Matter of Farrell

• Decision Date: 15 December 1982
• Docket Number: Bankruptcy No. 180-05449-A256.
• Citation: 27 BR 241
• Parties: In the matter of James T. FARRELL and Elizabeth A. Farrell, Debtors.
• Court: U.S. Bankruptcy Court — Eastern District of New York

27 B.R. 241 (1982)

In the matter of James T. FARRELL and Elizabeth A. Farrell, Debtors.

Bankruptcy No. 180-05449-A256.

United States Bankruptcy Court, E.D. New York.

December 15, 1982.

Barst, Mukamal & Babitt, New York City, for debtors; James Pagano, Jeffrey Fogelson, New York City, of counsel.

David Halperin, P.C., New York City, for ESIC Capital, Inc.; Howard Slotnick, New York City, of counsel.

DECISION AND ORDER

CONRAD B. DUBERSTEIN, Bankruptcy Judge.

James and Elizabeth Farrell filed a petition for relief and plan pursuant to Chapter 13 of the Bankruptcy Code. In their Chapter 13 Statement under the Section entitled "11a Secured debts," the sum of $140,548 is listed by them as the amount claimed by ESIC Capital, Inc. (hereafter "ESIC") secured by a second mortgage executed by James Farrell on the Farrell residence. The claim is listed as disputed with an indication that nothing is owed ESIC.

The Farrell's Chapter 13 plan states that "the debtors propose to pay secured creditors outside of the plan as follows: "Dime Savings Bank—Mortgage—$564.00 per month, Republic National Bank—Mortgage —$138.00 per month, ESIC Capital Corp. (Disputed)." The plan further provides for 100% payment to unsecured creditors over a period of three years.

At the hearing on confirmation ESIC filed an objection to the confirmation of the plan on the ground that the plan does not provide for satisfaction of its secured claim. In addition, ESIC filed a secured proof of claim in the sum of $129,372.89 together with interest from June 2, 1980, at the rate of 14 per cent per annum plus attorneys' fees in the amount of $8,000. Attached to the proof of claim is a copy of a judgment of foreclosure and sale procured by ESIC on the debtors' residence.

The factual history of the relationship between ESIC and the Farrells to the extent that it is not in dispute is as follows:

In November, 1971, James T. Farrell purchased F & J Industries, Inc. ("F & J"). Following the purchase, James and Elizabeth Farrell entered into an agreement with ESIC which provided as follows: 1) ESIC lent F & J the sum of One Hundred Twenty-Five Thousand ($125,000.00) dollars for a term of seven (7) years. Interest was fixed at fourteen (14%) percent per annum. 2) the repayment of the loan was jointly and severally guaranteed by the Farrells and 3) James T. Farrell, executed and delivered to ESIC a second mortgage on the Farrells' residence, title to which is held by James Farrell alone, as security for the loan.

In November of 1979, F & J ceased doing business. F & J failed to pay its debt to ESIC and the Farrells defaulted on their guarantee. As a result, ESIC commenced an action in the Supreme Court of the State of New York, Nassau County, in January, 1980 to foreclose its second mortgage. The debtors failed to answer within the statutory time period and thus defaulted. Prior to the formal entry of a judgment, the debtors sought a stipulation from ESIC allowing them to file a late answer. ESIC refused to stipulate.

Mr. Farrell made a motion in state court to open his default in pleading and obtain an extension of time to serve his answer. He asserted that the default was excusable and that there were meritorious defenses to ESIC's claim. The defenses as set forth in his moving papers consisted of the following:

1. It was impossible for the debtors to perform because the City of New York forced a closing of the store during the New York visit of Fidel Castro; the store was on the same block as the Cuban Embassy to the United Nations. The street was closed off to the public for security reasons.

2. The debtors had paid ESIC $4,000 in interest payments which were applied to a further advance of $50,000 made by ESIC which had increased the aggregate amount of advances to $175,000.

3. The foreclosure action could not affect the debtor, Elizabeth Farrell, because she did not co-sign the mortgage agreement, but was a joint owner of the residence.¹

The State Court denied Mr. Farrell's motion on March 18, 1980. This determination was never appealed. On July 30, 1980 a judgment of foreclosure was entered.

Less than one week before the scheduled sale of the property, the debtors filed their Chapter 13 petition. The filing of the petition automatically stayed the sale of the property in accordance with Section 362 of the Bankruptcy Code (11 U.S.C. Section 362). In response, ESIC filed its objections to the confirmation of the plan.

