In re McMahon

• Decision Date: 29 November 2006
• Docket Number: Bankruptcy No. 04-77426-PWB.,Adversary No. 05-6027-PWB.
• Citation: 356 B.R. 286
• Parties: In re Arthur H. McMAHON, Jr., Debtor. Colorado West Transportation Co., Inc., Plaintiff, v. Arthur H. McMahon, Jr., Defendant.
• Court: U.S. Bankruptcy Court — Northern District of Georgia

356 B.R. 286

In re Arthur H. McMAHON, Jr., Debtor.

Colorado West Transportation Co., Inc., Plaintiff, v. Arthur H. McMahon, Jr., Defendant.

Bankruptcy No. 04-77426-PWB.

Adversary No. 05-6027-PWB.

United States Bankruptcy Court, N.D. Georgia, Atlanta Division.

November 29, 2006.

COPYRIGHT MATERIAL OMITTED

Gus H. Small, Kelly Serene Scarbrough, Cohen Pollock Merlin Axelrod & Small, Atlanta, GA, for Colorado West Transportation Co., Inc.

Mathew A. Schuh, Morris, Schneider & Prior, LLC, Atlanta, GA, for Arthur H. McMahon, Jr.

ORDER

PAUL W. BONAPFEL, Bankruptcy Judge.

The Plaintiff obtained a default judgment against the chapter 7 Debtor (Defendant herein) in a Colorado state court on a fraud claim because the Debtor abandoned defense of the litigation after he lost preliminary dispositive motions. The Plaintiff seeks a determination that the debt is excepted from discharge under 11 U.S.C. § 523(a)(2)(A) due to the Debtor's alleged fraud. (For convenience, the Court uses the term "fraud" to encompass "false pretenses, false representations, and actual fraud" as those words are used in § 523(a)(2)(A).)

At the trial in this Court, the Plaintiff moved for entry of judgment as a matter of law on the ground that, under the doctrine of issue preclusion (sometimes referred to as collateral estoppel), the default judgment established Debtor's fraud for purposes of determining the debt's nondischargeability. FED.R.CIV.P. 52(c), applicable under FED. R. BANKR.P. 7052. Reserving ruling on this issue, the Court heard evidence on the merits and determined that the Plaintiff did not prove two of the elements required to establish the fraud exception. Specifically, the Plaintiff did not prove that any representation made by the Debtor was false or that the Plaintiff justifiably relied on any representation. If issue preclusion is required, however, the default judgment prevents the Debtor from litigating these issues, and the Court must enter judgment that the debt is nondischargeable.

A default judgment ordinarily does not have issue preclusive effect in a federal court because the issues are not actually litigated. E.g. Bush v. Balfour Beatty Bahamas, Ltd. (In re Bush), 62 F.3d 1319, 1323 (11th Cir.1995) (citing cases). The federal rule is thus consistent with the approach of § 27 of the Restatement (Second) of Judgments (1982) [hereinafter "Restatement (Second)"].¹ See generally Christopher Klein, Lawrence Ponoroff, and Sarah Borrey, Principles of Preclusion and Estoppel in Bankruptcy Cases, 79 AMER. BANKR. L.J. 839, 842-44 (2005) [hereinafter "Principles of Preclusion"].

The Plaintiff contends, however, that a default judgment has issue preclusive effect under Colorado law and that the full faith and credit statute, 28 U.S.C. § 1738, requires its application in this litigation. After setting out the facts relating to the Colorado lawsuit,² this Order considers these issues. The Court concludes that Colorado law does not require issue preclusion in this proceeding and that, even if it does, the full faith and credit statute does not require a bankruptcy court to give issue preclusive effect to a state court default judgment.

I. FACTS

In July 1996, the Plaintiff sued the Debtor in a Colorado court seeking unspecified damages based on fraud arising out of the Plaintiff's purchase in 1994 of the assets of Telluride Mountain Investments, Inc. ("TMI"), a corporation controlled by the Debtor. The complaint also asserted a claim for adjustments to the purchase price based solely on the contract in the liquidated amount of $24,839. (PX-1(A)).

The Debtor moved to dismiss for lack of service and jurisdiction (PX-1(E)), but withdrew the motion (PX-1(I), (J)). Instead of filing an answer, he moved to dismiss and/or for summary judgment, seeking dismissal of the complaint for failure to join TMI as an indispensable party, for lack of specificity in pleading fraud, and because certain contractual provisions barred the claims (PX-1(K)).

Because of the existence of disputed material facts, the Colorado court refused to dismiss (PX-D) and set a status conference for June 26, 1997. (PX-1, docket sheet). After the Debtor's lawyers withdrew because the Debtor could not pay them (PX-1(O)), the court rescheduled the status conference for July 23. The court's minute order stated in pertinent part, "The [Debtor] will be expected to participate in all future [hearings] and should [he] fail to do so [he] may suffer default with an entry of judgment against [him]." (PX-1, docket sheet; next to last page of PX-1(O)).

