In re Binns

• Decision Date: 21 July 2005
• Docket Number: No. 05-6008EM.,05-6008EM.
• Citation: 328 B.R. 126
• Court: U.S. Bankruptcy Appellate Panel, Eighth Circuit
• Parties: In re Michael BINNS and Mary Ann Binns, Debtors. Karen Jacobus, Plaintiff — Appellee, v. Michael Binns and Mary Ann Binns, Defendant — Appellants.

328 B.R. 126

In re Michael BINNS and Mary Ann Binns, Debtors Karen Jacobus, Plaintiff — Appellee, v. Michael Binns and Mary Ann Binns, Defendant — Appellants.

No. 05-6008EM.

United States Bankruptcy Appellate Panel of the Eighth Circuit.

Submitted: June 24, 2005.

Filed: July 21, 2005.

Spencer P. Desai, St. Louis, Missouri, Sherry K. Dreisewerd, St. Louis, Missouri, appeared on the brief, for appellant.

Edward Renshaw of Carbondale, Illinois, for appellee.

Before DREHER, FEDERMAN, and VENTERS, Bankruptcy Judges.

VENTERS, Bankruptcy Judge.

Debtor-Defendants Michael Binns and Mary Ann Binns ("Debtors") appeal the bankruptcy court's order granting partial summary judgment in favor of Plaintiff Karen Jacobus ("Plaintiff") on her complaint to determine the dischargeability of a debt under 11 U.S.C. § 523(a)(2)(A) and (B). The court granted summary judgment under § 523(a)(2)(B) based on the application of collateral estoppel and the Rooker-Feldman doctrine to a state court judgment against the Debtors, but denied summary judgment under § 523(a)(2)(A). The Debtors timely appealed the court's order as well as the court's subsequent denial of a motion to reconsider that order.

We have jurisdiction over this appeal from the final order of the bankruptcy court. See 28 U.S.C. § 158(b). For the reasons set forth below, we reverse the court's order and remand the case for further proceedings consistent with this opinion.

I. STANDARD OF REVIEW

We review the court's entry of summary judgment de novo.¹ A grant of summary judgment must be reversed if there is a genuine issue of material fact precluding judgment as a matter of law.² The court's application of collateral estoppel and the Rooker-Feldman doctrine is also subject to de novo review.³

II. BACKGROUND

On March 20, 2001, the Plaintiff initiated a lawsuit against the Debtors in the Circuit Court for Randolph County, Illinois ("Circuit Court"). The lawsuit alleged, inter alia, that the Debtors had defrauded the Plaintiff in connection with the sale of their business to her by misrepresenting the value of the business, both orally and through the production of written financial records. The Debtors were properly served with process but chose not to appear or defend the lawsuit.⁴ On July 30, 2002, the Circuit Court entered a judgment ("Default Judgment") against the Debtors. The Default Judgment awarded compensatory damages in the amount of $597,890, and further stated, in pertinent part:

The Court Further Finds that with reference to the allegations in the complaint, the Defendants' failure to appear or otherwise answer the pleadings, the Defendants' admission that the gross sales amount of Marilyn's Hallmark in 1999 were [sic] intentionally overstated, that Michael Binns provided false financial records to the Plaintiff to induce the Plaintiff's purchase of Marilyn's Hallmark, the court assesses $200,000 for punitive damages due to the intentional actions of fraud, plus the costs of the suit in the amount of $1,116.75.⁵

The Debtors did not appeal or otherwise contest the Default Judgment.

The Debtors filed for protection under chapter 7 of the bankruptcy code on December 11, 2003, and, on April 19, 2004, the Plaintiff initiated an adversary proceeding against them to obtain a determination that the debt arising from the Default Judgment is nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A) and (B). The Plaintiff moved for summary judgment, and, on February 11, 2005, the court ruled that the debt was not excepted from discharge as a matter of law under § 523(a)(2)(A), but that it was under § 523(a)(2)(B). The court determined that the findings in the Default Judgment satisfied each of the elements of § 523(a)(2)(B), and that those findings were binding on the court by the application of collateral estoppel and under the Rooker-Feldman doctrine. In subsequently denying the Debtors' Motion to Reconsider, the court reiterated its position that the Rooker-Feldman doctrine precluded the re-litigation of the Circuit Court's finding of fraud.

