A judgment does not of itself make a debt not dischargeable (unable to be legally written off) in bankruptcy. But under some circumstances a judgment can make discharging the debt more difficult or even impossible.
WHAT DEBTS CAN’T BE DISCHARGED (LEGALLY WRITTEN OFF) IN BANKRUPTCY?
Although most debts do get discharged in bankruptcy, those that do not fall into two categories. (See my earlier blog post, Two Types of Debts You May Still Owe After Bankruptcy.)
The first category includes debts that aren’t discharged simply because of the kind of debt they are. The creditor doesn’t need to object to the discharge of the debt. Examples include all child and spousal support, income taxes that meet certain timing conditions, and criminal fines and restitution.
The second category of potentially non-dischargeable debts includes those that the creditor must object to. The creditor must timely object to these kinds of debts or else they will get discharged. This category requires allegations of certain kinds of bad behavior by the debtor involving the debt. Examples include debts created through alleged fraud or misrepresentation (such as bounced checks), fraud while in a fiduciary relationship (such as financial elder abuse), or “willful and malicious injury” to a person or property (such as physically hurting somebody in a fight).
Today’s blog post is about judgments arising from this second category of debts, involving alleged fraudulent or other bad behavior by the debtor.
HOW DOES A CREDITOR ESTABLISH THAT A DEBT OF THIS SORT SHOULD NOT BE DISCHARGED IN BANKRUPTCY?
A creditor must prove all of the allegations required to establish the specific behavior that makes the debt not dischargeable. For example, to show that a debt was incurred fraudulently under Section 523(a)(2) of the Bankruptcy Code a creditor would have to prove:
(1) that the debtor made a representation; (2) the debtor knew at the time the representation was false; (3) the debtor made the representation with the intention and purpose of deceiving the creditor; (4) the creditor relied on the representation; and (5) the creditor sustained damage as the proximate result of the representation.
Apte v. Japra (In re Apte), 93 F.3d 1319, 1322 (9th Cir. 1996).
The creditor could try to prove each of these elements at trial in the bankruptcy court. But its job could be made much easier if those elements were previously proved in a state court lawsuit with a resulting judgment against the debtor.
SO ONCE A STATE COURT JUDGMENT IS ENTERED AGAINST ME DOES THAT MEAN THE DEBT CAN’T BE DISCHARGED IN BANKRUPTCY?
That’s sometimes true. But often it’s not.
As I said at the beginning, the mere fact that a debt has been turned into a judgment does NOT necessarily make that debt not dischargeable. If the underlying debt can be discharged before the entry of the judgment then it can be discharged after the judgment.
The bankruptcy discharge effectively wipes out both the debt and the judgment. First, the discharge “operates as an injunction against [essentially any action] to collect, recover, or offset any [discharged] debt as a personal liability of the debtor . . . .” (Section 524(a)(2) of the U.S. Bankruptcy Code.) And second, the discharge “voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor. (Section 524(a)(1) of the Bankruptcy Code.) The debt and the judgment are both legally gone.
BUT DOESN’T A JUDGMENT CREATE A LIEN ON YOUR HOME AND PERSONAL PROPERTY?
A judgment CAN subsequently turn into a lien on your real estate and maybe on other property you own. (See this earlier blog post about the steps a creditor can take to do this.) Once the creditor records a lien against your home or other property you may be able to get rid of the lien. (See my blog post, Avoiding A Judgment Lien in Bankruptcy.) A judgment which has turned into a judgment lien attached to your property adds a separate set of challenges not addressed in today’s blog post.
WHAT IF THE JUDGMENT DEBT IS BASED ON ALLEGATIONS OF THE KINDS OF BAD BEHAVIOR THAT COULD MAKE THE DEBT NOT DISCHARGEABLE?
First, the creditor has to object to the discharge of the debt or else the debt will still be discharged and the judgment voided (under Section 524 of the Bankruptcy Code as detailed above). Assuming the creditor gets appropriate notice of your bankruptcy case, it must formally make this objection within a short timeframe. Talk with your bankruptcy lawyer about how to ensure appropriate notice and what the creditor’s deadline would be in your case.
Second, assuming the creditor does object to the discharge of its debt on time, the really big consideration is the wording of the judgment.
Does the judgment’s language simply say that you owe a certain amount of money on the debt That is, the judgment may be worded like most straightforward collection judgments.
Or instead does the judgment include specific language about the misrepresentation(s), fraud, or “willful and malicious injury” of the debtor that resulted in the debt and the judgment?
WHY IS THE LANGUAGE OF THE JUDGMENT SO IMPORTANT?
The precise language of the state court judgment can be crucial because the bankruptcy court may be bound by that language. So if the judgment states merely that the debtor owes the creditor money, the judgment itself does not make that debt any more difficult to discharge. However, if the state court judgment specifically states that it is based on findings of facts citing fraudulent or other bad behavior, the bankruptcy court can be bound by the prior court’s determination of that behavior.
WHY SHOULD ONE COURT BE BOUND BY AN ENTIRELY DIFFERENT COURT JUDGMENT’S LANGUAGE?
