1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

FILED

SEP 29 2017

SUSAN M. SPRAUL, CLERK

U.S. BKCY. APP. PANEL

OF THE NINTH CIRCUIT

NOTFOR PUBLICATION

UNITED STATES BANKRUPTCY APPELLATE PANEL

OF THE NINTH CIRCUIT

In re: ) BAP No. CC-16-1412-LTaKu

)

JOHN EMIL ALLE and MARY REILLY) Bk. No. 2:13-bk-38801-SK

ALLE, )

) Adv. No. 2:14-ap-01146-SK

Debtors. )

______________________________)

)

JOHN EMIL ALLE; MARY REILLY )

ALLE, )

)

 Appellants, )

)

v. ) M E M O R A N D U M*

)

EARL E. GALES, JR.; STARLA )

GALES; ROBERT L. OPPENHEIM; )

LOIS J. OPPENHEIM, )

)

Appellees. )

______________________________)

Argued and Submitted on June 22, 2017

at Pasadena, California

Filed - September 29, 2017

Appeal from the United States Bankruptcy Court

for the Central District of California

Honorable Sandra R. Klein, Bankruptcy Judge, Presiding

_________________________

Appearances: David Brian Lally argued for Appellants; Anthony

J. Napolitano of Buchalter Law Firm argued for

Appellees.

_________________________

Before: LAFFERTY, TAYLOR, and KURTZ, Bankruptcy Judges.

*This disposition is not appropriate for publication.

Although it may be cited for whatever persuasive value it may

have (see Fed. R. App. P. 32.1), it has no precedential value. 

See 9th Cir. BAP Rule 8024-1.
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

INTRODUCTION

This appeal challenges the bankruptcy court’s

determinations that certain claims are nondischargeable under

§ 523(a)(4)1 as resulting from defalcation by a fiduciary and

embezzlement. In brief, the bankruptcy court concluded that the

defendant, who was the managing member of Shadow Mountain

Properties, LLC (“SMP”), a California limited liability company

(“LLC”) in which plaintiffs were the only other members and

which was formed for the express purpose of acquiring and

operating for-profit real property, was a fiduciary to the

plaintiffs via the application of California law governing LLCs. 

We agree with this conclusion. 

The bankruptcy court also concluded that: (i) the

defendant’s failure to provide monthly bank statements and

written accountings of the financial condition of the LLC and

apparent misappropriation of SMP’s funds were defalcations

committed by defendant in his fiduciary capacity, and that SMP’s

loss of its real property through foreclosure supported

nondischargeable claims against defendant of $800,000, their

original investment; and (ii) SMP’s loss of the real property

also supported a claim for embezzlement against defendant, in

the same damage amount of $800,000. We cannot agree with these

conclusions. 

As an initial matter, the bankruptcy court’s ruling did not

1Unless specified otherwise, all chapter and section

references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, all

“Rule” references are to the Federal Rules of Bankruptcy

Procedure, and all “Civil Rule” references are to the Federal

Rules of Civil Procedure.

-2-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

contain a finding that defendant acted with the mental intent

required to support a claim of defalcation. And the record does

not support the bankruptcy court’s ruling that the alleged

defalcations – failure to report SMP’s financial condition and

misuse of funds – while certainly breaches of defendant’s

fiduciary duties, “caused” the damages here, as required by the

law defining claims for defalcation under § 523(a)(4). Nor does

the law support the bankruptcy court’s finding that the

defendant’s misuse of funds adequately supported a judgment on

the embezzlement claim in the amount of the plaintiffs’ original

investment. Indeed, neither the law nor the record support the

conclusion that the proper measure of damages for the alleged

defalcations or embezzlement was the amount of plaintiffs’

initial investment in SMP. 

Accordingly, we AFFIRM in part, REVERSE in part, VACATE the

judgment, and REMAND. 

FACTS2

A. Formation of Shadow Mountain Properties, LLC

In January 2006 Debtor John Alle and his wife Mary Alle,

Earl and Starla Gales, and Robert and Lois Oppenheim formed SMP

as a California LLC. Each couple owned a one-third interest in

SMP. SMP was formed to purchase, operate, and manage a 12-unit

residential income property on Shadow Mountain Drive in Palm

Desert, California (the “Property”). Under the Operating

Agreement (“OA”) for SMP, Alle was designated managing member

2The facts are taken from the bankruptcy court’s findings on

summary judgment and are undisputed except as noted.