ESIC asserts that its claim cannot be considered under dispute as it has already been litigated and a judgment of foreclosure has entered. The debtors contend that they have meritorious defenses to the foreclosure and that this court should look behind the state court foreclosure judgment to examine and determine the validity of those defenses at a full trial. Debtors' defenses include allegations that ESIC's loan was usurious as well as the other defenses that were previously asserted in James Farrell's motion to vacate default. ESIC claims that principles of res judicata prevent the bankruptcy court from looking behind the state court judgment.

It is clear that the bankruptcy court by virtue of 28 U.S.C. Section 1738 is to give full faith and credit to a prior final state court judgment in the same manner as would the court in that state pursuant to the Full Faith and Credit Clause of the Constitution. In re Lockwood, 14 B.R. 374, 377, 8 B.C.D. 128 (Bkrtcy.E.D.N.Y.1981); In re Bus Stop, Inc., 3 B.R. 26, 6 B.C.D. 138 (Bkrtcy.S.D.Fla.1980). Res judicata requires that a valid final judgment on the merits by a court of competent jurisdiction be treated as an absolute bar to the assertion of claims or defenses in a subsequent action based on the same cause of action involving the same parties whether or not such claims or defenses were pleaded or determined in the prior proceeding. Teltronics v. L.M. Ericsson Telecommunications, 642 F.2d 31 (2d Cir.1981), cert. den. 452 U.S. 960, 101 S.Ct. 3108, 60 L.Ed.2d 971 (1981). Both the federal district courts and the New York courts hold that this is so even if the prior judgment was entered on default. 18 Moore's Federal Practice, paragraph 0.409(4) (2d. ed. 1982). Newton v. Hook, 48 N.Y. 676 (1872); Mitchell v. Insurance Co. of America, 40 A.D.2d 873, 338 N.Y.S.2d 92 (A.D.2d Dep't.1972).

The test for determining whether the causes of action are the same in both proceedings has been stated by the Second Circuit in Herendeen v. Champion International Corp., 525 F.2d 130, (2d Cir.1975) in the following manner:

"Most frequently cited as the relevant criteria by both this court and the New York courts are whether a different judgment in the second action would impair or destroy rights or interests established by the judgment entered in the first action, whether the same evidence is necessary to maintain the second cause of action as was required in the first, and whether the essential facts and issues in the second were presented in the first." Id. at 133-4.

Obviously, a determination by this court that ESIC does not have a valid claim thereby invalidating ESIC's judgment of foreclosure would destroy rights established by the state court judgment. Additionally, since this court would have to look to the law of the State of New York to determine the validity of the defenses raised regarding impossibility of performance and usery and the validity of ESIC's loan and security, the same evidence is necessary to a determination in this proceeding as would have been required in the prior proceeding. Lastly, this court is not aware of any facts or issues which exist now that did not exist at the time of the earlier proceeding nor is it aware of any issues that could not have been raised earlier. Therefore, if the general rule requiring the application of res judicata is to prevail, this court must find that the state court proceedings are res judicata as to the Farrells' defenses to ESIC's objection to confirmation.

The debtors argue that the Supreme Court decision in Brown v. Felsen, 442 U.S. 127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979) gives this court the authority to look behind the state court judgment and allow the debtors to submit evidence designed to prove the allegations they believe would constitute defenses to ESIC's foreclosure action and its objection to confirmation in the within proceeding, notwithstanding principles of res judicata and full faith and credit. In Brown v. Felsen, Brown had guaranteed a loan made by Felsen, the debtor, for Felsen's car dealership corporation. The lender brought a collection suit naming Brown, Felsen and Felsen's corporation as defendants. Brown submitted an answer and cross-claim alleging the non-disclosure of material facts. The suit was settled by stipulation which provided that the defendants, Brown, Felsen and the Corporation, were jointly and severally liable to the lender and that Felsen was liable to Brown, although the first cause of action on which Felsen's liability to Brown was based, was not disclosed in the stipulation or the resulting judgment. Thereafter, Felsen filed a petition in bankruptcy and listed the debt to Brown in his petition. Brown brought an action pursuant to Section 17a(2) and Section 17a(4), the nondischargeability sections of the Bankruptcy Act, seeking to have the guaranteed debt declared nondischargeable on the ground that it was a product of fraud, deceit and malicious conversion. The debtor made a motion for summary judgment contending that the prior state court proceeding did not result in a finding of fraud and that this finding cannot now be made because the concept of res judicata bars relitigation of the nature of Felsen's debt to Brown. The Supreme Court, reversing the holdings of the court below, rejected the contention that res judicata applied and held that "the bankruptcy court is not confined to a review of the judgment and record in the prior state court proceedings when considering the dischargeability...