Bankruptcy Judge Squires Opinion (15)

I. JURISDICTION AND PROCEDURE

The Court has jurisdiction to entertain this matter pursuant to 28 U.S.C. § 1334 and Internal Operating Procedure 15(a) of the United States District Court for the Northern District of Illinois. It is a core proceeding under 28 U.S.C. § 157(b)(2)(I).

A. Exception to the Discharge of a Debt

The party seeking to establish an exception to the discharge of a debt bears the burden of proof. In re Harasymiw, 895 F.2d 1170, 1172 (7th Cir. 1990); Banner Oil Co. v. Bryson (In re Bryson), 187 B.R. 939, 961 (Bankr. N.D. Ill. 1995). The United States Supreme Court has held that the burden of proof required to establish an exception to discharge is a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 291 (1991); see also In re McFarland, 84 F.3d 943, 946 (7th Cir.), cert. denied, 519 U.S. 931 (1996); In re Thirtyacre, 36 F.3d 697, 700 (7th Cir. 1994). Exceptions to discharge are to be construed strictly against a creditor and liberally in favor of a debtor in order to further the policy of providing a debtor with a fresh start in bankruptcy. In re Morris, 223 F.3d 548, 552 (7th Cir. 2000); In re Reines, 142 F.3d 970, 97273 (7th Cir. 1998), cert. denied, 525 U.S. 1068 (1999); In re Scarlata, 979 F.2d 521, 524 (7th Cir.

1992); In re Zarzynski, 771 F.2d 304, 306 (7th Cir. 1985). “The statute is narrowly construed so as not to undermine the Code’s purpose of giving the honest but unfortunate debtor a fresh start.” Park Nat’l Bank & Trust of Chi. v. Paul (In re Paul), 266 B.R. 686, 693 (Bankr. N.D. Ill. 2001).

B. 11 U.S.C. § 523(a)(2)(A)

Section 523 of the Bankruptcy Code enumerates specific, limited exceptions to the dischargeability of debts. Section 523(a)(2)(A) provides that:

(a) A discharge under section 727 . . . does not discharge an

individual debtor from any debt–
. . .

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by–

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition[.]

11 U.S.C. § 523(a)(2)(A) (2005). Section 523(a)(2)(A) lists three separate grounds for

dischargeability: actual fraud, false pretenses and a false representation. Id.; Bletnitsky v. Jairath

(In re Jairath), 259 B.R. 308, 314 (Bankr. N.D. Ill. 2001). A single test is applied to all three

grounds even though the elements for each vary under common law. Jairath, 259 B.R. at 314.

1. False pretenses or false representation

In order to except false pretenses or a false representation from discharge under § 523(a)(2)(A), a creditor must establish the following elements: (1) the debtor made a false representation of fact (2) which the debtor either (a) knew to be false or made with reckless disregard for its truth and (b) made with an intent to deceive; and (3) the creditor justifiably relied on the false representation. Baker Dev. Corp. v. Mulder (In re Mulder), 307 B.R. 637, 643 (Bankr. N.D. Ill. 2004); Bednarsz v. Brzakala (In re Brzakala), 305 B.R. 705, 710 (Bankr. N.D. Ill. 2004). To prevail on a § 523(a)(2)(A) complaint, all three elements must be established. Glucona Am., Inc. v. Ardisson (In re Ardisson), 272 B.R. 346, 357 (Bankr. N.D. Ill. 2001). Failure to establish any one fact is outcome determinative. Jairath, 259 B.R. at 314.

“Proof of intent to deceive is measured by the debtor’s subjective intention at the time the representation was made.” CFC Wireforms, Inc. v. Monroe (In re Monroe), 304 B.R. 349, 356 (Bankr. N.D. Ill. 2004). “Where a person knowingly or recklessly makes false representations which the person knows or should know will induce another to act, the finder of fact may logically infer an intent to deceive.” Jairath, 259 B.R. at 315.

Reliance on a false pretense or false representation under § 523(a)(2)(A) must be “justifiable.” Field v. Mans, 516 U.S. 59, 74-75 (1995). The justifiable reliance standard imposes no duty to investigate unless the falsity of the representation is readily apparent. Id. at 70-72. Whether a party justifiably relies on a misrepresentation is determined by looking at the circumstances of a particular case and the characteristics of a particular plaintiff, not by an objective standard. Id. at 71; Bombardier Capital, Inc. v. Dobek (In re Dobek), 278 B.R. 496, 508 (Bankr. N.D. Ill. 2002). To satisfy the reliance element of § 523(a)(2)(A), the creditor must show that the debtor made a material misrepresentation that was the cause-in-fact of the debt that the creditor wants excepted from discharge. Mayer v. Spanel Int’l Ltd. (In re Mayer), 51 F.3d 670, 676 (7th Cir.), cert. denied, 516 U.S. 1008 (1995) (“Reliance means the conjunction of a material misrepresentation with causation in fact.”). “[A] person is justified in relying on a representation of fact although he might have ascertained the falsity of the representation had he made an investigation.” Mercantile Bank v. Canovas, 237 B.R. 423, 429 (Bankr. N.D. Ill.