-3-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

with direct and sole responsibility for the day-to-day

management and operation of the Property. 

Alle arranged for SMP to purchase the Property from the

Humiston Family Trust (“HFT”) for $1,600,000. The Gales and the

Oppenheims (collectively, “Plaintiffs”) each contributed

$400,000 toward the acquisition of the Property, and HFT carried

back a note and deed of trust for the $800,000 balance of the

purchase price.

B. The Operating Agreement

The OA provided that Alle, as managing member of SMP, would

have full authority in connection with the management of the

Property, including tenant relations and services, vendor

relations, record-keeping, accounting, and cash flow management. 

For his services, Alle was to be paid a management fee of $300

per month. He was also entitled to “reimbursement for any and

all out-of-pocket expenses paid or incurred by him in connection

with the Property,” except costs associated with the formation

of the LLC and the purchase of the Property, as well as funds

required for the operation of the Property through December 31,

2010. 

The OA authorized the managing member to require members

under appropriate circumstances to make capital contributions in

ratio to their ownership interests. It further obligated the

managing member to deposit partnership monies into the

partnership bank account, to provide members with monthly

financial reports and bank statements and annual financial

statements, and to distribute profits on a monthly basis.

-4-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

C. SMP’s Cash Flow Problems

Sometime during 2008, the Property began experiencing cash

flow problems. Over the next several years, Alle communicated

several times with Gales and Oppenheim,3 orally and in writing,

to inform them that the Property was no longer making money and

that he recommended they sell it. Alle initially approached

Gales and Oppenheim in 2008 about selling the Property, but they

did not want to sell because, according to Alle, they “had no

place else to put their money, . . . did not want to pay capital

gains taxes . . . [and] they didn’t want to give up their

monthly/annual cash-on-cash returns of 9% per month.”

Although Alle was communicating generally with Gales and

Oppenheim regarding SMP’s financial condition, sometime in 2010

Alle stopped sending monthly operating reports and bank

statements to them. Alle also fell behind on sending

distribution checks. 

Around 2010 to 2011, the Property’s revenues decreased

because tenants either moved out or were evicted. Also, some

units became uninhabitable due to tenant damage. Alle requested

that Plaintiffs pay expenses for plumbing, eviction fees, legal

fees, insurance, taxes, trash, monthly maintenance, remedial

expenses (such as paint, appliance repairs, broken fixtures,

accounting, and bookkeeping), but Plaintiffs refused, insisting

that Alle should pay for those expenses from his personal funds. 

3References to “Gales” and “Oppenheim” are to Earl Gales and

Robert Oppenheim, respectively. Although their spouses were

members of the LLC, they did not actively participate in the

communications with Alle.

-5-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

As noted, the OA provided that Alle was entitled to be

reimbursed for his out-of-pocket expenses related to the

Property.

Gales admitted in his deposition testimony that Alle told

Plaintiffs that the Property was losing money and that they

should sell it, but “we never received any documentation.” 

Gales also testified that during 2010, in an attempt to

determine the value of the Property, he personally investigated

comparables near the Property.

Over the next several months, Gales and Oppenheim requested

monthly reports and distribution checks; despite promises to do

so, Alle did not provide any financial reports. Alle also

continued to broach the subject of selling the Property, but

Gales and Oppenheim were opposed to the idea. 

Eventually, in July 2011, Alle met personally with Gales

and Oppenheim at his office and warned them about the financial

challenges facing SMP. The parties reviewed bills and rent

rolls. Alle told Gales and Oppenheim that there was

insufficient cash in the operating account to maintain the

building properly, fix units for new tenants, and pay taxes and

that, even if the Plaintiffs’ distributions were reduced, SMP

could not afford to maintain the Property. 

D. Alle uses SMP funds for his personal expenses.

According to bank statements and check copies admitted in

the bankruptcy court, during 2009, 2010, and 2011, Alle withdrew

from the SMP bank account $44,529.84 in cashier’s checks,

$15,097.84 in unidentified checks, and $7,924.10 in cash

withdrawals, along with $26,921.86 of expenditures that appeared

-6-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

to be solely for Alle’s personal expenses or expenses related to

other properties he owned.

E. The Notice of Default

In the meantime, SMP fell behind on payments on the debt

secured by the Property. As early as May 2009, HFT informed

Alle that late payments on the note would no longer be

tolerated. Alle did not inform Plaintiffs of this default or

his correspondence with the creditor.