Basically, courts respect each other’s decisions. If one court fully and clearly determines a matter, another court will generally accept that determination as final as long as a number of conditions are met. This long-standing principle is called res judicata, or collateral estoppel. (There are distinctions between these terms but those are beyond the scope of today’s blog post.)
Reasons for this long-standing principle in the law are that it:
- “protects litigants from harassment through the [repeated] litigation of the same claim or issue”
- “avoid[s] inconsistent judgments; having the same issue decided in different ways can only undermine the general public’s esteem for the legal system”
- “sav [es] the courts’ time by avoiding repetition of litigation”
- Allan D. Vestal, Res Judicata/Preclusion by Judgment: the Law Applied in Federal Courts, 66 Mich. L. Rev. 1723, 1723 (1967-1968).
- The law does not want to waste the resources of either the litigating parties or the courts by allowing a matter that has been resolved in one court to be re-litigated in another.
BUT WHY WOULD A FEDERAL BANKRUPTCY COURT BE BOUND BY A STATE COURT JUDGMENT?
- Federal courts are in certain respects superior to state courts. However, federal bankruptcy courts generally accept state court judgments because of the U.S. Constitution’s “full faith and credit” clause (Article IV, Section 1), and the federal statute (28 U.S.C. § 1738) that applies this clause. As the U.S. Supreme Court has stated:
- The preclusive effect of a state court judgment in a subsequent federal lawsuit generally is determined by the full faith and credit statute, which provides that state judicial proceedings “shall have the same full faith and credit in every court within the United States . . . .”
- Marrese v. Am. Acad. of Orthopaedic Surgeons, 470 U.S. 373, 380, 105 S.Ct. 1327, 84 L.Ed.2d 274 (1985). The phrase “in every court within the United States” includes federal courts, which includes bankruptcy courts.
- WHO DECIDES THE CONDITIONS UNDER WHICH A STATE COURT JUDGMENT WOULD BE BINDING ON A BANKRUPTCY COURT?
- There are situations in which federal law is supreme over state law. However in this arena each state has the right to determine the rules about when a judgment from one court is binding on another court. The sentence from the U.S. Supreme Court case cited above finishes as follows:
- The preclusive effect of a state court judgment . . . is determined by the full faith and credit statute, which provides that state judicial proceedings “shall have the same full faith and credit in every court within the United States . . . as they have by law or usage in the courts of such State . . . from which they are taken.”
Id. (italics added). So California law generally determines the circumstances under which a state court judgment is accepted by the bankruptcy court.
UNDER WHAT CONDITIONS WOULD A CALIFORNIA STATE COURT JUDGMENT BE BINDING ON A BANKRUPTCY COURT?
The Supreme Court of California gets the final say about the requirement of this principle:
First, the issue sought to be precluded from relitigation must be identical to that decided in a former proceeding. Second, this issue must have been actually litigated in the former proceeding. Third, it must have been necessarily decided in the former proceeding. Fourth, the decision in the former proceeding must be final and on the merits. Finally, the party against whom preclusion is sought must be the same as, or in privity with, the party to the former proceeding.
Lucido v. Superior Court, 51 Cal.3d 335, 272 Cal.Rptr. 767, 795 P.2d 1223, 1225 (1990).
So, a prior state court judgment helps the creditor establish in bankruptcy court that a debt is not dischargeable only if the judgment meets these five requirements as to each element that the creditor must prove.
To make better sense of this, let’s look back at the example of a debt allegedly not dischargeable because the debtor incurred the debt through fraud (Section 523(a)(2) of the Bankruptcy Code). One of the elements that the creditor must prove is that “the debtor made the [false] representation with the intention and purpose of deceiving the creditor.” Was this the identical issue “actually litigated” and “necessarily decided” in the state court to the point of a final decision rendered against the same debtor? If this “intent to deceive” element of fraud was “actually litigated” and “necessarily decided” in the state court in a final decision against the debtor, then bankruptcy court is generally bound by the state court’s determination about this element of fraud.
GENERALLY BOUND? ARE THERE STILL CIRCUMSTANCES IN WHICH THE BANKRUPTCY COURT DOES NOT NEED TO FOLLOW THE STATE COURT JUDGMENT?
Both federal and California courts have recognized that this principle of res judicata/collateral estoppel should be applied with flexibility and discretion. The U.S. Supreme Court itself has said that trial courts (such as bankruptcy courts) should use “broad discretion to determine when it should be applied.” Parklane Hosiery Co. v. Shore, 439 U.S. 322,331, 99 S.Ct. 645, 58 L.Ed.2d 552 (1979). Furthermore, “[a]ny reasonable doubt as to what was decided by a prior judgment should be resolved against giving it collateral estoppel effect.” Berr v. Fed. Deposit Ins. Corp. (In re Berr), 172 B.R. 299, 306 (9th Cir. BAP 1994). The California Supreme Court has said: “We have repeatedly looked to the public policies underlying the doctrine before concluding that collateral estoppel should be applied in a particular setting.” Lucido v. Super. Ct., 51 Cal.3d 335, 272 Cal.Rptr. 767, 795 P.2d 1223, 1225 (1990).
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