Will My State Court Judgment Survive Bankruptcy?
If you’re a Plaintiff in a civil matter, the ability to collect your judgment is probably the most important factor in deciding whether to invest in the litigation. There are steps that you can take to ensure that your stipulated judgments have a higher probability of surviving a bankruptcy by the Defendants.
11 U.S. Code § 523 outlines specific exemptions to bankruptcy dischargeability. In particular, § 523(a)(2)(A) precludes a debtor from discharging debts which are obtained by “false pretenses, a false representation or actual fraud.” § 523(a)(4) precludes dischargeability for “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” § 523(a)(6) precludes debts for willful and malicious injury by the debtor to another entity or to the property of another entity.” However, in order for debt described in § 523(a)(2), (4), and (6) to be precluded from a discharge, a creditor must first obtain a judgment from a bankruptcy court stating that the debt is nondischargeable.
In order to obtain this nondischargeability judgment, the creditor must first commence an adversary proceeding against the debtor in bankruptcy court. In practical terms, adversary proceedings function much like bankruptcy trials and often involve legal issues that have been previously litigated by the parties. Much like state court trials, adversary proceedings in bankruptcy court are often time-consuming and costly. In order to mitigate these factors, judgment creditors can take steps to apply collateral estoppel to avoid the pitfall of re-litigating matters already decided in prior legal proceedings.
In Grogan v. Garner, the United States Supreme Court stated that collateral estoppel applies in bankruptcy court dischargeability actions. [ref]Grogan v. Garner, 498 U.S. 279 (1991)[/ref] There are four general elements that must be satisfied to apply collateral estoppel: (1) the causes of action are the same; (2) the issue was actually litigated in the prior action; (3) the resolution of the issue was necessary to the prior judgment; and (4) the litigants are the same parties. Under Grogan, it would seem that if all of these elements are met, the bankruptcy court will apply collateral estoppel. However, in practice, it is not always this simple. Different bankruptcy courts have competing views as to when collateral estoppel applies in nodischargeability proceedings.
In particular, the second element above – whether the issue was actually litigated in the prior action, has caused bankruptcy courts to develop distinct approaches to applying collateral estoppel in § 523(a) adversary proceedings. Consent and default judgments form a particular point of divergence for bankruptcy courts in this regard. A consent judgment is essentially a judgment based on an agreement between the parties in a law suit to settle the matter, aimed at ending the litigation with a judgment that is enforceable. Different courts have distinct views as to whether consent and default judgments constitute “actual litigation”, and therefore, whether collateral estoppel may be applied. The differing approaches among various courts fall into three general categories.
The first approach holds that no preclusive effect is given to a consent or default judgment. Courts adhering to this view premise their approach on the fact that federal courts have exclusive jurisdiction to determine the dischargeability of claims arising under § 523(a)(2). Courts following this approach maintain that while a state court may determine the facts surrounding the existence of a debt, attempts to bind the bankruptcy court to that determination are void for lack of subject matter jurisdiction. Of the three general approaches, this is the narrowest view and the most uncommon viewpoint.
The second approach holds that preclusive effect may be given to a consent judgment if the parties intended for the judgment to be binding. Under this approach, a standard consent judgment by itself will not satisfy the requisite elements needed to establish collateral estoppel. In many cases, the element requiring final adjudication of factual issues will not be met without a more detailed consent judgment. However, courts adhering to this approach are more likely to apply collateral estoppel if the parties expressly state in the consent judgment that they intend to be bound by certain facts. Courts following this approach are more likely to bar re-litigating facts expressly outlined in the consent judgment.
The third approach gives preclusive effect to both consent and default judgments where the state court has made specific, factual findings on the identical dischargeability issue in question, regardless of whether the parties’ intended to be bound by the consent judgment. [ref]Dennis v. Dennis (In re Dennis), 25 F.3d 274, 278 (5th Cir. 1994)[/ref] Under this approach, courts apply collateral estoppel only as to “those elements of the claim that are identical to the elements required for discharge.” [ref]Grogan v. Garner, supra, 498 U.S. 279, 284 (1991)[/ref]
Courts following this approach may even apply collateral estoppel to state court default judgments if the state where the judgment was rendered gives preclusive effect to a default judgment. Although it is still an often contested matter, California gives preclusive effect to default judgment under In re Nourbakhsh, 67 F.3d 798 (9th Cir. 1995). Provided the elements of collateral estoppel are satisfied, courts following this approach give consent and default judgment preclusive effect in dischargeability proceedings under § 523(a).
Practical Points:
Attorneys can take steps when obtaining state court judgments, especially consent or default judgments, to allow their client an easier path to a nondischargeability determination in bankruptcy court. First, determine whether the judgment debtor is a likely bankruptcy candidate. If so, attorneys should get familiar with the bankruptcy rulings in the jurisdiction where a judgment debtor receives their judgment. In California, the Bankruptcy Court will look to state law where the action was filed to determine whether or not a default or consent judgment will have a collateral estoppel effect in the California Bankruptcy Court. Attorneys can look to the records and consult with other bankruptcy specialists familiar with that jurisdiction to determine the approach a particular judge is likely to take.
If the underlying state matter is in California, then a default judgment or consent judgment can have a collateral estoppel effect. If there is going to be a default judgment or a judgment after trial, request that the final order outline the elements of nondischargeability in the final order after the prove up or trial. If there are multiple causes of action, then it is particularly important that the order specify the damages for non-dischargeable cause of action
Also, when drafting a judgment order, attorneys should put in language as specific as possible outlining the facts which will allow the bankruptcy court to apply collateral estoppel. A little extra time and effort when obtaining a state court judgment can prove highly valuable if you suspect that a judgment debtor will likely attempt to discharge the judgment debt through bankruptcy.
Finally, with respect to stipulated judgments, attorneys need to be careful in drafting appropriate stipulations and judgments. It is important that the stipulation and judgment not only outline the cause of action believed to gives rise to nondischargeability and associated damages, they should also outline the activities that give rise to the nondischargeable judgment. For example, if you sue for breach of contract and fraud, it is not enough to say that the parties stipulate to judgment for fraud and accept damages of $100,000. The parties must stipulate to acts that were committed with the requisite intent, reliance, causality and damages and the stipulated facts must be included in the fraud judgment. Judge Margaret Mann published a decision outlining the Southern District’s reasoning on stipulated judgments. You can find her decision here.
If you have any questions about how your judgment, or one against you, stacks up against a bankruptcy discharge, give us a call. We would be happy to answer your questions.