Eventually, in August 2011, HFT recorded a Notice of

Default and Election to Sell (“NOD”), which stated that the

reinstatement amount was $12,478.33. Alle admitted that he

received a copy of the NOD shortly after it was recorded and

asserted that the next day, he met with Gales and Oppenheim in

his office and notified them that he had received the NOD. Alle

testified that at that meeting Gales and Oppenheim told Alle

that they were unwilling to contribute further capital and were

unwilling to accept less than $3,000 per month in distributions

from SMP, and they instructed Alle to negotiate a settlement

with HFT. Gales and Oppenheim, however, asserted that Alle

never informed them of the NOD. 

According to Alle, a few weeks later, Alle met with Gales

and Oppenheim again to discuss the foreclosure, delinquent

property taxes, a cut-off notice from utilities, outstanding

rents, and timing of distribution checks. 

F. Alle’s Attempts to Negotiate a Loan Modification

Beginning in October 2011, HFT’s attorney and Alle began

negotiating a potential loan modification. It is undisputed

that Alle did not notify Plaintiffs of any of these

-7-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

negotiations. The final modification proposed by HFT in

December 2011 provided that HFT would cancel the trustee’s sale

on satisfaction of various conditions, including the payment by

December 21 of $16,666.65, representing interest payments due on

the note, along with legal fees and trustee’s fees,

reimbursement for insurance premium advances, payment of current

property taxes, and proof of an installment agreement with

Riverside County for the payment of property tax arrears. Alle

did not accept this proposal but requested additional time to

pay the property taxes in exchange for paying a higher interest

rate. HFT rejected this proposal. The day before the scheduled

foreclosure sale, Alle made one more modification proposal in

which he requested a two-week continuance of the sale.

HFT did not respond to Alle’s final proposal, and the

foreclosure sale occurred on December 22, 2011. A trustee’s

deed for the Property was issued to HFT. According to Alle, he

notified Plaintiffs orally of the completion of the sale, but

Gales and Oppenheim testified that he did not. 

G. Post-Foreclosure Events

Communications among Alle, Gales, and Oppenheim after the

foreclosure sale belie Alle’s assertion that he had informed

Plaintiffs of the foreclosure sale. For example, about a week

after the sale, Oppenheim wrote to Alle to inquire about the

status of the financial information and documentation that Alle

had promised in July. In response, Alle defended his management

of the Property, pointed out that he had not taken any

distributions from the Property other than $300 per month as a

management fee during the first year of ownership, and noted

-8-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

that he had complied with Gales’ and Oppenheim’s desire to keep

the Property. Alle also promised that Gales and Oppenheim would

not lose any money on their investments.

Oppenheim and Alle exchanged similar correspondence again

in February 2012, with Oppenheim expressing concerns regarding

Alle’s failure to satisfy the OA’s reporting requirements and

Alle defending himself. This time Alle asserted that he had

provided all requested information and promised to send a letter

“with the game plan for the property.” 

According to Oppenheim, he discovered the foreclosure sale

in April 2012 when he received an email from a real estate

broker attaching a copy of the trustee’s deed. Immediately

thereafter, Oppenheim emailed Alle to ask for an explanation. 

According to Plaintiffs, Alle responded with an email stating

that he had decided to sell the property to the lender due to

unpaid property taxes. Alle promised that Plaintiffs would not

lose any money and that he would continue making distributions

over the next eight years. Alle contended that this email,

which was presented as an exhibit to the declaration of Earl

Gales in support of Plaintiffs’ motion for summary judgment, was

a “sham exhibit.” In any event, the bankruptcy court made clear

that this email was not material to its ruling.

In November 2012, Plaintiffs filed a complaint against the

Alles in Los Angeles County Superior Court, asserting several

causes of action, including breach of contract, breach of

fiduciary duties, fraud, conversion, and for an accounting. 

Trial in the state court was set for December 2013. 

-9-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

H. The Alles’ Bankruptcy Filing and the Adversary Proceeding

A few days before the date set for trial in the state

court, the Alles filed a chapter 7 bankruptcy petition, which

stayed the state court litigation. Thereafter, Plaintiffs filed

an adversary proceeding against Alle seeking a declaration of

nondischargeability under (i) § 523(a)(4) for defalcation while

acting in a fiduciary capacity and embezzlement and (ii) under

§ 523(a)(2)(A) for fraud. Plaintiffs sought to have declared

nondischargeable their initial investments totaling $800,000

plus attorneys’ fees and costs.4

In June 2016, Plaintiffs filed a motion for summary

judgment (“MSJ”) seeking entry of judgment on all causes of

action. In support of the MSJ, Plaintiffs submitted

declarations that attached, among other documentary evidence,

copies of SMP’s bank statements, cancelled checks, and

supporting documents. 