The Debtor did not attend the status conference (PX-1, docket sheet; last page of PX-1(O)), and the Plaintiff moved for default judgment on July 30 (PX-A). Attached to the motion is an affidavit of its principal, Sid Brotman, that states the basis for the Plaintiffs damages on the fraud claim. According to the affidavit, the Debtor made false representations that overstated TMI's historical income. Because Mr. Brotman based the purchase price on a multiple of income, the affidavit concludes, the Plaintiff paid $375,000 more than it would have paid based on TMI's true income. The affidavit also requested damages on the contract claim in the liquidated amount of $24,829.

Although the notice to the Debtor of the filing of the motion stated that he had three days from the date of service on July 30 to respond (PX-B), the trial court entered default judgment two days later, on August 1 (PX-Q). The default judgment recites that the Debtor had failed to appear at the status conference and that he was indebted to the Plaintiff in the amount of $399,829, plus interest. The judgment made no finding that the Debtor had engaged in fraud.

The judgment did not specify how much was awarded on each of the two claims. Nevertheless, it is clear that the total judgment amount of $399,829 is the sum of the damages of $24,829 on the contract claim and $375,000, the amount the affidavit claims as damages due to fraud. It is, therefore, arithmetically clear that the default judgment awarded $375,000 on the fraud claim.

Some five years later, the Debtor moved to set aside the default judgment on the grounds that it had been entered without three days' prior notice as Colorado procedure requires and that he had meritorious defenses (PX-1(S)). On November 5, 2002, the court denied the motion, concluding that the failure to give proper notice was not jurisdictional and that the Debtor had not sought relief within a reasonable time as Colorado law requires (PX-E).

The Debtor filed his chapter bankruptcy case on October 21, 2004. The Plaintiff seeks a determination that the Debtor's liability under the default judgment is excepted from discharge under 11 U.S.C. § 523(a)(2)(A) due to fraud.

II. DISCUSSION

This Court determined after trial that the Plaintiff had failed to prove all of the elements of fraud that would except its judgment from discharge under § 523(a)(2)(A). The Plaintiff, however, contends that it is entitled to a determination that the debt is nondischargeable as a matter of law because the default judgment conclusively establishes that the Debtor is liable for fraud, the same issue that controls the exception from discharge.

A prior judgment may have preclusive effect in later litigation under two doctrines, traditionally referred to as the doctrines of res judicata and collateral estoppel. Modern terminology, following the approach of the Restatement (Second), replaces the term "res judicata" with "claim preclusion" and the term "collateral estoppel" with "issue preclusion." The modern terms are more analytically helpful and contribute to greater clarity of thought. See Principles of Preclusion at 847, citing 18 CHARLES ALAN WRIGHT, ARTHUR R. MILER & EDWARD H. COOPER, FEDERAL PRACTICE AND PROCEDURE § 4402 (2d ed.2003). The Supreme Courts of the United States and of Colorado have adopted this approach. E.g., New Hampshire v. Maine, 532 U.S. 742, 748-49, 121 S.Ct. 1808, 149 L.Ed.2d 968 (2001); Argus Real Estate, Inc. v. E-470 Public Highway Auth., 109 P.3d 604 (Colo.2005).

The doctrine of claim preclusion prevents the relitigation of a claim that the prior judgment adjudicated. This principle prevents relitigation of a claim, broadly defined under a transactional test that includes matters that have been litigated and matters arising out of the same transaction that could have been raised in the original litigation. See Principles of Preclusion at 847. The Supreme Court has held that claim preclusion does not apply in dischargeability litigation. Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979).

The doctrine of issue preclusion prevents the relitigation of any issue that was necessarily adjudicated in rendering the prior judgment. The Supreme Court has recognized that issue preclusion applies in dischargeability litigation. Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991).

The Plaintiff invokes issue preclusion. The Plaintiff correctly posits that fraudulent conduct under Colorado law is the same type of conduct that renders the liability nondischargeable under 11 U.S.C. § 523(a)(2)(A). See, e.g., Evans v. Dunston (In re Dunston), 146 B.R. 269 (D.Colo.1992); Pacific Energy and Minerals, Ltd. v. Austin (In re Austin), 93 B.R. 723 (Bankr.D.Colo.1988). Because the judgment resolved the fraud issue, the Plaintiff concludes, the Debtor cannot relitigate it in this proceeding, and the Plaintiff is entitled to judgment as a matter of law that the liability established by the judgment is excepted from discharge.

A default judgment ordinarily does not have issue preclusive effect in a federal court because the issues are not actually litigated. E.g. Bush v. Balfour Beatty Bahamas, Ltd. (In re Bush), 62 F.3d 1319, 1323 (11th Cir.1995) (citing cases). See also Franks v. Thomason (In re Franks), 4 B.R. 814, 821-22 (N.D.Ga.1980) (Default judgment entered in a proceeding in which the debtor initially...