United States Court of Appeals FOR THE EIGHTH CIRCUIT

_____________ No. 96-4043

_____________ In re: Mary Beth Usery, * * Debtor. * *

-------------------------------------- * * Ewing B. Gourley; Carol L. Gourley, * * Plaintiffs-Appellees, * * Appeal from the United States
v. * District Court for the Western * District of Missouri. Mary Beth Usery; Steven Usery; James * McLeod, Trustee, * * Defendants-Appellants, * * Fred C. Moon, Trustee of the Estate of * Mary Beth Usery, * * Appellant. * *

-------------------------------------- * * Mary Beth Usery; Steven Usery; James * McLeod, Trustee of the Shawn Usery * Trust and the Stephanie Usery Trust, * * Plaintiffs-Appellants, * * William Hart, Trustee Under Certain *The Honorable Richard H. Kyle, United States District Judge for the District of 1 Minnesota, sitting by designation.
-2- Deeds of Trust, * * Plaintiff, * *
v. * * Ewing B. Gourley; Carol L. Gourley; * E.B.G. Health Care III, Inc.; E.B.G. * Health Care IV, Inc.; Health Care * Retirement Village, Inc.; Health Care * Laundry Services, Inc., * * Defendants-Appellees. *

_____________ Submitted: June 9, 1997 Filed: August 22, 1997

_____________ Before BOWMAN and MORRIS SHEPPARD ARNOLD, Circuit Judges, and KYLE, 1 District Judge.

_____________ BOWMAN, Circuit Judge.
This adversary proceeding arises out of a nursing home sale tainted by fraud

. The Ban kruptcy Court awarded the purchasers, Ewing and Carol Gourley, more than $5.4 mil lion in damages resulting from the fraudulent representations of the sellers , Mary Beth a nd Steven Usery. The Userys appealed to the District Court, whic h affi rmed. We now affirm as to liability but reverse and remand for a new trial o n damages.-3- I.

In 1988, Mary Beth Usery owned a majority interest in Central Health Car e Cent ers, Inc. (CHCC). The remaining equity in the company was owned by Mary Be th's then-husband Steven and by trusts benefitting their children. Through CHCC, the Userys owned and operated two nursi ng homes in Springfield, Missouri, known as Northside Nursing Center (Northside) and Ozark Nursing and Care Center (Ozark); an apartment complex; and a laundry facility. The Userys had oper ated the nursing homes profitably for a number of years and had withdrawn la rge amounts of cash from CHCC to support their lavish lifestyle. Steven's management of the homes, and particularl y his reduc tion in staffing levels in 1987, eventually caused trouble: a March 198 8 inspection of Northside by the Missouri Division of Aging revealed s erious deficiencies in pati ent care, and CHCC had to enter into a consent agreement with the Division in order to retain its license. The agreement froze Medicaid admissions, require d No rthside to increase staffing levels, and gave the home until July 1989 to fix it s problems or shut down.

In late 1988, the Userys, who were beginning divorce proceedings, decided to sell the homes rather than attempt to continue operating them. Through thei r
acco untant, Judy Breeding (who was also a director of CHCC), they met Ewin g Gourley, who was well-known i n Missouri as a successful manager of nursing homes. Breeding had done accounting work for Gourley in his business and i n his then-pending divorce. Gourley eventually expressed interest in leasing the nursing homes fro m CHC C with an option to purchase, but Mary Beth insisted on selling the propertie s outright.
At a key meeting on March 10, 1989, the deal came together. Gourley explained to the Userys that his assets were tied up because of c ontinuing litigation relating to his divorce. See Gourley v. Gourley (In re Marriage of Gourle y) , 811 S.W.2d 13 (Mo. Ct. App. 1991). He emphasized that he could afford to buy the homes only if they-4-

produced sufficient cash flow to allow him to service existing debt and to pay th e Userys for the sale. The Userys and Breedi ng (who is not a party to this case) assured Gourley that, even though 1988 financial results were not yet availab le, the homes' cash flow in 1988 wa s substantially the same as the 1987 cash flow, which the Userys and Breeding calculated to be approximately $960,000 after service of existing debt. I n fact, th e Userys had preliminary 1988 financial records available at the time tha t showed a significantly lower cash flow. Gourley later discovered these records in a cardboard box at Northside.