After hearing argument on the MSJ, the bankruptcy court

granted Plaintiffs’ MSJ with respect to Plaintiffs’ claims under

§ 523(a)(4) for defalcation and embezzlement and denied the MSJ

with respect to Plaintiffs’ claim under § 523(a)(2)(A). The

bankruptcy court awarded Plaintiffs’ requested damages of

$800,000 but did not articulate the basis for the award. The

bankruptcy court declined to award damages on the $94,473.64

embezzlement claim because Plaintiffs had not requested those

4Alle was initially represented by counsel in this adversary

proceeding. However, on June 10, 2016, Alle’s attorney filed a

Substitution of Attorney substituting Alle in pro per. Alle

thereafter participated in the adversary proceeding without

counsel until the filing of this appeal in November 2016.

-10-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

damages in their MSJ. The bankruptcy court deferred the issue

of attorneys’ fees to permit Plaintiffs to file a motion

substantiating the fees.

Thereafter, Plaintiffs dismissed their § 523(a)(2)(A) claim

in its entirety and their § 523(a)(4) claim for embezzlement,

but only with respect to the portion of damages attributable to

Alle’s misappropriation of funds from the SMP checking account. 

The bankruptcy court entered judgment on the § 523(a)(4) claims

for $800,000 plus attorney’s fees and costs and post-judgment

interest. The bankruptcy court subsequently awarded Plaintiffs

their attorneys’ fees and costs in the amount of $351,730.02 and

entered an amended judgment reflecting the fee award. 

In the meantime, Alle filed a motion to vacate the

bankruptcy court’s ruling on summary judgment pursuant to Civil

Rules 59(e) and 60(b), applicable in bankruptcy via Rules 9023

and 9024. He thereafter filed an amended motion to vacate,

which included the amended judgment. After a hearing, the

bankruptcy court denied the motion to vacate. Alle timely

appealed.

JURISDICTION

The bankruptcy court had jurisdiction pursuant to 28 U.S.C.

§§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C.

§ 158.

ISSUES

1. Did the bankruptcy court err in granting summary

judgment on Plaintiff’s § 523(a)(4) claim for defalcation while

acting in a fiduciary capacity?

2. Did the bankruptcy court err in granting summary

-11-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

judgment on Plaintiffs’ § 523(a)(4) claim for embezzlement?

3. Did the bankruptcy court apply an incorrect legal

standard in awarding damages based on Plaintiffs’ initial

investment in SMP?

STANDARDS OF REVIEW

We review de novo the bankruptcy court’s decision to grant

summary judgment. Plyam v. Precision Dev., LLC (In re Plyam),

530 B.R. 456, 461 (9th Cir. BAP 2015); Gertsch v. Johnson &

Johnson Finance Corp. (In re Gertsch), 237 B.R. 160, 165 (9th Cir

BAP 1999). Likewise, whether the bankruptcy court used the

correct legal standard in computing damages is reviewed de novo. 

Neptune Orient Lines, Ltd. v. Burlington N. and Santa Fe Railway

Co., 213 F.3d 1118, 1119 (9th Cir. 2000).

Under de novo review, we look at the matter anew, as if it

had not been heard before, and as if no decision had been

rendered previously, giving no deference to the bankruptcy

court’s determinations. Freeman v. DirecTV, Inc., 457 F.3d 1001,

1004 (9th Cir. 2006).

DISCUSSION

A. The bankruptcy court erred in granting summary judgment on

Plaintiff’s claim under § 523(a)(4) for defalcation while

acting in a fiduciary capacity.

Section 523(a)(4) excepts from discharge any debt “for fraud

or defalcation while acting in a fiduciary capacity,

embezzlement, or larceny.” To prevail under § 523(a)(4) for

defalcation while acting in a fiduciary capacity, the plaintiff

must show by a preponderance of the evidence that (1) an express

trust existed; (2) the debt was caused by fraud or defalcation;

-12-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

and (3) the debtor acted as a fiduciary to the creditor at the

time the debt was created. Stephens v. Bigelow (In re Bigelow),

271 B.R. 178, 186 (9th Cir. BAP 2001) (citing Otto v. Niles

(In re Niles), 106 F.3d 1456, 1459 (9th Cir. 1997), abrogated on

other grounds, Bullock v. BankChampaign, N.A., 133 S. Ct. 1754

(2013)).

