Jamie Harris in our firm recently posted about collateral estoppel in bankruptcy cases. Collateral estoppel is one of those terms that usually ends the conversation at cocktail parties, or draws glazed looks when attorneys discuss it with clients. I like to explain it as “you only get one bite at the apple.” Individuals or businesses that are considering bankruptcy are often involved in lawsuits. These may range from credit card collection suits, to foreclosures, to allegations of fraud or misrepresentation or fights between business partners. Depending on what has happened in a lawsuit, you may not be able to take full advantage of the rights and protection bankruptcy offers.
An example of losing the “second bite at the apple” is often seen in foreclosure lawsuits. A borrower may not have defenses in a lawsuit where the lender is enforcing its mortgage and selling real property, and may decide not to spend money on legal fees to fight what they see as a losing battle. Instead, the borrower may file bankruptcy to get the chance to catch up on a mortgage and stay in a home. But the foreclosing lender asks the court not just to sell the real property, but for a judgment for the unpaid balance due on the loan. Getting such a judgment normally prevents a borrower/debtor from questioning the amount due in a later bankruptcy proceeding.
A recent decision by the federal district court in Indianapolis, Indiana provides an example. In Harris v. Deutsche Bank National Trust Co., Case 1:15-cv-00928, 2/8/16, Ms. Harris participated in the state court foreclosure action and made several arguments that the loan balance was not properly calculated. The state court ruled in favor of the lender, granted a judgment allowing the lender to sell the real estate, and held Ms. Harris personally liable for the debt. Ms. Harris filed a Chapter 13 bankruptcy (presumably, to catch up her mortgage and stay in her home), and objected to the bankruptcy claim which the lender filed. Both the bankruptcy judge and the federal district judge (on appeal), ruled that Ms. Harris could not question the amount of the lender’s claim in bankruptcy, because the state court had already determined the amount that was due. The practical result of this could well be that Ms. Harris won’t be able to stay in her home, since she may not be able to pay enough money to bring her mortgage current during her Chapter 13 bankruptcy.
Other, more serious consequences can result from having a judgment entered in a state court lawsuit. We have seen many cases where an individual was accused of fraud, misrepresentation, or malicious conduct in a state court lawsuit; had a judgment entered against them on such claims; then sought the protection of the bankruptcy court. People often don’t realize that while a bankruptcy normally ends the obligation to pay creditors (a “discharge”), some types of debts survive. These include debts such as taxes, alimony and child support, or criminal restitution. Exceptions also exist for debts which result from fraud, misrepresentation or “willful and malicious” injuries. In applying these exceptions, bankruptcy courts often rule that exceptions to discharge should be “narrowly construed,” and favor granting a discharge to debtors. However, if a state court judge or jury has already considered the facts and issued a judgment that finds the elements of fraud, misrepresentation or willful and malicious injury exist, the debtor probably won’t get a “second bite” in bankruptcy court. The bankruptcy judges in the Eastern District of Kentucky have used collateral estoppel on at least two recent occasions to deny debtors relief from state court judgments finding such conduct. Fisher v. Anderson (In re Anderson), 2014 WL 98691 (Bankr. E.D. Ky. January 10, 2014), aff’d, 520 B.R. 89 (B.A.P. 6th Cir. 2014); Panther Petroleum, LLC v. Couch (In re Couch), 2016 WL 97524, at *4 (Bankr. E.D. Ky. Jan. 7, 2016).
If you are involved in litigation that could result in a judgment against you, no matter how unlikely you think it may be, it is worth your time to have a risk analysis done and evaluate whether or not a judgment against you could limit future bankruptcy relief due to collateral estoppel. We’re here to help.