As the parties began to structure their deal, the Userys made two othe r significant misrepresentations. When Gourley inquired about acco unts payable, he was told that they totaled about $75,000 and were current. After the sale, Gourle y disco veredthat the Userys had been keeping two sets of books and that payable s actually exceeded $500,000, including many delinquent accounts. The resulting drain
on cash was exacerbated by Mary Beth's insistence, before the closing, on drawin g down half of a $500,000 line of credit established especially for the transition. Th e Userys also represented that all of the long-term debt that Gourley agreed to assume was business-related debt. In fact, the long-term debt included loans totaling $110,000 that Steven had obtained through CHCC for personal purposes, as well as a debt o f $18,000 owed by the Userys to Breeding for personal tax advice. Based on the Userys' representations, Gourley and his new wife, Carol, agreed to purchase Northside, Oz ark, the apartments, and the laundry facility for a total price of $ 8 million. The Gourleys assumed $4.1 million in long-term debt of CHCC, an d they gave the Userys a note, payable over twenty years, for the balance. As the deal was structured , the amount of the note was to be adjusted after the closing to account for the difference between payables and Medicaid receivables, but this "net-out " transa ctionnever took place. Although the Gourleys were able to get Northside ou t from under the consent agreement with the state, they ran into operational difficulties immediately after taking over the homes, and they had to invest substantial amounts ofAt one point, the Gourleys paid Mary Beth $23, 000 over and above the amount 2 th en due because she claimed she needed cash. Although she promised to credit this amount against the balance of the note, she never did. -5- their own money

in order to keep the businesses afloat. After a series of negotiations between the parties failed, the Gourleys stopped m aking payments on the note because of a shortage of cash. Because the note was Mary Beth's primary source of income, 2 she filed for Chapter 11 bankruptcy in February 1992.

In b ankruptcy court, the Gourleys filed an adversary proceeding against th e Userys, alleging that the Userys' fraud rendered the note void and unenforceable. Mary Beth filed an adversary proceeding against the Gourleys to collect the balance due on the note; Steven

and the trustee of the Usery children's trusts intervened and joined in Mary Beth's complaint. The Bankruptcy Court consolid ated the actions and conducted a bench trial, none of the parties having demanded a jury. After a thirteen-day trial, the
cou rt announced findings and conclusions from the bench, ruling in favor of th e Gourleys and awarding approximately $2.2 million in damages, subject to furthe r calcula tions. At the same time, the court converted Mary Beth's bankruptcy to a Chapter 7 liquidation.

More than two years later, the court filed a written memorandum opinio n awarding the Gourleys more than $5.4 million in damages. The primary reason for the increase in damage s over the original figure was the inclusion in the final judgment of general damages for the misrepresentation of the cash flow, discussed in more detail later in this opinion. Because the Gourleys' damag es exceeded the balance of the note, the court declared the note satisfied and entered the excess as a judgment against the Userys. The court also denied Mary Beth a discharge of her debt to the Gourleys.
The Userys, joined by the trustee of M ary Beth's bankruptcy estate, appealed to the District Court, which affirmed.-6--7- II.
As the second court of appeal in a bankruptcy case, we apply the same standard of review as the District Court, reviewing the Bankruptcy Court's legal conclusions de novo and its finding s of fact for clear error. See First Nat'l Bank v. Pontow , 111 F.3d 604, 609 (8th Cir. 1997); Hold-Trade Int'l, Inc. v. Adams Bank & Trust (In re Quality Processing , Inc.) , 9 F.3d 1360, 1363 (8th Cir. 1993). Reversal is appropriate if th e Bankr uptcy Court misunderstood or misapplied the law. See Nangle v. Lauer (In r e Lauer) , 98 F.3d 378, 383-85 (8th Cir. 1996); Hold-Trade Int'l , 9 F.3d at 1364-66.

III.