Whether a relationship is a “fiduciary” one within

the meaning of section 523(a)(4) is a question of

federal law. The broad, general definition of

“fiduciary” is inapplicable in the dischargeability

context. Instead, the fiduciary relationship must be

one arising from an express or technical trust that was

imposed before and without reference to the wrongdoing

that caused the debt.

Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir. 1996)

(citing Ragsdale v. Haller, 780 F.2d 794, 795 (9th Cir. 1986)). 

The bankruptcy court did not err in concluding that a

qualifying trust under § 523(a)(4) existed and that Alle acted as

a fiduciary at the time the Property was lost to foreclosure. 

The bankruptcy court’s findings, however, were inadequate to

support the conclusion that there was a defalcation: the

bankruptcy court made neither a sufficient finding that Alle’s

state of mind satisfied the applicable standard, nor an explicit

finding that Alle’s conduct caused Plaintiffs’ damages. 

1. The bankruptcy court did not err in concluding that a

trust existed for purposes of § 523(a)(4).

For purposes of § 523(a)(4), a trust may be created by

statute or by agreement. In re Bigelow, 271 B.R. at 186; Lovell

v. Stanifer (In re Stanifer), 236 B.R. 709, 715 (9th Cir. BAP

1999). State law is relevant to determine whether there is an

express or technical trust within the meaning of § 523(a)(4). 

-13-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Id. at 714. 

For a technical trust to be created by statute, “[t]he

statute must define the trust res, spell out the trustee’s

fiduciary duties[,] and impose a trust prior to and without

reference to the wrong which created the debt.” Id. at 715

(citation omitted). Under California law, creation of an express

trust by agreement requires (1) sufficient words to create a

trust; (2) a definite subject; and (3) a certain and ascertained

object or res. Id. at 714.

In the OA, the parties agreed to form and become members of

SMP and that Alle would be the managing member. The OA further

provided that SMP’s purpose was to “own, operate, and manage the

. . . Property, and to do all things incidental to or in

furtherance of said purpose.” The OA also specified that Alle

was “responsible for the management and operation of the

Property” and that he had “full authority in connection with the

Property.” Further, the OA authorized Alle, as managing member,

to make withdrawals from the SMP bank account. The OA required

Alle to provide financial reports and to distribute the profits

to members on a monthly basis. 

Contrary to the bankruptcy court’s finding, the OA by itself

did not create an express trust under California law because it

did not include language expressing an intent to create a trust. 

See Lonely Maiden Prods., LLC v. GoldenTree Asset Mgmt, LP,

135 Cal. Rptr. 3d 69, 78, 201 Cal. App. 4th 368, 379 (2011). It

is undisputed, however, that the OA created a limited liability

company and spelled out the obligations of its members. Under

California law in effect when SMP was formed, the fiduciary

-14-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

duties a manager owed to a limited liability company and its

members were those of a partner to a partnership and the other

partners. Cal. Corp. Code § 17153.5 And, under California

partnership law, partners are trustees over the assets of the

partnership; thus, those partners are fiduciaries under

§ 523(a)(4). Ragsdale v. Haller, 780 F.2d 794, 796-97 (9th Cir.

1986). Accordingly, when considered in light of California law,

a technical trust was created for purposes of § 523(a)(4), while

the OA specified the trust res, here, the Property and its

profits and defined the managing partner’s fiduciary duties. 

On appeal, Alle seems to dispute that the requirement of a

“certain and ascertained res” was met because “while there was

real property involved, the issue of rents was a moving target

and thus the “res” was not defined for purposes of a fiduciary

relationship. Although this argument is not convincing, it

highlights that the bankruptcy court did not make clear what the

defalcation was with respect to the Property; we address that

issue below.

2. The bankruptcy court did not err in finding that Alle

acted as a fiduciary at the time the debt was created.

As discussed above, California law imposed fiduciary duties

upon Alle as managing member of SMP. Alle was acting as a

fiduciary with respect to the trust assets during all relevant

times. 

5Cal. Civ. Code § 17704.09, which became effective on

January 1, 2014, addresses the fiduciary duties of members of

limited liability companies.

-15-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

3. The bankruptcy court erred in concluding that the debt

was caused by defalcation under § 523(a)(4).

