Klingman v. Levinson

Decision Date18 September 1987
Docket NumberNo. 86-2831,86-2831
Citation831 F.2d 1292
Parties, 16 Bankr.Ct.Dec. 1151, Bankr. L. Rep. P 71,990 Francine KLINGMAN, Plaintiff-Appellee, v. Melvin E. LEVINSON, Defendant-Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Melvin E. Levinson, Wilmette, Ill., for defendant-appellant.

Lionel I. Brazen, Chicago, Ill., for plaintiff-appellee.

Before COFFEY, RIPPLE and MANION, Circuit Judges.

RIPPLE, Circuit Judge.

In this appeal, we are asked to decide whether the appellee's judgment against the appellant is dischargeable in bankruptcy. The bankruptcy court held that the judgment was nondischargeable and the district court affirmed. For the reasons set forth below, we affirm the judgment of the district court.

I Background

In 1967, appellee Francine Klingman and appellant Melvin Levinson entered into a trust agreement. Mr. Levinson, an attorney, was named trustee. On March 11, 1970, Ms. Klingman filed suit against Mr. Levinson in the Circuit Court of Cook County alleging dissipation of the trust assets. The action was resolved by a consent judgment. Pursuant to that judgment, Mr. Levinson was to pay Ms. Klingman the amount of the original trust corpus, $37,550, plus interest and $10,000 in attorneys' fees. As part of the consent judgment, the parties stipulated:

4. That Defendant [Mr. Levinson], in disregard of his fiduciary duties and obligations as Trustee, has failed to retain and conserve the said trust corpus and income therefrom, but rather, in violation of and disregard of his fiduciary duties and obligations as Trustee, has, through his misappropriation and defalcation, allowed or caused the dissipation and loss of the said trust corpus and income therefrom.

* * *

* * *

6. That malice is the gist of this action, and that the Defendant has stipulated that it is his intention that the obligation to Plaintiff [Ms. Klingman] created by this Agreed Judgment Order not be dischargeable in any bankruptcy or similar proceeding, and that in any subsequent proceeding all of the allegations of the Complaint and findings of this Court may be taken as true and correct without further proof.

7. That the parties have stipulated and agreed that Plaintiff may recover from Defendant, in addition to any other amounts due, the expenses incurred by Plaintiff in maintaining this action, specifically including attorneys' fees, through the time of satisfaction of this judgment, which sum is found to be $10,000.00.

Agreed Judgment Order at 1-3; Appellant's Supp.App. at 4-7.

On April 22, 1982, Mr. Levinson filed a petition in bankruptcy. Ms. Klingman filed a response claiming that her judgment against Mr. Levinson pursuant to the consent agreement was nondischargeable under 11 U.S.C. Sec. 523(a)(4) because it resulted from fraud or defalcation by Mr. Levinson while he acted in a fiduciary capacity. Mr. Levinson filed an answer and two counterclaims. The bankruptcy court dismissed Mr. Levinson's counterclaims on May 29, 1985. 1

On March 18, 1986, the bankruptcy court granted Ms. Klingman's motion for summary judgment. The court held that Mr. Levinson was barred from relitigating the issue of defalcation under the principle of collateral estoppel because he had stipulated to the finding that he had violated his fiduciary duties by defalcating the assets of the trust. The bankruptcy court further held that the $10,000 debt representing legal fees was also nondischargeable because the award was ancillary to the primary debt. In re Levinson, 58 B.R. 831, 837 (Bankr.N.D.Ill.1986); Appellant's App. at 29-30. The district court affirmed the orders issued by the bankruptcy court based on the same reasoning that the principle of collateral estoppel precluded Mr. Levinson from claiming that the judgment was not the result of defalcation. Klingman v. Levinson, 66 B.R. 548 (N.D.Ill.1986); R. 13.

II Analysis
A. Collateral Estoppel and the Question of Dischargeability: General Principles

Section 523(a)(4) of the Bankruptcy Code provides that:

A discharge under section 727, 1141, or 1328(b) of this title does not discharge an individual debtor from any debt--

for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny....

The bankruptcy court and the district court held that the stipulation contained in the consent judgment that the appellant, "through his misappropriation and defalcation, allowed or caused the dissipation and loss of the said trust corpus and income therefrom" rendered the judgment nondischargeable under Sec. 523(a)(4). Mr. Levinson contends that the Supreme Court's decision in Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979), precludes the use by the bankruptcy court of the state court finding in the consent judgment that the dissipation of the trust assets resulted from misappropriation and fraud. He maintains that Ms. Klingman should not be able to use the doctrine of collateral estoppel offensively to establish that he acted with fraud or defalcation.