The Userys first take issue with the Bankruptcy Court's findings that the y defr audedthe Gourleys. The court found specifically that the Userys made thre e material misrepresentations; as explained above, these misstatements concerned cash flow, accounts payable, and the relationship of t he debts assumed to the businesses the Gourleys purchased.
The parties agree that Missouri lawapplies to this case. A claim of fraud under Missouri law requires the plaintiff to show nine elements:
1) a repr esentation; 2) its falsity; 3) its materiality; 4) the speaker' s knowledge of its falsity, or his ignorance of its truth; 5) the speaker' s intentthat it should be acted on by the person and in the manne r re asonably contemplated; 6) the hearer's ignorance of the falsity of th e repre sentation; 7) the hearer's reliance on the representation being true ; 8) his right to rely thereon; and, 9) the hearer's consequent an d proximately caused injury.

Heberer v. Shell Oil Co. , 744 S.W.2d 441, 443 (Mo. 1988) (en banc ). We are satisfied that the Bankruptcy Court's findings of fact on the issue of liability are not clearlyWe also reject without further discussion the Userys' argument that th e Gourleys 3 waived their fraud claim. -8- erroneous, and we have no quarrel with the court's legal conclusions on this issue

. Because a det ailed discussion will add little to the body of Missouri law on fraud, we affirm as to liability on the basis of the Bankruptcy Court's thorough and well-reasoned opinion. 3

IV.
As to the calculation of damages, however, we believe that the Bankruptc y Court erred in several respects. We consider general damages first, followed by particular items of special damages.

A. In Mi ssouri, a victim of fraud has two options: rescission of the transaction , whichpermits the victim to return any benefits received from and to recover benefits conferred on the perpetrator, or affirmance of the transaction, which permits the victim to recover damages. See Rosenblum v. Jacks or Better of Am. W. Inc. , 745 S.W.2d 754, 764 (Mo. Ct. App. 1988). The Gourleys have chosen the latter option. In such
a case, dam ages are measured by the "benefit of the bargain" rule, which allows th e victim to recover "the differ ence between the actual value of the property and what its value would have been if [the property] had been as represented." Heberer , 74 4 S.W.2d at 443. Courts have articulated this sta ndard in slightly varying language. See Blue v. Rose , 786 F.2d 349, 352 (8th Cir. 1986) (applying Missouri law) ("th e difference between the actual value of the purchased property and its value had it been
as represe nted"); Rosenblum , 745 S.W.2d at 764 ("the difference in value betwee n what [the victim] actually received and what he would hav e received had there been no fraud"). Regardless of the particular wording, however, the purpose of the rule is t o-9-

compens ate the victim for the harm caused by the defendant's fraudulen t representations. See Heberer , 744 S.W.2d at 443-44. Damages a re measured as of the time of the transaction. See Auffenberg v. Hafley , 457 S.W.2d 929 , 937 (Mo. Ct. App. 1970).

The Bankruptcy Court adopted the testimony of the Gourleys' expert as to the actual value of the nursing homes. That expert determined a value for each home by app lying a capitalization rate (16.9% for Ozark, 18.7% for Northside because of th e increa sed risk posed by the consent agreement) to each home's average cash flow for the years 1985, 1986, and 1988. The abnormally large cash flow in 1 987 was excluded as not rep resentative of the performance of the homes. Using this method, the expert determined that the two homes together w ere worth $5,175,000 at the time of the sale. The Bankruptcy Court then subtracted this figure from the purchase price of $8 million and determined that the Gourleys' general damages were $2,825,000.

We perceive two errors in the Bankruptcy Court's calculation. First, the court neglected to account for the apartment complex and the laundry facility, which wer e includedin the $8 million total price but not in the expert's valuation. This omission
resu ltedin an overstatement of damages by perhaps $800,000 (a figure used b y Gourley in his testimony regarding the value of the apartment complex and the laundry facility) . Second, and more fundamentally, the court confused the price the Gourleys actually paid for the Userys' businesses ($8 million) with the value those businesse s would have had if the Userys' representations h ad been true (an amount that we cannot determine definitively on appeal, but that is probably less than $8 million). Becaus e a purchaser may pay more or less for a business than the business is actuall y worth (and more or less than the business would be worth if the se ller's fraudulent statements were true), the sale price is not necessarily equivalent to the value of the business "had i t been as represented." Blue , 786 F.2d at 352. The Gourleys u ndoubtedly paid more for the nursing homes than the homes were worth, but the record and the testimony of the Gourleys' own expert suggest that they did so for two reasons: the Userys'-10-

misrepresentations and the G ourleys' bad judgment. The purpose of a fraud lawsuit is to compensate the victim for the effects of the defendant's misrepresentations, not t o
save the victim from his or her own unwarranted optimism about the viability of a business