III. DISCUSSION

The Debtors raise four issues in this appeal: (1) whether the findings in the Default Judgment are entitled to collateral estoppel effect; (2) the extent of that effect, i.e., whether the findings contained in the Default Judgment satisfy the requirements of § 523(a)(2)(B); (3) whether the application of the Rooker-Feldman doctrine to the Default Judgment supports a determination of nondischargeability under § 523(a)(2)(B); and (4) whether the punitive damages awarded in the Default Judgment are nondischargeable. The Debtors maintain that the court erred when it answered all of these questions in the affirmative.

Because we find that the Default Judgment is not entitled to collateral estoppel effect and that the Rooker-Feldman doctrine does not apply under these circumstances, issues (2) and (4) are moot.

Collateral Estoppel

The court correctly held that the preclusive effect of a state court judgment in a subsequent federal case is determined by reference to state law.⁶

It has long been established that [28 U.S.C.] § 1738 does not allow federal courts to employ their own rules of res judicata in determining the effects of state judgments. Rather, it goes beyond the common law and commands a federal court to accept the rules chosen by the state from which the judgment was taken.⁷

But we disagree with the court's conclusion that default judgments have collateral estoppel effect under Illinois law.

Admittedly, Illinois law is not crystal clear on this issue,⁸ and the case on which the court relied to conclude that collateral estoppel applies to default judgments could be interpreted to support its conclusion. However, we believe it would be more consistent with the current status of Illinois law to decline to give collateral estoppel effect to default judgments.

The court relied on Sawyer v. Nelson.⁹ In Nelson, the Illinois Supreme Court considered whether judgment creditors who had obtained a judgment in an action based on trover and malice could collaterally estop the judgment debtor from asserting in a later proceeding that malice was not the "gist" of that action.¹⁰ The judgment in the prior action did not indicate on which count or cause of action it was based. Accordingly, the Illinois Supreme Court held that the judgment debtor would not be prevented from denying malice in the later proceeding because "it did not appear on the face of the record and was not shown by extrinsic evidence that the precise question at issue was raised and determined" in the earlier proceeding.¹¹

Although the judgment in the prior action had been obtained by default, the Nelson court did not specifically discuss the default nature of the prior judgment nor how this circumstance would have affected its analysis of the plaintiff's estoppel argument had the judgment been unambiguous on its face. Standing alone, this distinction might not be enough to convince us that Nelson does not, in fact, reflect the state of Illinois law on this subject. But the precedential value of Nelson is limited by a more recent (and apparently the only) Illinois Supreme Court case directly addressing (albeit in dicta) the applicability of collateral estoppel to default judgments.

In Housing Authority for LaSalle County v. Young Men's Christian Association of Ottawa,¹² the Illinois Supreme Court noted without further comment that several courts had determined that "default judgments have limited preclusive effects under the doctrine of collateral estoppel."¹³ (Despite the use of the word "limited," all of the cases cited by the YMCA court hold that collateral estoppel does not apply at all to default judgments.) The YMCA court appears to have made that comment only to emphasize a distinction between collateral estoppel and res judicata — a doctrine that the YMCA court observed "always" follows from default judgments — but we find the statement to be persuasive evidence of the Illinois Supreme Court's position on the collateral estoppel/default judgment issue, especially considering that it would be highly unlikely that the court would recite these cases and a law review article arguing for the abolition of collateral estoppel for default judgments¹⁴ if there was Illinois Supreme Court precedent to the contrary.¹⁵

Therefore, we find that collateral estoppel does not apply to default judgments under Illinois law. Consequently, the court's grant of summary judgment, which was based on the application of collateral estoppel to the Default Judgment, must be reversed and the case remanded for a trial on the merits of the Plaintiff's complaint.

We note that reversal would still be necessary here even if collateral estoppel did apply to default judgments under Illinois law because the Circuit Court's findings in the Default Judgment are insufficient to establish a claim under § 523(a)(2)(B).

To prevail under § 523(a)(2)(B), the Plaintiff has to establish by a preponderance of the evidence that the Debtors obtained money from her (1) by the use of a statement in writing that was materially false; (2) that pertained to their business's financial condition; (3) on which she reasonably relied; and (4) that the Debtors made with the intent to deceive the Plaintiff. 11 U.S.C. § 523(a)(2)(B).

The Plaintiff relied on the Default Judgment to establish all of these elements as a matter of law, but the Default Judgment only stated that the Debtors committed "fraud," without any findings or discussion of the reasonableness of the Plaintiff's reliance. The Plaintiff's state law complaint was also silent on that issue.

Those omissions are critical because a finding of reasonable reliance cannot be inferred from a bald finding of fraud under Illinois law. We have not found, nor have the parties identified — in the pleadings or at oral argument — any clear statement of Illinois law on the degree of reliance necessary to establish fraud. Some cases indicate...