In re A-1 24 Hour Towing, Inc.

• Decision Date: 19 September 1983
• Docket Number: Bankruptcy No. BK-LV-82-635.
• Citation: 33 BR 281
• Parties: In re A-1 24 HOUR TOWING, INC., Debtor.
• Court: U.S. Bankruptcy Court — District of Nevada

33 B.R. 281 (1983)

In re A-1 24 HOUR TOWING, INC., Debtor.

Bankruptcy No. BK-LV-82-635.

United States Bankruptcy Court, D. Nevada.

September 19, 1983.

Lenard D. Schwartzer, Las Vegas, Nev., for debtor.

Stanley W. Pierce, Las Vegas, Nev., for creditor Raymond H. Davis dba Desert Auto Wrecking.

ORDER

ROBERT C. JONES, Bankruptcy Judge.

Background

In August of 1979 creditor Raymond H. Davis, doing business as Desert Auto Wrecking in Las Vegas, purchased 68 cars from the debtor's towing service for $10,000.00. Of the 44 cars actually delivered, some of the most valuable were shortly thereafter impounded by the police and later returned not to Davis but to the debtor, which resold them to third parties. Because of the losses arising from this transaction, Davis brought an action for damages in the Eighth Judicial District Court in Las Vegas and was eventually granted a default judgment against the debtor on 3 September 1980 for $29,299.08. This money judgment included $22,686.00 for damages, $1,544.58 in interest, costs of $68.50, and punitive damages of $5,000.00.

This debtor filed its initial Chapter 11 case on 14 May 1981, which was dismissed on 12 May 1982. The present Chapter 11 case was filed on 20 May 1982. The amount of the Davis debt as scheduled by the debtor in the present Chapter 11 case is $29,645.15,¹ and it is not listed as disputed. Though not disputed on the schedules, on 27 October 1982 the debtor included this debt in its objection to various claims.

At the 23 March 1983 hearing on this particular objection, the debtor's attorney explained that after the debtor's original attorney allowed the default judgment to be entered the debtor retained a second attorney to collaterally attack the default judgment; but before the motion to set aside was heard by the state court the debtor filed its first petition and the state court did not formally rule. The debtor's present bankruptcy counsel admitted that because the motion to set aside was made more than six months after the entry of the judgment the motion would have been denied by the state court. See Nev.R.Civ.P. 60(b). However, counsel argued that there are other means available for the collateral attack of the judgment other than a motion to set aside filed within six months. Rule 60(b) states: "This rule does not limit the power of a court to entertain an independent action to relieve a party from a judgment, order, or proceeding, or to set aside a judgment for fraud upon the court."

The above facts were presented to the Court by way of exhibits, argument, briefs, and court files.

Arguments of Counsel

Notwithstanding the pre-petition judgment entered by the state court, counsel for the debtor argued that the bankruptcy court has the equitable power to look behind the judgment and ascertain its true amount. Debtor argued that the amount of the judgment is grossly disproportionate to the true extent of the creditor's losses and that the main effect of allowing the claim amount to stand as stated would be to prejudice the other unsecured creditors. This debt is the largest claim against the estate, and the validity of it is purportedly crucial to the success of any proposed Chapter 11 plan (none has yet been filed).

Creditor's counsel argued that any independent action filed to attack the judgment must be, according to Nevada case law, based upon allegations of fraud, which has not been alleged in this case.

At the conclusion of the hearing and argument, the Court asked the parties to brief the question of whether the Court has any right to look behind the judgment. The parties agreed that if the Court concluded there was no such right the objection to the claim would be denied. If, however, the Court decided that such a right or power did exist, then it was agreed that a subsequent evidentiary hearing must be scheduled to determine whether the Court should look behind the judgment and, if so, to further determine the amount of the Davis claim against the debtor's estate.²

Neither party has raised the question of subordination of the claim or any portion of it. See for example, 11 U.S.C. § 726(a)(4) as to punitive damages, and 11 U.S.C. § 1129(a)(7) and (b)(2)(B).

Discussion

Although not articulated by counsel, the question is whether the sanctity of a prior court default money judgment,³ protected and preserved by the operation of full faith and credit and res judicata, may be violated or abridged by the bankruptcy court's exercise of its equitable power (28 U.S.C. § 1481).

Constitutionally-mandated full faith and credit only applies when both the first and second judicial proceedings are in state court. U.S. Const. art. 4, § 1. However, there is also a federal statutory full faith and credit clause operative on the courts of the United States. 28 U.S.C. § 1738.⁴ "Section 1738 requires federal courts to give the same preclusive effect to state court judgments would be given in the courts of the state from which the judgments emerged." Kremer v. Chemical Construction Corp., 456 U.S. 461, 466, 102 S.Ct. 1883, 1889, 72 L.Ed.2d 262 (1982).