. If, for example, the Gourleys had agreed to pay $18 million for th e businesses because they believed that they could make phenomenal profits, they would hav e lost $10 million more than they actually did, but they would not be entitled t o collect an additional $10 million from the Userys. The extra $10 million would have been a product of the Gourleys' folly, not a consequence of the Userys' fraud.
Principles of causation and damages are equally relevant in this situation. Any harmresulting from expectations that are overly optimistic even in light of th e de fendant's fraudulent statements is not a "natural and probable consequence" of th e defendant's fraud. Heberer , 744 S.W.2d at 444. Similarly, the goal of the benefit-ofthe-bargain rule is to restore the plaintiff to the position in which he or she would have been in the abs ence of fraud. If the bargain would have been unprofitable even in the abse nce of fraud, the plaintiff must accept the bad bargain or else sue for rescissio n inst ead of damages. For these reasons, the benefit-of-the-bargain rule focuses on the value of the property as represented and its actual value, and the courts generall y di sregardthe contract price. See DeBow v. Higgins , 425 S.W.2d 135, 142-43 (Mo

. 1968) (accepting expert's valuation of property as represented as $32,600--less tha n purchase price--but remanding fo r new trial because of uncertainty as to actual value); Klecker v. Sutton , 523 S.W.2d 558, 564 (Mo. Ct. App. 1975) (reco gnizing that nothing in record supported plaintiff's theory that sale pr ice was equivalent to value of property as represented).
On occasion, Missouri courts will use the co ntract price as a proxy for the value of the property as represented, at least where no other evidence of value is presented. See , e.g. , Sm ith v. Tracy , 372 S.W.2d 925, 939 (Mo. 1963). This method o f cal culationis inappropriate in the instant case, however, because the $8 million an d $5,175,000 figures reflect different assumptio ns. In valuing a business, it is customaryWe rej ect as frivolous the Userys' argument that the contract represented only 4 a sale of assets and not a sale of ongoing businesses. Regardless of the caption of the agreement, it is clear from the content that the Gourleys were purchas ing the businesses as going concerns. See Chambers v. McN air , 692 S.W.2d 320, 323-24 (Mo. Ct. App. 1985) (int erpreting contract for sale of inventory and fixtures as contract for sale o f business).
-11- to extrapolate from income figures to a valuation figure by using a capitalization rate reflecting the risk inherent in the market and the business. As we have noted, th e 4 Gourleys' expert did just this to calculate the actual value of the nursing homes; hi s capitalization rates were 16.9% and 18.7%. But if we exa mine the $8 million purchase price in l ight of the cash flow figures as the Gourleys believed them to be (i.e., th e fr audulent

figures), the purchase price reflects an effective capitalization rate o f approximately 12% for the whole package. A factfinder cannot compare figure s derived from different capitali zation rates (and therefore different risk assumptions) to determine the damages attributab le to fraud, because part of the difference will be due to the change in risk perception and not due to the fraud at all.

On r emand, the Bankruptcy Court must determine the difference between th e actual value of the nursing homes a nd the value of the homes as represented, using the
same capitalization rate for each part of the equation. In other words, the court must use the same process to calculate both valuation figures, changing only the cash-flow numb ers. Because valuation is a subjective art, we are unable to make a specifi c finding as to damages on appeal, but we note that each of the illustrative calculations
we h ave undertaken, including the example presented in the Userys' reply brief, ha s yielded benefit-of-the-bargain damages of less than $600,000.-12- B.
The Bankruptcy Court also awarded damages flowing directly from the Userys' other misrepresentations, those concerning accounts payable and the source of th e debts assumed by the Gourleys.
The court calculated that accounts payable tot aled $538,417.19, not $75,000, as the Usery s had represented. The Userys have given us no reason to question th e District Court's calculation. The court properly awarded the Gourleys the difference between the actual accounts payable and the Medicare receivables (which wer e $236,68 1.79), for net damages of $301,735.40. Contrary to the Userys' arguments , they are not entitled to a credit of $75,00 0 against this figure. It is true that the Userys disclosed that the homes were carrying $75,0 00 in payables, and so this amount is not, strictly speaking, damages caused by fraud. Nevertheless, the Userys agreed to net out the rece ivables and payables after the sale, and they never did so. If the Userys wish the court to enforce their contractual right to the benefit of the Medicare receivables, they must permit the Gourleys to recover the amount to which they are contractually entitled. The Bankruptcy Court's award of the net payables to the Gourleys was no t clearly erroneous.

