but is not necessarily entitled to the benefit of his bargain. In re Anguiano (9th Cir.BAP 1989) -- B.R. --, 89 D.A.R. 7275.      The essential fraud found by the Court in this matter was the misrepresentation as to the status of the cash accounts when MPL agreed to be the primary insurer. If MPL had known the truth, that there was a gross deficiency in those accounts which prohibited it from getting into the position of primary insurer with a clean slate, then it would not have become involved at all. As a result of the misrepresentation, MPL was tricked into becoming a true insurer rather than just allowing its name to be used for a fee. While the Court will not award MPL its fee, it is appropriate to award MPL its net out-of-pocket losses for claims paid in excess of premiums received.      In order to calculate the amount of the judgment, the Court relies on the graph supplied by MPL's witness, accountant Robert W. Cain, entitled "Sources/Uses of Cash." According to that graph, MPL made $2,166,317.00 in cash payments and recovered $290,512.00 in premiums. Accordingly, the Court fixes damages under section 523(a)(2) in the amount of $1,807,805.00.      While the Court has found that MPL suffered losses in the amount of $885,922.01 due to Hyde's defalcation in a fiduciary capacity, MPL would recover twice for this loss if the sum is added to the fraud damages. Accordingly, the Court will make no additional award pursuant to section 523(a)(4). However, the finding of liability under this section may bolster MPL's claim to attorneys' fees.
VI. Conclusion
     The Court will enter a nondischargeable judgment in favor of MPL in the amount of $1,807,805.00, plus costs of suit and interest at the legal rate from and after June 1, 1986. If MPL asserts a right to attorneys' fees, it shall immediately file an appropriate motion. Upon the resolution of any disputes regarding fees and costs, counsel for MPL shall submit an appropriate form of judgment.      This memorandum constitutes findings and conclusions pursuant to FRCP 52(a) and Bankruptcy Rule 7052.
Dated: June 21, 1989                                                                              _______________________                                                                                                                      Alan Jaroslovsky                                                                                                                      U.S. Bankruptcy