Defalcation is the misappropriation of trust funds or money

held in any fiduciary capacity.6 In re Lewis, 97 F.3d at 1186

(9th Cir. 1996). Defalcation also includes the failure by a

fiduciary to account for money or property that has been

entrusted to him. Pemstein v. Pemstein (In re Pemstein),

492 B.R. 274, 282 (9th Cir. BAP 2013). Once a creditor has shown

that the debtor is a fiduciary to whom funds have been entrusted,

the burden shifts to the fiduciary to account fully for all funds

received. In re Niles, 106 F.3d at 1462. Additionally, a

defalcation under § 523(a)(4) requires a culpable state of mind

involving either bad faith, moral turpitude or an intentional

wrong. Bullock, 133 S. Ct. at 1759. Thus, in order to find a

defendant liable for a defalcation under § 523(a)(4), in addition

to finding that he occupied the requisite fiduciary relationship

at the time of the alleged wrongdoing (which we agree was

established here), the bankruptcy court must also find that any

misappropriation or failure to account was done with the

requisite mental state and was the cause of the damage to the

plaintiff.

a. Intent

The bankruptcy court did not make any finding that Alle

possessed the requisite state of mind to support liability under

§ 523(a)(4). At a minimum, the court needed to find that Alle

6“Misappropriation” is “the application of another’s

property or money dishonestly to one’s own use.” Black’s Law

Dictionary (10th ed. 2014).

-16-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

committed an intentional wrong, which includes

not only conduct that the fiduciary knows is improper

but also reckless conduct of the kind that the criminal

law often treats as the equivalent. . . . we consider

conduct as equivalent if the fiduciary consciously

disregards (or is willfully blind to) a substantial and

unjustifiable risk that his conduct will turn out to

violate a fiduciary duty. That risk must be of such a

nature and degree that, considering the nature and

purpose of the actor’s conduct and the circumstances

known to him, its disregard involves a gross deviation

from the standard of conduct that a law-abiding person

would observe in the actor’s situation.

Bullock, 133 S. Ct. at 1759-60 (internal quotations and citations

omitted). 

Although the bankruptcy court recited the applicable

standard – that defalcation requires a culpable state of mind

involving knowledge of, or gross recklessness with respect to,

the improper nature of the conduct – its only reference to Alle’s

intent was to note that “he must have known he was required to

provide [financial information] to Plaintiffs.” The bankruptcy

court needed to have found that the debt resulted from (i) acts

of bad faith, moral turpitude, or other immoral conduct;

(ii) intentional improper conduct or criminally reckless conduct;

or (iii) conscious disregard or willful blindness to a

substantial and unjustifiable risk. Heers v. Parsons

(In re Heers), 529 B.R. 734, 742-43 (9th Cir. BAP 2015). The

court made no findings that would satisfy this standard. Nor is

it clear whether the bankruptcy court could have made such

findings on summary judgment, see Provenz v. Miller, 102 F.3d

1478, 1489 (9th Cir. 1996) (scienter should not ordinarily be

determined on summary judgment), but we leave such determinations

to the bankruptcy court on remand. 

-17-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

b. Causation

One of the required elements for a defalcation claim is that

the debt was “caused by” the fraud or defalcation. 

In re Bigelow, 271 B.R. at 186. In circumstances where the trust

res consists of funds that are to be invested by a fiduciary,

causation is usually easy to ascertain. To the extent the funds

are missing or dissipated via improvident investments, coupled

with the requisite mental state (post-Bullock), numerous opinions

confirm that such conduct can support a claim of defalcation. 

See, e.g., In re Lewis, 97 F.3d at 1187 (commingling partner’s

investment with other funds and failure to provide partner with

complete accounting). By comparison to the facts presented in

this case, these “funds are missing” fact patterns generally do

not require extensive analysis on the question of causation. If

cash entrusted to a fiduciary is missing from where it is

supposed to be, the inherent cause of its absence is usually the

fiduciary having put it somewhere else. But where assets other

than funds are at issue, causation needs to be more fully

explained.7 

7Certainly, assets other than funds may constitute a trust

res subject to defalcation under § 523(a)(4): See, e.g., Cora v.

Jahrling (In re Jahrling), 816 F.3d 921 (7th Cir. 2016)

(attorney’s breach of fiduciary duty in selling elderly client’s

real property at a price far below market value and failing to

include in the closing documents the retention of a life estate

was a defalcation under § 523(a)(4)); Baker v. Friedman

(In re Friedman), 298 B.R. 487 (Bankr. D. Mass. 2003) (partner’s

failure to disclose to other partner impending cancellation of

life insurance policies owned by partnership for nonpayment

constituted a defalcation); Brawer v. Gelman (In re Gelman),

47 B.R. 735 (Bankr. S.D. Fla. 1985) (attorney’s failure to

(continued...)