We are less comfortable with the court's award of damages in the amount of the non-business-re lated debts assumed by the Gourleys. With regard to the $110,000 in loans taken out by Steven Usery for personal reasons, we note that these loans wer e disclosedclearly in the purchase agreement as debts to be assumed by the Gourleys. The Gourl eys therefore received a credit of $110,000 against their note to the Userys in exchange for assuming these loans. If the Gourleys had known that these loans were not bus iness-related, we have no doubt that they would not have assumed the loans

. In tha t case, however, the Gourleys would have owed the Userys an additiona l $110,000 on the purchase-m oney note, because they had already agreed to pay a total of $8 million for the businesses. The Gourleys' damages thus were not $110,000,-13-

because the Gourleys would have owed someone $110,000 in any event. Rather, their damage s must be measured by the difference between the cost of paying the ban k $110,000 ac cording to the terms of the loans and the cost of paying the Usery s $110,0 00 over the twenty-year term of the purchase-money note. Accordingly, th e Bankruptcy Court's award of $110,000 in damages was clearly erroneous.

We are unsure how to handle the $18,000 debt owed to Breeding that th e Gourleys unwittingly assumed, b ecause we are unable to uncover any evidence of this debt in the record, and the parties have done nothing to assist us in doing so. The debt is n ot apparent among those specifically assumed by the Gourleys in the sal e agreement , and if it is among the accounts payable, the Gourleys have receive d d amages for it already. If, as the Bankruptcy Court's memorandum opinion seems to suggest, the Breeding debt surfaced after the sale and the Gourleys felt compelled to acknowledge the debt because they required Breeding's accounting services, it is not at all c lear that the Gourleys' recourse is properly against the Userys. Without an y assistance fro m the parties, we are unable to reach a more definite conclusion, and so we leave this issue for the court's further consideration on remand.

C.
Finally, w e consider the Bankruptcy Court's award of special damages. Under Missouri law, "[a] defrauded party may recover special damages necessarily incurred solely by reason of the fraud." Miller v. Higgins , 452 S.W.2d 121, 125 (Mo. 1970). Special damages (in contract terms, incidental and consequential damag es) are awarded in addition tobenefit-of-the-bargain damages. See Blue , 786 F.2d at 352; Chambers , 692 S.W.2d at 325.
Most of the $2.3 million in consequential damages awarded by the court related to add itional funds that the Gourleys had to plow into the businesses to keep the m viable. The Gourleys set up each of the businesses in corporate form, and theThe Gourl eys' attempt to support the award of special damages by means o f 5 alternative ca

lculations is nearly incomprehensible and is based on numerous exhibits that the Gourleys have not included in the appellate record. We therefore find th e argument particularly unpersuasive, and we leave t his double-counting argument as yet another issue for plenary consideration on remand.
-14- corporations took out hundreds of thousands of dollars in loans, secured by personal guarant ies from the Gourleys. The Gourleys, as shareholders, also loaned significant amount s to the corporations. The Bankruptcy Court's award of special damage s included f

our components: the principal amounts of the bank loans and shareholde r loans (about $1.8 million), interest paid on the bank loans (about $430,000), interest foreg one on the shareholder loans (about $12,000), and the money the Gourleys paid to Mary Beth that never was credited against the note ($23,000).

As the Userys argue, the causation issue we have discussed previously with respe ctto the benefit-of-the-bargain damages also affects consequential damages

