Kelleran v. Andrijevic

• Citation: 825 F.2d 692
• Decision Date: 04 August 1987
• Docket Number: No. 911,D,911
• Parties: , 17 Collier Bankr.Cas.2d 565, Bankr. L. Rep. P 71,930 C. Russell KELLERAN, Jr., Eighteen Mile Corporation, Plaintiffs-Appellants, v. Slavko ANDRIJEVIC, a/k/a Al Andrie, Defendant-Appellee. ocket 86-7995.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Page 692

825 F.2d 692

56 USLW 2102, 17 Collier Bankr.Cas.2d 565,

Bankr. L. Rep. P 71,930

C. Russell KELLERAN, Jr., Eighteen Mile Corporation, Plaintiffs-Appellants, v. Slavko ANDRIJEVIC, a/k/a Al Andrie, Defendant-Appellee.

No. 911, Docket 86-7995.

United States Court of Appeals, Second Circuit.

Argued March 10, 1987.

Decided Aug. 4, 1987.

E. Thomas Jones, Buffalo, N.Y. (C. Russell Kelleran, Jr., Buffalo, N.Y., of counsel), for plaintiffs-appellants.

Edwin R. Ilardo, Hamburg, N.Y., for defendant-appellee.

Before MESKILL and NEWMAN, Circuit Judges, and BLUMENFELD, ^* District Judge.

MESKILL, Circuit Judge:

This is an appeal from a judgment entered in the United States District Court for the Western District of New York, Curtin, C.J., affirming a judgment entered in the United States Bankruptcy Court, McGuire, J., that disregarded the preclusive effect of a state court default judgment fixing the liability of the debtor-appellee, Andrijevic, to one of the creditors-appellants This appeal presents the issue whether the bankruptcy court's equitable powers permit it to disregard the preclusive effect of a state court default judgment where the judgment was obtained by a creditor without fraud or collusion, but the bankruptcy court finds the creditor's claims to be "wholly without merit."

Eighteen Mile Corporation, and disallowed the creditors' claims.

Reversed and remanded.

BACKGROUND

The relevant facts may be summarized briefly. Andrijevic and Kelleran formed Eighteen Mile Corporation for the purpose of buying and developing real estate. Following a deterioration in the relationship between Andrijevic and Kelleran, Andrijevic filed a mechanic's lien on certain real estate owned by Eighteen Mile. Eighteen Mile timely filed an answer denying Andrijevic's claim and counterclaimed for breach of contract and willful exaggeration of a mechanic's lien. Creditor-appellant Kelleran brought a separate suit against Andrijevic for unpaid legal fees.

Andrijevic defaulted on the counterclaims by not serving a reply. Subsequently, Andrijevic tried to reopen the default judgment, but was unsuccessful. The New York Supreme Court (Erie County) entered judgment in favor of Eighteen Mile with respect to the counterclaims as to liability and scheduled a damages inquest. Before the damages inquest could take place, Andrijevic commenced the instant bankruptcy proceeding which automatically stayed all state proceedings, including the damages inquest.

Kelleran and Eighteen Mile filed proofs of their claims in the bankruptcy court, with Eighteen Mile seeking to enforce the state court default judgment. The bankruptcy court, however, found that the creditors' claims were "wholly without merit" and refused to give the state court default judgment binding effect. The bankruptcy court found for Andrijevic as to each of the creditors' claims and disallowed them. The district court affirmed, finding the creditors' claims to be "incredible." J. App. at 144. This appeal followed.

DISCUSSION

"Congress has specifically required all federal courts to give preclusive effect to state-court judgments whenever the courts of the State from which the judgments emerged would do so...." Allen v. McCurry, 449 U.S. 90, 96, 101 S.Ct. 411, 415, 66 L.Ed.2d 308 (1980) (citing 28 U.S.C. Sec. 1738 (1982)). Bankruptcy courts fall within Congress' mandate. See, e.g., In the Matter of Farrell, 27 B.R. 241, 243 (Bkrtcy.E.D.N.Y.1982). The bankruptcy court, therefore, was bound to give preclusive effect to the default judgment obtained in the state court by Eighteen Mile to the same extent as would a New York court.

In New York, when a party defaults by failure to answer and the court orders an inquest as to damages, the defaulting litigant may not further contest the liability issues. Amusement Business Underwriters v. American International Group, 66 N.Y.2d 878, 498 N.Y.S.2d 760, 762, 489 N.E.2d 729, 731 (1985); Rokina Optical Co. v. Camera King, Inc., 63 N.Y.2d 728, 480 N.Y.S.2d 197, 198-99, 469 N.E.2d 518, 519-20 (1984); Metropolitan Property & Liability Ins. v. Cassidy, 127 Misc.2d 641, 486 N.Y.S.2d 843, 847 (N.Y.Sup.Ct.1985). The bankruptcy court, therefore, was bound to the liability determinations in the state judgment unless an exception existed to prevent operation of the judgment's preclusive effect. Bankruptcy courts may look beyond a state court default judgment 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, 858, 90 L.Ed. 970 (1946). Andrijevic concedes that neither of these exceptions applies here.