-18-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Plaintiffs listed in their MSJ several alleged breaches of

fiduciary duties by Alle: failure to remain current with mortgage

and property tax payments and to cure defaults on those

obligations; failure to provide monthly financial reports and

bank statements; failure to make complete and timely tax and

governmental filings on behalf of SMP; failure to advance funds

required for the operation of the Property through 2010; and

failure to notify Plaintiffs of the NOD and the impending

foreclosure sale.

Although the bankruptcy court stated in its ruling that it

agreed with Plaintiffs that Alle’s conduct resulted in the debt

owed to Plaintiffs – seemingly agreeing that all of the

identified conduct was the defalcation – the bankruptcy court

explicitly found that Alle’s defalcation consisted only of

(1) his failure to properly account for the Property’s income and

expenses, and (2) his misappropriation of SMP’s funds. The

bankruptcy court did not make an explicit finding that Alle’s

failure to inform Plaintiffs of the impending foreclosure was a

defalcation, probably because there was conflicting evidence as

to whether Alle informed Plaintiffs of the impending foreclosure

in time for them to take any action.8

7(...continued)

disclose his disbarment and his subsequent abandonment of

client’s claim was a defalcation).

8Alle testified in his declaration that he informed the

Plaintiffs of the NOD shortly after he received it and discussed

the impending foreclosure with them at meetings in August and

September of 2011. Plaintiffs denied this, and subsequent

correspondence between the parties, which did not mention the

(continued...)

-19-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

The evidence on summary judgment supported a finding that

Alle breached his fiduciary duties as managing member of SMP by

failing to provide financial reports and bank statements after

2009. But the only evidence presented with respect to causation

was Gales’ and Oppenheim’s declaration testimony that “[b]ecause

Alle never provided us with any information regarding the default

on the Humiston loan, the pending foreclosure sale and the

proposed loan modification agreement, [we] were never given any

opportunity to cure defaults or otherwise save our investments in

Shadow Mountain or the Property.” Notably, that testimony does

not mention as a cause Alle’s failure to provide monthly

financial statements or bank statements or his misappropriation

of funds from the SMP checking account. Thus, strictly speaking,

the record does not support a finding that the identified

defalcations caused the damages to Plaintiffs. 

And more importantly, the bankruptcy court did not explain

how Alle’s identified breaches of fiduciary duties – the failure

to provide monthly reports and bank statements and the diversion

of SMP’s funds – was the cause of Plaintiffs’ damages. Such an

explanation would necessarily have required the court to identify

precisely what those damages were, as the two issues are

8(...continued)

foreclosure, seemed to support Plaintiffs’ version of events. 

There is no evidence in the record that Alle informed Plaintiffs

of the specific date of the foreclosure sale, and it is

undisputed that Alle did not inform Plaintiffs of his last-minute

attempts to negotiate a modification of the note.

-20-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

intertwined.9 It is undisputed that the funds contributed by

Plaintiffs were invested as agreed by the parties. It appears,

then, that a defalcation could have occurred only with respect to

the LLC’s assets: the Property and its profits. But the

bankruptcy court did not articulate the connection between Alle’s

conduct and the ultimate loss of SMP’s primary asset.

In sum, the bankruptcy court did not err in finding that a

qualifying trust existed or that Alle was acting as a fiduciary

when he failed to provide the required financial information to

Plaintiffs or when he used SMP’s funds for non-SMP expenses. The

bankruptcy court erred, however, in failing to make the necessary

findings regarding the state of mind element of a defalcation

under § 523(a)(4) and in implicitly finding, without explanation,

that Alle’s identified fiduciary breaches were the cause of the

damage to Plaintiffs.

B. The bankruptcy court erred in entering judgment for

Plaintiffs on their embezzlement claim.

The bankruptcy court also granted summary judgment to

Plaintiffs for embezzlement under § 523(a)(4) but did not award

damages in the amount of the misappropriated funds because

Plaintiffs’ motion had not put Alle on notice that Plaintiffs

sought additional damages for that claim. Thereafter, Plaintiffs

dismissed the embezzlement claim in part. Their notice of

dismissal stated that Plaintiffs were not dismissing the

embezzlement claim to the extent it formed a basis for the

9As discussed in Section C below, neither the parties nor

the bankruptcy court specified the basis for the damages award.