. Spec ial damages are recoverable only if they are "incurred solely by reason of th e fraud." Miller , 452 S. W.2d at 125. As with general damages, it appears that some of the Gourleys' need for additional ca pital was caused by the Userys' misrepresentations and some was caused by the Gourleys' overly optimistic p rojections of what they could do with the nursing homes. We have no basis for resolving this difficulty on appeal, and so this issue also must be considered on remand.
The Userys argue further that some of the lo ans included in the award of special damages are double-counted because these loans in reality were obtained only t o refinance the loans the Gourleys assumed as part of the purchase or to pay off othe r loans that also have been counted as special damages. The Userys may well be correct, tho ugh the record on appeal leaves us somewhat less than certain. We are mor e 5 concerned, ho wever, with another form of double-counting that surfaces occasionally among the Userys' arguments: the special damages appear to cover much of the same ground as the benefit-of-the-bargain damages for the cash -flow misrepresentation. TheWe take care to point out that the Userys' misrepresentation regarding accounts 6 payable may be a proper subject of special damages. It is clear fro m the record that the larg e total of undisclosed overdue payables hampered the Gourleys' operation of th e homes significantly by draining the h omes of cash necessary for operations. Any such losses proved by the Gourleys on remand would be recoverable as special damages. -15- Gourleys' t heory of special damages was that they had to invest large amounts o f money in order to make the businesses profitable, as the Userys represented they were. The purpose of the benefit-of-the -bargain damages, however, is also to ensure that the Go urleys get businesses that are as valuable as the Userys stated they were. Th e Gou rleys cannot recover for what is essentially the same loss under two differen t theories; general damages and special damages must represent distinct injuries. See , e.g. , Blue , 786 F.2d a

t 352 (allowing difference between represented value and actual value of cattle as general damages, and costs related to purchasing and caring for cattle until re sale as special damages); Miller , 452 S.W.2d at 124-25 (allowing differenc e between represented value and actual value of stock as general damages, an d prepayment

penalties, attorney fees, and refinancing expenses as special damages) ; Hanes v . Twin Gable Farm, Inc. , 714 S.W.2d 667, 668-72 (Mo. Ct. App. 1986 ) (allo wing difference between represented value and actual value of bull as genera l da mages, and loss resulting from bull's failure to beget calves as consequentia l damages). On remand, the Bankruptcy Court should give due regard to limiting th e Gourleys to only a single recovery for the cash-flow misrepresentation. 6

We n eed not consider the Userys' claim that the Gourleys may not recove r special damages that arose af ter the Gourleys discovered the fraud. It is not clear that Missouri bars the

recovery of special damages arising after the victim discovers he or she has been defrauded, the only support for such a rule coming in unexplaine d comments o f the Missouri Court of Appeals some years ago. See Salmon v

. Brookshire , 301 S.W.2d 48, 56 (Mo. Ct. App. 1957) ( opinion on motion for rehearing) ("This record does not contain any evidence of special damages, not speculative i n nature, that occurred prior to plaintiff's discov ery of the alleged fraud and which wouldThe Userys' citation of Clements as though it were a case applyin g Missouri law 7 is not well taken. -16- be the proper basis of an instruction . . . ."); Blackmore v. Sisson , 139 S.W.2d 1084, 1096 (Mo . Ct. App. 1940) ("In fraud cases computation of damages is as a rule fixed
as of the d ate fraud is discovered."). Even in states where it is settled that the la w prohibits recovery of consequential damages arising after the fraud is discovered, the theory is that a party to an executory contrac t who discovers fraud may not go forward and compou nd the damages, but instead must terminate the relationship and sue fo r damages at that point. See Clements Auto Co. v. Ser vice Bureau Corp. , 444 F.2d 169, 184 (8th Cir. 1971) (applying Minnesota law). Where termination would b e 7 "economicall y unreasonable," the victim may be able to recover further damages. Id. It is enough for present purposes that we recognize that it is not clear from the record whether the Gourleys would have been able to rescind the agreement fully once they discove red the fraud, because the Gourleys had assumed the Userys' loans and ha d undertaken other commitments to other lenders a nd the state. In any event, it may turn out that when the Bankruptcy Court recalculates special da mages, none of the damages properly recoverable will be damages arising after the fraud was discovered, and the issue will be moot . If the issue remains live on remand, the Bankruptcy Court will be in the best position to apply Missouri law to the facts.

V.
Because of several errors in the calculation of damages, a ne w trial limited to the issue of damages is required. The judgment of the District Court is affirmed as t o liability and reversed as to damages, and the case is remanded with instructions t o remand to the Bankruptcy Court for further proceedings in accordance with thi s opinion.-17-

A true copy.

Attest:
CLERK, U.S. COURT OF APPEALS, EIGHTH CIRCUIT.