In re Wald

Decision Date26 March 1997
Docket NumberBankruptcy No. 95-00408-BGC-7,Adversary No. 95-00202.
Citation208 BR 516
PartiesIn re Michael Emil WALD and Suzanne S. Wald, Debtors. Robert A. ANGUS and and Kathleen Angus, Plaintiffs, v. Michael Emil WALD, Defendant.
CourtU.S. Bankruptcy Court — Northern District of Alabama

Jay Clark, Birmingham, AL, for plaintiffs.

Charles Cleveland, Birmingham, AL, for defendant.


BENJAMIN COHEN, Bankruptcy Judge.

The Collateral Estoppel Effect of State Court Default Judgments in Bankruptcy Dischargeability Proceedings

Summary of Holding

To determine whether a state court default judgment should be given collateral estoppel effect in a bankruptcy dischargeability proceeding, a bankruptcy court should consider and apply federal law rather than the collateral estoppel law of the state in which the judgment was entered. In the instant case, the default judgment entered against this debtor by the state court should not be given collateral estoppel effect in the dischargeability proceeding pending before this Court.

I. Introduction

On April 6, 1994, the state Circuit Court for Jefferson County, Alabama entered a default judgment against the debtor and in favor of the plaintiffs for $49,009.77. On January 20, 1995, the debtor filed the pending Chapter 7 bankruptcy case seeking, in part, a discharge of that debt. On May 3, 1995 the plaintiffs filed the pending adversary proceeding to determine the dischargeability of the debt.

The plaintiffs contend before this Court that the debt underlying the state court default judgment was the result of either fraud by the debtor or was the result of willful and malicious injury caused by the debtor, and conclude that the state court default judgment collaterally estops the debtor from litigating the dischargeability questions before this Court. The consequence, according to the plaintiffs, is that the debt is, as a matter of law, nondischargeable. In support of their contentions, the plaintiffs argue that the debtor's "participation" in the state court case qualifies the default judgment for actually litigated status for purposes of the Eleventh Circuit Court of Appeals case of Bush v. Balfour Beatty Bahamas, Ltd. (In re Bush), 62 F.3d 1319 (11th Cir.(Fla.) 1995) where the court allowed collateral estoppel effect to be afforded a default judgment because of a defendant's extensive participation prior to the entry of default. In contrast, the debtor maintains that the state court default judgment has no effect in the pending proceeding and that if the plaintiffs seek to prevent the discharge of the debt, they must, at a minimum, establish the facts underlying their claims.

This matter is before the Court on the plaintiffs' Renewed Motion for Summary Judgment.1 After notice, a hearing on the motion was held on July 29, 1996. Jay Clark, the attorney for the plaintiffs, and Charles Cleveland, the attorney for Michael Emil Wald, one of the debtors and the only defendant in this proceeding, appeared.2

II. Findings of Fact

Mr. and Mrs. Angus, the plaintiffs, hired Mr. Wald, who was a general contractor, to build a house for them. During the process of construction, a dispute arose and the plaintiffs fired Mr. Wald. The plaintiffs completed the construction themselves and on November 15, 1993 filed an action against the debtor in the Circuit Court of Jefferson County, Alabama. The complaint in that suit, Civil Action No. CV 93-008885-00, contained three counts. The first alleged that the debtor breached his contract with the plaintiffs by failing to "timely" complete the house; by failing to obtain and keep insurance on the premises during the period of construction; and, by failing to pay for labor and materials used in the construction. The second count alleged that subsequent to entering into the contract, the debtor, either fraudulently or mistakenly, misrepresented the date on which the house would be completed. The third count alleged that the debtor obtained draws against the plaintiffs' construction line of credit by misrepresenting, either fraudulently or mistakenly, that the money withdrawn would be used to pay for costs already incurred by him in constructing the plaintiffs' house.3

On December 29, 1993 the plaintiffs filed an application with the state court for an entry of default because the debtor had not answered the complaint. On January 5, 1994, a stamped form judgment granting the application was entered on the state court docket sheet. That entry provided that judgment by default was rendered in favor of the plaintiffs and against the defendant with leave to the plaintiffs to prove damages within 30 days.4

On January 19, 1994, the debtor filed an answer to the plaintiffs' complaint which stated, in its entirety: "I deny all of the charges you have made against Weld Construction and Mike Wald. At this time I am unable to afford legal representation, but I'm trying to earn enough money to defend myself against those charges." Answer filed January 19, 1994 in Civil Action No. CV 93-08885-00, Circuit Civil Court of Jefferson County, Alabama. The debtor was not represented by an attorney when he filed his answer or at any other time during the course of the state court case.