-21-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

$800,000 in damages. The judgment awarded Plaintiffs $800,000 on

the embezzlement claim.

Section 523(a)(4) excepts from discharge debts for

embezzlement. A fiduciary relationship is not a predicate for

recovery under this theory. Transamerica Comm. Fin. Corp. v.

Littleton (In re Littleton), 942 F.2d 551, 555 (9th Cir. 1991). 

Under federal law, embezzlement is defined as “the fraudulent

appropriation of property by a person to whom such property has

been entrusted or into whose hands it has lawfully come.” Id.

(citing Moore v. United States, 160 U.S. 268, 269 (1885)). To

prevail on an embezzlement claim under § 523(a)(4), a creditor

must prove three elements: (1) property rightfully in the

possession of a nonowner; (2) the nonowner’s appropriation of the

property to a use other than that for which it was entrusted; and

(3) circumstances indicating fraud. Id.

The bankruptcy court found that the foregoing elements had

been proven, but it did not award damages in the amount of the

embezzled funds. And it is not clear how the embezzlement claim

could have been the basis for the $800,000 damage award. See

Patel v. Patel (In re Patel), 551 B.R. 488, 496 (Bankr. D.N.M.

2016) (damages for embezzlement are generally equal to the value

of the misappropriated property); Telmark, LLC v. Booher

(In re Booher), 284 B.R. 191, 214 (Bankr. W.D. Pa. 2002) (same). 

Accordingly, the bankruptcy court erred in entering judgment on

Plaintiffs’ embezzlement claim.

C. The bankruptcy court did not make sufficient findings to

support the amount of damages awarded.

In their MSJ, Plaintiffs requested damages of $800,000,

-22-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

representing Plaintiffs’ total investment in SMP, but did not

state the legal basis for the amount sought. The bankruptcy

court seemed to accept this number as the proper measure of

damages without any analysis. 

 The Code does not define the appropriate measure of damages

for defalcation under § 523(a)(4); thus the bankruptcy court

should look to state law. See Light v. Whittington

(In re Whittington), 530 B.R. 360, 407-08 (Bankr. W.D. Tex. 2014)

(because there was no pre-existing judgment on plaintiff’s

claims, bankruptcy court determined defendant’s nondischargeable

liability arising from fraud and breach of fiduciary duty by

looking to Texas state law) (citing Morrison v. W. Builders of

Amarillo, Inc. (In re Morrison), 555 F.3d 473, 479 (5th Cir.

2009)). 

As noted, it does not appear that Plaintiffs’ initial

investment was the proper measure of damages. See Destino v.

Bockting, 2012 WL 258408, at *2-3, 467 Fed. App’x 678, 680-81

(9th Cir. Jan. 30, 2012) (holding that bankruptcy court erred in

awarding damages for defalcation in the total amount of invested

funds where some of those funds were spent in accordance with the

parties’ agreement, and remanding for recalculation of damages

that plaintiff could prove were misapplied); see also

In re Friedman, 298 B.R. at 505 (where debtor’s defalcation

involved partnership assets and not the creditor’s initial

investment in the partnership, the proper measure of damages was

the value of what the plaintiff would have received had the

contract been performed); and Int’l Fid. Ins. Co. v. Fox

(In re Fox), 357 B.R. 770, 778 (Bankr. E.D. Ark. 2006) (where

-23-
1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

misappropriation forms the basis for a defalcation claim, only

that portion of the trust res inappropriately expended is

nondischargeable, citing Matter of Thomas, 729 F.2d 502 (7th Cir.

1984)).

Thus, on remand, the bankruptcy court should make findings

as to the proper measure of damages under California law and the

facts of this case.

D. The bankruptcy court’s ruling on the motion to vacate is

moot.

Because we are vacating and remanding the bankruptcy court’s

judgment, we need not address whether the bankruptcy court abused

its discretion in denying Alle’s motion to vacate.

CONCLUSION

For the reasons set forth above, although the bankruptcy

court did not err in finding that a qualifying trust existed,

that Alle was acting as a fiduciary, and that he breached his

fiduciary duties under the OA, it erred in granting summary

judgment to Plaintiffs on their § 523(a)(4) claim. We therefore

AFFIRM in part, REVERSE in part, VACATE, and REMAND for further

proceedings in accordance with this disposition.

-24-