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Success in Prosecuting a Bankruptcy Non-Dischargeability Proceeding




by:
David J. Cook
Cook Collection Attorneys, PLC - San Francisco Office

 
May 9, 2014

Previously published by Metropolitan News-Enterprise

Why Does The Defendant Default?
 
Facing civil litigation, the defendant defaults because the defendant intends to file bankruptcy and escape the costs of any defense. The defendant reasons why waste money on attorney’s fees when the claim will be discharged in bankruptcy court?

Expect no less. Even the trial counsel relishes bankruptcy that mitigates expense and effort of the default process. Ever so helpful, the defendant advises trial counsel of the bankruptcy case number.

Occasionally, the defendant procrastinates, thereby permitting the plaintiff to cycle the case through to a default judgment.
 
Is This Good Or Bad?
 
What value does this “paper judgment” retain when the defendant files bankruptcy? Does bankruptcy imbue the default judgment with intrinsic value, or render the paper judgment worthless?

Let’s see.
 
What If the Claim Can Support The Non-dischargeability Of The Debt?
 
Bankruptcy Code § 523(a) enables a creditor to file suit in bankruptcy court and exempt the debt from the discharge. This note highlights the relief available under § 523(a)(2) [fraud], § 523(a)(4) [breach of fiduciary duty], and § 523(a)(6) [willful and malicious].i

Non-dischargeability litigation is costly because these claims are fact-specific and the court requires that the plaintiff proves the element of the case. Bankruptcy courts follow the Federal Rules of Civil Procedure, including Rule 26(a) that mandates extensive disclosures.

These cases are not necessarily impossible, improbable or even difficult to prosecute—but they do require counsel to prove up each element of the claim for relief. Juries render verdicts on inferences, while bankruptcy judges make findings from the stone cold record.

The standard of proof is a preponderance of the evidence.

To mitigate the burden of non dischargeability case, trial counsel can invoke collateral estoppel arising from the state court litigation in proving up the elements of non-dischargeability. See Grogan v. Garner [1991] 498 U.S. 279; Marrese v. American Acad. Of Orth. Surgeons (1985) 470 U.S. 373, 380; also 28 U.S.C. § 1738.

The starting point, of course, is that counsel needs to recycle this task back to the state court complaint, the default process, the hearing on the default judgment, and to the form of default judgment itself.

In litigating the state court case, counsel should necessarily incorporate Bankr.C. § 523(a) in the state court process save, of course, the caption, but not much more else. Collateral estoppel applies if threshold requirements are met. See Harmon vs. Kobrin (In Re Harmon)(9th Cir. 2001) 250 F.3d 1240, 1245. Counsel should literally draft, file and prosecute state court litigation as if the matter was heard by a bankruptcy judge, save and except for the final closing of non-dischargeability.

For example, Bankr. C. § 523(a)(2) renders a common law fraud non-dischargeable. Bankr.C. § 523(a)(4) renders a debt non-dischargeable for funds embezzled by a state law fiduciary. Bankr.C. § 523(a)(6) renders non-dischargeable an intentional tort lacking any justifiable excuse or cause. “Willful and malicious” are treated separately and not lumped together. See Barboza v. New Form, Inc. (In Re Barboza)(9th Cir. 2008) 545 F.3d 702, 706.

Here is a roadmap in litigating these potential non-dischargable claims in state court:

1. Plead each state law cause of action separately, discretely and accurately, incorporate key documents and provide a fact specific history. Name the names, date the dates, frame the facts, repeat the representations and detail the damages. The pleading style: Blow-by-blow. Eschew daisy chain pleadings. Eschew notice pleadings. Swap out inference, and swap in facts. Employ the Dragnet school of pleadings: “Just the facts, ma’am.” Leave nothing to the imagination. Call this “detail-driven pleading.”

2. The prayer for relief in the complaint should segregate compensatory and punitive damages for each separate and distinct cause of action, as opposed to a single-dollar aggregate summary prayer. The damage calculus must dovetail the individual claims and provide a clear common sense connection. The amounts must be both reasonable and based on findings in the record, otherwise counsel discovers that pigs are fed and hogs become artisan bacon.

3. The prove-up hearing serves as more than a “walk-through.” Counsel should try each independent cause of action and seek specific, detailed findings of fact on the record for each individual claim. Most default hearings are summary in nature and judges will typically render the default judgment without any great detail. Not so good here. The court should recite separate and discrete relief and findings on the record that replicate the fact-driven causes of action. Be prepared to actually “try” the case even though there is a default judgment. Don’t be shy: Counsel should tell the court why this level of detail is required and why a specific finding is necessary.

4. The form of judgment must segregate each cause of action and the damages attributable to each cause of action. This is an absolute necessity. Even better, incorporate findings of fact into the judgment (or have separate findings) that replicate Bankr.C. § 523(a). The judgment should incorporate findings, relief and damages mirroring the complaint.
 
Why Does This Help You?
 
The bankruptcy court will, and will be required to, invoke collateral estoppel incorporating the state court findings in the ensuing non-dischargeability action. If the state court litigation replicates relief under Bankr.C. § 523(a), et seq., counsel can convert an otherwise uncollectible default judgment into a non-dischargeable debt that survives the bankruptcy discharge.

Most tort claims hover around Section 523(a)(6) relief [willful and malicious]. Section 523(a)(6) requires a specific textual finding that “willful injury requirement is only met when the debtor has a subjective motive to inflict injury or when the debtor believes that injury is substantially certain to result from his [or her] own conduct,” (see Ormsby vs. First Am. Title Co. of Nevada [In re Ormsby] [9th Cir. 2010] 591 F.3d 1199, 1206), and might be inferred from the record (Ormsby at 1207). Malice is a separately proven. “[A] malicious injury involves (1) a wrongful act, (2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or excuse. Ormsby at 1207.

The default judgment blossoms in value by mitigating the burden and costs of litigation. Settlement beckons on the bankruptcy steps when the non-dischargeability complaint knocks on the door. The default judgment must incorporate enormous precision to crack open the bankruptcy door to this accessible relief. “Whether the issue of intent was litigated and resolved in the state court action, as required for application of collateral estoppel, is a question of law.” See E.B. Harper & Co v. Nortek, Inc. (7th Cir. 1997) 104 F.3d 913, 922.

This world is certainly not pre-ordained, nor pre-destined, and collateral estoppel is subject to vicissitudes of judicial discretion. See Parklane Hosiery v. Shore (1979) 439 U.S. 322, 331. The fall-back position is the motion for summary adjudication under Fed R. Civ. P. 56(g). See In re Scott R. Smith [B.A.P., 9th Cir. 2009] 2009 WL 6058677—on appeal to the 9th Circuit (only remaining issue is state of mind from a fully tried district court case). Even a summary adjudication is a victory relieving the plaintiff from a financial burden if forced to recycle the entire case in non-dischargeability litigation as opposed to a single issue (usually state of mind).

The Punchline
 
The U.S. Supreme Court labels the bankruptcy discharge as a “fresh start.” The state court proceeding, replicating Bankr.C. § 523(a) relief, is a better start. Collateral estoppel renders relief under Bankr. C. § 523(a) the head start, and the successful summary judgment in bankruptcy court is start to finish.
 
i A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt—

¿..

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;

(B) use of a statement in writing—

(i) that is materially false;

(ii) respecting the debtor’s or an insider’s financial condition;

(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive; or . . . .

(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny; . . ..

..

(6) for willful and malicious injury by the debtor to another entity or to the property of another entity

 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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Author
 
David J. Cook
Practice Area
 
Bankruptcy
 
Cook Collection Attorneys, PLC Overview