In Brown, the Supreme Court held that the principle of res judicata did not prevent a creditor from offering evidence of fraud to a bankruptcy court to establish the nondischargeability of a debt even though the record in an earlier state court proceeding had not established fraud. The state court suit would have involved litigation of the debtor's fraud, but the suit was settled by a stipulation that did not indicate the cause of action upon which the defendant's liability was based. The Court reasoned that res judicata should not bar the submission of evidence about the debtor's allegedly fraudulent conduct because without such evidence, the bankruptcy court would be unable to determine whether the debtor committed fraud, a question that was for the first time squarely in issue. The Court further stated that the dischargeability of the debt was an issue that Congress intended the bankruptcy courts, rather than the state courts, to decide. Id. at 138, 99 S.Ct. at 2212.

In Brown, however, the Court clearly distinguished between the application of res judicata and the application of collateral estoppel. The Court stated that:

This case concerns res judicata only, and not the narrower principle of collateral estoppel. Whereas res judicata forecloses all that which might have been litigated previously, collateral estoppel treats as final only those questions actually and necessarily decided in a prior suit. If, in the course of adjudicating a state-law question, a state court should determine factual issues using standards identical to those of Sec. 17, [governing the dischargeability of certain debts] then collateral estoppel, in the absence of countervailing statutory policy, would bar relitigation of those issues in the bankruptcy court.

Because respondent does not contend that the state litigation actually and necessarily decided either fraud or any other question against petitioner, we need not and therefore do not decide whether a bankruptcy court adjudicating a Sec. 17 question should give collateral-estoppel effect to a prior state judgment. In another context, the Court has held that a bankruptcy court should give collateral-estoppel effect to a prior decision. The 1970 amendments to the Bankruptcy Act, however, have been interpreted by some commentators to permit a contrary result.

Id. at 139 n. 10, 99 S.Ct. at 2213 n. 10 (citations omitted).

Despite this guidance by the Supreme Court, there is disagreement among the courts regarding the collateral estoppel effect accorded state court judgments in bankruptcy proceedings involving dischargeability. Some courts, because of the bankruptcy courts' exclusive jurisdiction in determining dischargeability, will give no collateral estoppel effect to state court determinations, while other courts do apply collateral estoppel when the issue was litigated previously by the parties. Compare In re Rahm, 641 F.2d 755, 757 (9th Cir.) (a prior state court judgment has no collateral estoppel force on a bankruptcy court considering dischargeability, but may establish a prima facie case of nondischargeability), cert. denied, 454 U.S. 860, 102 S.Ct. 313, 70 L.Ed.2d 157 (1981) with Matter of Shuler, 722 F.2d 1253, 1256 (5th Cir.) ("collateral estoppel may apply to subsidiary facts actually litigated and necessarily decided"), cert. denied, 469 U.S. 817, 105 S.Ct. 85, 83 L.Ed.2d 32 (1984); Goss v. Goss, 722 F.2d 599, 602-04 (10th Cir.1983), and Matter of Ross, 602 F.2d 604, 607 (3d Cir.1979) ("doctrine of collateral estoppel may be applicable to a dischargeability determination by the bankruptcy court"). The majority of courts apply collateral estoppel to dischargeability determinations where the state litigation actually and necessarily decided the relevant issue. See Matter of Shuler, 722 F.2d at 1256 ("that collateral estoppel may apply to subsidiary facts actually litigated and necessarily decided--represents the predominant view of the other circuits that have considered the issue"). This result is, we believe, the appropriate one. As the Sixth Circuit noted in Spilman v. Harley, 656 F.2d 224, 227 (6th Cir.1981), "that Congress intended the bankruptcy court to determine the final result--dischargeability or not--does not require the bankruptcy court to redetermine all the underlying facts." Where a state court determines factual questions using the same standards as the bankruptcy court would use, collateral estoppel should be applied to promote judicial economy by encouraging the parties to present their strongest arguments. See id. at 228. Thus, if the requirements for applying collateral estoppel have been satisfied, then that doctrine should apply to bar relitigation of an issue determined by a state court.

B. Application of Collateral Estoppel Principles in this Case

As stated by the district court and acknowledged by the parties, there are four requirements for collateral estoppel: 1) the issue sought to...

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