Instead, Andrijevic would have us create a third exception. Kelleran and Andrijevic were business partners and, in addition, Kelleran, an attorney, represented Andrijevic on various legal matters unrelated to their business relationship. Andrijevic contends that the previous attorney/client relationship between the parties should somehow excuse Andrijevic's default. This contention is untenable. Andrijevic concedes that Kelleran was not acting as his attorney in the state court action, that Andrijevic did not look to Kelleran for assistance therein and that Kelleran did not prevent Andrijevic in any way from timely responding to the counterclaims. We, therefore, reject Andrijevic's argument that the suggested exception be recognized.

The courts below relied on a somewhat different theory in disregarding the preclusive effect of the state court judgment. Citing broad dictum from Margolis and its progeny discussing the equitable powers of the bankruptcy court, each court summarily determined, without specific factual or legal analysis, that Eighteen Mile's claims were so outrageous as to warrant independent review of the liability issues decided in the state court. See J. App. at 133 (bankruptcy court's analysis); J. App. at 141-45 (district court's analysis).

The lower courts' application of Margolis to the instant case was error. Margolis and its progeny speak only to the bankruptcy court's broad equitable power to remedy fraudulent procurement of default judgments. The Margolis line does not alter section 1738's requirement that bankruptcy courts respect lawfully obtained state court judgments. Andrijevic concedes that the only established exceptions to this rule are not applicable in this case. While the record strongly suggests that the merits of Eighteen Mile's 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 Ins. & Annuity Ass'n 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.

The Bankruptcy Court's Damages Findings

Andrijevic contends that even if the courts below erred in disregarding the binding effect of the default judgment, they may be upheld on another ground. The default judgment spoke only to liability; it expressly contemplated a damages inquest that never took place. Andrijevic, therefore, contends that the bankruptcy court's analysis of the damages issues properly before it, in which the elements of the damages claims were deemed "facially outrageous" and summarily rejected, J. App. at 127, should be affirmed because these findings were not barred by the state proceedings.

While we agree that the state proceedings did not bar litigation of the damages issues, Rokina Optical, 480 N.Y.S.2d at 198-99, 469 N.E.2d at 519-20, we nonetheless remand to the bankruptcy court for a reevaluation of these issues. ¹ The bankruptcy court's analysis of damages was undertaken only after it had disallowed the claims on the merits; the bankruptcy court expressly stated that its analysis of the damages issues was unnecessary in light of its resolution of the liability issues. J. App. at 127. Moreover, the bankruptcy court's analysis of damages improperly incorporated some of its findings regarding liability, a matter already resolved by the state court default judgment.

The judgment of the district court is reversed. ² The district court is instructed to remand the matter to the bankruptcy court for a rehearing on damages giving res judicata effect to the liability judgment of the state court. ³

BLUMENFELD, District Judge (dissenting):

I cannot agree with my fellow members of the panel that the entry by the state court of this "default judgment" against the appellee on counterclaims brought by one of the appellant-creditors precludes the bankruptcy court from looking behind the state court determination and disallowing the claims in the bankruptcy proceeding. To require a mechanical application of the doctrine of res judicata and the seeming dictate of 28 U.S.C. Sec. 1738 ignores the broad equitable powers of the bankruptcy court to take actions necessary to achieve an equitable distribution of the bankrupt's estate among creditors. Although the federal bankruptcy power is "a field whose boundaries may not yet be fully revealed," Continental Ill. Nat'l Bank v. Chicago, Rock Island and Pac. Ry. Co., 294 U.S. 648, 671, 55 S.Ct. 595, 604, 79 L.Ed. 1110 (1935), in this instance, given the bankruptcy court's broad equity powers, it is clear that a number of factors combine to support the bankruptcy judge's decision to go behind the state court determination. These will be discussed separately.

I. The Nature of Bankruptcy Court Power

A. Paramountcy of Bankruptcy Law

The power of the bankruptcy court stems from a grant of authority in Article I of the Constitution, which grants to Congress the power "to establish ... uniform Laws on the subject of Bankruptcies throughout the United States." U.S. Const. art I, Sec. 8, cl. 4. The bankruptcy law is a paramount law, which takes precedence over all...