Bowers v. Connecticut Nat. Bank, Civ. No. H-87-163(AHN).

• Decision Date: 29 September 1987
• Docket Number: Civ. No. H-87-163(AHN).
• Citation: 78 BR 388
• Parties: Florence BOWERS v. CONNECTICUT NATIONAL BANK.
• Court: U.S. District Court — District of Minnesota

78 B.R. 388 (1987)

Florence BOWERS v. CONNECTICUT NATIONAL BANK.

Civ. No. H-87-163(AHN).

United States District Court, D. Connecticut.

September 29, 1987.

Richard Liebert, Hunt & Liebert, Hartford, Conn., for appellant.

Thomas Boscarino, Berman, Sable & Boatman, Hartford, Conn., for appellee.

RULING ON BANKRUPTCY COURT APPEAL

NEVAS, District Judge.

This case presents the question whether a federal bankruptcy court was in error in according preclusive effect to a state appellate court's finding on the validity of a promissory note. The issue has been extensively briefed and orally argued by the parties. For the following reasons, the judgment of the bankruptcy court 69 B.R. 822, is reversed and the case remanded to that court for further determinations consistent with this ruling.

Background

On November 1, 1978, Florence Bowers executed an unsecured promissory note for $50,000 in favor of the Hartford National Bank, the predecessor to the Connecticut National Bank ("CNB"). On April 23, 1980, Bowers executed a renewal demand note for $40,000, the balance due on the original note, again in favor of CNB. The replacement note was secured by a mortgage on Bowers's home. During negotiations prior to the execution of the 1980 note, CNB agreed to implement an installment payment schedule; the bank also agreed not to call the note if Bowers stayed current on these periodic payments. About eight days after the renewal note was executed, CNB made demand for full payment. Bowers was not able to meet this demand and, on September 8, 1980, CNB sued in state court to foreclose the mortgage.

I. Connecticut Superior Court Proceedings

In addition to the $40,000 principal, CNB sought interest, attorneys' fees, and costs. The bank alleged that the mortgage in question was third in line behind two other mortgages on the same property. In her substituted counterclaim Bowers alleged that CNB fraudulently induced her to execute the third mortgage and breached its oral promise not to call the note if installments were timely paid. She sought restitution of the mortgage or cancellation of the instrument and damages.

After a two-day court trial in February 1983, before Judge Julius Kremski of the superior court in Hartford, the court held that "the parties entered into a valid agreement to modify the renewed demand note which permitted periodic payment on a scheduled basis. . . . CNB failed to carry out its part of this agreement." Memorandum of Decision, October 4, 1983, at 6. Moreover, "there was a failure of consideration on the part of CNB as to the complete transaction, and . . . CNB has not proved a legal basis for its complaint." Id. at 6-7. The court entered judgment for Bowers on CNB's complaint. Id. at 7. As to the counterclaim, the court held that

the renewal note, the mortgage and the agreement to set out a repayment schedule were all one transaction; that CNB was to provide to Bowers the schedule of payments, and the demand by CNB for full payment of the renewal note invalidated the complete transaction.

. . . .

Upon Bowers\'s counterclaim, the judgment of the court is that her mortgage to CNB is hereby cancelled and declared to be null and void.

Id. at 7. CNB appealed from the judgment of the superior court.

II. Connecticut Appellate Court Proceedings

On appeal, CNB argued, among other things, that (1) the trial court had erred in denying its claim for foreclosure because of a failure of consideration; and (2) the relief ordered by the superior court was inequitable and excessive. Hartford National Bank & Trust Co. v. Bowers, 3 Conn.App. 656, 657-58, 491 A.2d 431, 432 (1985). The appellate court held that the trial court was within its discretion in precluding foreclosure of the mortgage for Bowers's failure to pay the balance of the $40,000 demand note. Id. at 660, 491 A.2d at 433. As the court concluded:

Since the plaintiff did not live up to its end of the bargain, it was not unreasonable for the trial court to cancel the mortgage. Although in the present case the trial court\'s award was unusual, it cannot be said that it was an abuse of discretion. We, therefore, conclude that the court did not err in its award on the defendant\'s counterclaim.

There is no dispute, however, as to the validity of the note in the principal amount of $40,000 due by the defendant thereunder. Consequently, the court erred in failing to render judgment for the plaintiff on the note in that amount.

Id. at 660-61, 491 A.2d at 433. The court remanded to the trial court and directed it to render judgment for CNB as to the principal amount due on the note and for further proceedings as to any interest, costs, and attorneys' fees also due. Id. at 661, 491 A.2d at 433.