As noted by creditor's counsel, the procedure for challenging a prior judgment in state court (once the appeal time has run) is to file a Rule 60(b) independent action. The "independent action" segment of this rule has been read by the state's highest court to "afford relief upon proof of extrinsic fraud." Savage v. Salzmann, 88 Nev. 193, 495 P.2d 367, 368 (1972). Extrinsic fraud was defined by that same court as

fraud by reason of which "`there was, in fact, no adversary trial or decision of the issue in the case\'; where `there has never been a real contest in the trial or hearing of the case.\'" Villalon v. Brown, 70 Nev. 456, 569, 273 P.2d 409, 415 (1954), citing United States v. Throckmorton, 98 U.S. 61 25 L.Ed. 93 . . . (1878). "Extrinsic fraud has been held to exist when the unsuccessful party is kept away from the court by a false promise or compromise, or such conduct as prevents a real trial upon the issues involved, or any other act or omission which procures the absence of the unsuccessful party at the trial. Further, it consists of fraud by the other party to the suit which prevents the losing party either from knowing about his rights or defenses, or from having a fair opportunity of presenting them upon the trial." Murphy v. Murphy, 65 Nev. 264, 271, 193 P.2d 850, 854 (1948) quoted with approval in Colby v. Colby, 78 Nev. 150, 369 P.2d 1019 (1962).

Id. But the debtor has not alleged that the default judgment was the product of fraud, only that somehow an error was made in determining the damages. Indeed, it appears that the debtor realizes it has no basis in law to sustain an action collaterally attacking the judgment in state court or it surely would have filed one by now.⁵ Instead, the debtor comes to this Court for relief in equity.

This absence of a basis for an independent state court action may be subsumed within the following recognized limitations on the operation of full faith and credit:

The doctrine of full faith and credit extends only to valid judgments. And even for valid judgments full faith and credit is subject to limitations. Therefore, it is generally considered that full faith and credit does not apply where (1) there is no jurisdiction over the parties, (2) there is an overriding policy of the forum state against the application of full faith and credit in a particular instance, and (3) there is a limitation intrinsically related to the judgment which would prevent the application of full faith and credit in a particular instance.

In re Goodman, 25 B.R. 932, 936 (Bkrtcy.N. D.Ill.1982) (footnotes omitted). The debtor has not argued that the default judgment is invalid, nor that the state court did not have jurisdiction over the parties. Again, the dollar amount of the judgment appears to be the only dispute. Nor has it been argued that there exists a "limitation intrinsically related to the judgment which would prevent the application of full faith and credit." Instead, unknowingly to be sure, the debtor is arguing that the second limitation is applicable to the present matter—that the bankruptcy court, as the forum court, has an "overriding policy" of exercising its equitable power in appropriate circumstances to examine and perhaps readjust the amount of a claim reduced to judgment.⁶ The question of if and when this Court's equitable power may be so used will be discussed below.

Under res judicata (also commonly known as "claim preclusion") "a final judgment on the merits bars further claims by parties or their privies based on the same cause of action." Montana v. United States, 440 U.S. 147, 153, 99 S.Ct. 970, 973, 59 L.Ed.2d 210 (1979). Also, "res judicata prevents litigation of all grounds for, or defenses to, recovery that were previously available to the parties, regardless of whether they were asserted or determined in the prior proceeding." Brown v. Felsen, 442 U.S. 127, 132, 99 S.Ct. 2205, 2209, 60 L.Ed.2d 767 (1979). Further, "a judgment of a court having jurisdiction of the parties and of the subject-matter operates as res judicata, in the absence of fraud or collusion, even if obtained upon a default." Riehle v. Margolies, 279 U.S. 218, 225, 49 S.Ct. 310, 313, 73 L.Ed. 669 (1929) (emphasis added). See also In re White, 18 B.R. 246 (Bkrtcy.E.D.Va. 1982); In re Bystrek, 17 B.R. 894 (Bkrtcy.E. D.Pa.1982); In re McKenna, 4 B.R. 160 (Bkrtcy.N.D.Ill.1980).

Addressing res judicata in the present bankruptcy context the Eighth Circuit Court of Appeals has recognized that "as a general rule, in allowing and disallowing claims of creditors, bankruptcy courts are required to give res judicata effect to prior judgments of non-bankruptcy courts. . . . It is, however, well established that bankruptcy courts are courts of equity with broad powers to disallow or subordinate claims when equitable considerations warrant." Kapp v. Naturelle, Inc., 611 F.2d...