The next entry on the state court's docket sheet was handwritten and dated January 31, 1994. It read, "Case came on for hearing to prove damages. Deft. appeared pro se and indicated he was contemplating bankruptcy, but he believed he had in part a meritorious defense. This hearing is continued to March 2, 1994 at 8:45 A.M."

The next entry, dated March 2, 1994, was also handwritten and read, "Default judgment is made final. Plaintiff granted 30 days to prove damages."

On March 17, 1994, the plaintiffs filed an affidavit for the purpose of proving damages. In their affidavit, the plaintiffs described and requested compensatory damages in the amount of $37,009.77, including $10,000 for "emotional distress," and punitive damages of "$12,000 to $15,000." Affidavit filed March 17, 1994 in Civil Action No. CV 93-08885-00, Circuit Civil Court of Jefferson County, Alabama.

On April 6, 1994, another form judgment notation was stamped on the state court's case docket sheet. That entry stated, without elaboration or further detail, that judgment was granted in favor of the plaintiffs and against the defendant in the sum of $49,009.77.5

The debtor filed his Chapter 7 bankruptcy petition on January 20, 1995. The plaintiffs filed this adversary proceeding, contending that the debt underlying the state court judgment was the result of fraud and is nondischargeable under 11 U.S.C. ? 523(a)(2)(A). The plaintiffs also contend that the debt is nondischargeable under 11 U.S.C. ? 523(a)(6) as a willful and malicious injury. The plaintiffs argue before this Court that the state court judgment collaterally estops the debtor from litigating the dischargeability of the debt and that they are, therefore, entitled to a judgment of nondischargeability as a matter of law.

III. Conclusions of Law
A. Applicable Tests

Most courts apply one of two tests to determine whether a bankruptcy court should give collateral estoppel effect to a state court default judgment. These are The General Federal Rule and The State Law Test.

1. The General Federal Rule

The majority of courts follow the General Federal Rule, which requires that the issues sought to be precluded must have been actually litigated in the prior proceeding before collateral estoppel is applied. In a bankruptcy dischargeability context, a default judgment is therefore not generally accorded collateral estoppel effect because issues are not ordinarily, actually litigated to obtain a default judgment. In reality, the opposite is true. "Ordinarily a default judgment will not support the application of collateral estoppel because `in the case of a judgment entered by confession, consent, or default, none of the issues is actually litigated.'" Bush v. Balfour Beatty Bahamas, Ltd. (In re Bush), 62 F.3d 1319 (11th Cir. (Fla.) 1995)(quoting Restatement (Second) of Judgments ? 27 cmt. e (1982)). In dischargeability proceedings bankruptcy courts may apply this general federal rule of issue preclusion to state court default judgments pursuant to the United States Supreme Court decision of Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979).

In contrast, a number of courts have held that the decision of the Supreme Court of the United States in Marrese v. American Academy of Orthopaedic Surgeons, 470 U.S. 373, 105 S.Ct. 1327, 84 L.Ed.2d 274 (1985) allows bankruptcy courts, in dischargeability proceedings, to utilize state principles of collateral estoppel to determine the issue preclusive effect of a judgment rendered by that state, even if those principles would prevent a trial in the bankruptcy court of issues not actually litigated in the state court. An application of Marrese would require a court to consider first, whether a plaintiff's state court default judgment, under state collateral estoppel law, would preclude a determination of the dischargeability questions in a bankruptcy court. If it does, the full faith credit statute of 28 U.S.C. ? 1738 would require recognition of that result, and the bankruptcy court would then be required to consider second, whether there is an exception to the full faith and credit statute for the narrow question of the applicability of state court default judgments in bankruptcy dischargeability proceedings as some courts have recognized in Brown v. Felsen.

For purposes of the instant case, this Court finds that in determining the collateral estoppel effect of a state court judgment, the decision in Brown v. Felsen requires bankruptcy courts to apply federal law to determine the issue preclusive effect of a state court judgment. In Brown v. Felsen the Supreme Court established an exception to the full faith and credit statute. This...

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