On June 7, 1985, the Connecticut Supreme Court denied Bowers's petition for certiorari. Hartford National Bank & Trust Co. v. Bowers, 196 Conn. 810, 494 A.2d 906 (1985).¹

III. Bankruptcy Court Proceedings

Before any further trial court proceedings could take place, Bowers filed a chapter 13 petition, on October 3, 1985, in the United States Bankruptcy Court for the District of Connecticut. CNB filed a claim in the amount of $70,912.42, based on the principal and interest due on the 1980 note. On October 14, 1986, CNB initiated adversarial proceedings seeking the release of certain of Bowers's funds that had been garnished prepetition. Bowers objected, arguing that she was not indebted to CNB because the 1980 note was induced by fraud and was therefore invalid. Bowers argued that the Connecticut Appellate Court was wrong in holding that the $40,000 renewal note was valid. She requested that the bankruptcy court exercise its equitable powers and make its own findings as to the validity of the note.

Chief Bankruptcy Judge Robert Krechevsky held that "the debtor's position on this issue is meritless. The doctrine of res judicata bars reconsideration of the validity of the note" because a final judgment existed on this question. Memorandum of Decision Re: Application of Connecticut National Bank for Partial Payment of Secured Claim ("Bankruptcy Court Memorandum of Decision"), dated February 4, 1987, at 825. As to exercise of its equitable powers, the court stated:

The debtor, having been fully heard by the Connecticut courts, may not, by reason of a chapter 13 filing, relitigate her differences with CNB. The state-court proceedings between the debtor and CNB did not involve any scheme to defraud creditors and did not implicate any principles of bankruptcy law or administration.

Id. The court then ruled that CNB was entitled to a portion of the garnished funds as partial satisfaction of its secured claim. Id. at 826.

On February 13, 1987, Bowers applied to the bankruptcy court under 28 U.S.C. Section 158(a)² for leave to appeal to the United States District Court for the District of Connecticut. Leave was granted, and this appeal followed.

Discussion

I. Full Faith and Credit

28 U.S.C. Section 1738 provides in pertinent part that:

The records and judicial proceedings of any court of any . . . State . . . 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. . . .

This provision requires that a federal court give the same preclusive effect to a state court judgment "as would be given that judgment under the law of the State in which the judgment was rendered." Migra v. Warren City School District Board of Education, 465 U.S. 75, 81, 104 S.Ct. 892, 896, 79 L.Ed.2d 56 (1984). Accord Allen v. McCurry, 449 U.S. 90, 95-96, 101 S.Ct. 411, 415-16, 66 L.Ed.2d 308 (1980). The full faith and credit mandate of section 1738 also applies to federal bankruptcy courts. In re Farrell, 27 B.R. 241, 243 (Bankr.E.D. N.Y.1982).

In Kelleran v. Andrijevic, 825 F.2d 692 (2d Cir.1987), the Court of Appeals for the

Second Circuit was recently faced with the question whether a federal bankruptcy court must give preclusive effect to a default judgment obtained in a New York state court. The bankruptcy court refused to give the default judgment preclusive effect, and this ruling was affirmed by a United States district court. Id. at 694. The court of appeals reversed, holding that federal law required the bankruptcy court to recognize the validity of the default judgment because New York law recognizes the preclusive effect of such judgments. Id. at 694. The court noted, however, that a bankruptcy court could forego the preclusive effect of a state court's judgment if either of two exceptions existed. Id. at 694-95. The preclusive effect may be ignored "where the judgment was procured by collusion or fraud, Margolis v. Nazareth Fair Grounds & Farmers Market, 249 F.2d 221, 223-25 (2d Cir.1957), or where the rendering court lacked jurisdiction, Heiser v. Woodruff, 327 U.S. 726, 736, 66 S.Ct. 853, 857-58, 90 L.Ed. 970 (1946)." Kelleran, slip op. at 694-95. Because the defaulting litigant had conceded that neither of the "only established exceptions" applied to his case, the court of appeals declined to alter the rule that "bankruptcy courts respect lawfully obtained state court judgments." Id. at 695. As the court concluded:

While the record strongly suggests that the merits of the claims are doubtful, Andrijevic should have attacked these claims in the state court. Bankruptcy proceedings may not be used to re-litigate issues already resolved in a court of competent jurisdiction. Teachers Insurance & Annuity Association of America v. Butler, 803 F.2d 61, 66 (2d Cir. 1986). The courts below erred in refusing to give preclusive effect to the state court judgment.

Kelleran, at 695.

In the instant case, the bankruptcy court gave preclusive effect to the state appellate court's determination that no dispute surrounded the validity of the $40,000 promissory note. Bankruptcy Court Memorandum of Decision at 825. As Kelleran instructs, the bankruptcy court properly accorded this deference if Connecticut ...