1998) (quoting Field v. Mans, 516 U.S. at 70).

2. Actual fraud

The Seventh Circuit Court of Appeals has made it clear that misrepresentation and reliance thereon are not always required to establish fraud. McClellan v. Cantrell, 217 F.3d 890, 894 (7th Cir. 2000). Indeed, the Seventh Circuit recently defined the term “fraud”:

‘Fraud is a generic term, which embraces all the multifarious means which human ingenuity can devise and which are resorted to by one individual to gain an advantage over another by false suggestions or by the suppression of truth. No definite and invariable rule can be laid down as a general proposition defining fraud, and it includes all surprise, trick, cunning, dissembling, and any unfair way by which another is cheated.’

Id. at 893 (quoting Stapleton v. Holt, 250 P.2d 451, 453-54 (Okla. 1952)). “Actual fraud” is not limited to misrepresentation, but may encompass “any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another.” Id. Hence, a different analysis must be utilized when a creditor alleges actual fraud. Id. The McClellan court opined that because common law fraud does not always take the form of a misrepresentation, a creditor need not allege misrepresentation and reliance thereon to state a cause of action for actual fraud under § 523(a)(2)(A). Id. Rather, the creditor must establish the following: (1) a fraud occurred; (2) the debtor intended to defraud the creditor; and (3) the fraud created the debt that is the subject of the discharge dispute. Id. The fraud exception under § 523(a)(2)(A) does not reach constructive frauds, only actual ones. Id. at 894. “Though cases often say that exclusions from dischargeability should be narrowly construed, we have emphasized that they serve vital functions.” Id. at 893 (quoting Mayer, 51 F.3d at 674) (internal citations omitted). “Congress concluded that preventing fraud is more important than letting defrauders start over with a clean slate, and we must respect that judgment.” Id. (quoting Mayer, 51 F.3d at 674).

C. 11 U.S.C. § 523(a)(6)

Section § 523(a)(6) of the Bankruptcy Code provides that:

(a) A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt–

(6) for willful and malicious injury by the debtor to another entity or to the property of another entity[.]

11 U.S.C. § 523(a)(6) (2005). In order to be entitled to a determination of nondischargeability

under § 523(a)(6), the movant must prove three elements by a preponderance of the evidence:

(1) that the debtor intended to and caused an injury to the creditor’s property interest; (2) that the debtor’s actions were willful; and (3) that the debtor’s actions were malicious. Mulder, 307

B.R. at 641; Ardisson, 272 B.R. at 356; French, Kezelis & Kominiarek, P.C. v. Carlson (In re Carlson), 224 B.R. 659, 662 (Bankr. N.D. Ill. 1998), aff’d, No. 99 C 6020, 2000 WL 226706

(N.D.

Ill. Feb. 22, 2000), aff’d, No. 00-1720, 2001 WL 1313652 (7th Cir. Oct. 23, 2001). “Since a person will rarely, if ever, admit to acting in a willful and malicious manner, those requirements must be inferred from the circumstances surrounding the injury at issue.” Cutler

v.

Lazzara (In re Lazzara), 287 B.R. 714, 723 (Bankr. N.D. Ill. 2002).

“The word ‘willful’ in (a)(6) modifies the word ‘injury,’ indicating that nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.” Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998) (emphasis in original). Under Geiger and its more stringent standards, to satisfy the requirements of § 523(a)(6), the creditor must plead and prove that the debtor actually intended to harm it and not merely that the debtor acted intentionally and it was thus harmed. Id. at 61-62. In other words, the debtor must have intended the consequences of his act. Id; see also Berkson v. Gulevsky (In re Gulevsky), 362 F.3d 961, 964 (7th Cir. 2004). Injuries either negligently or recklessly inflicted do not come within the scope of § 523(a)(6). Geiger, 523 U.S. at 64.

The Supreme Court did not define the scope of the term “intent” utilized to describe willful conduct. Recent decisions, however, have found that either a showing of subjective intent to injure the creditor or a showing of a debtor’s subjective knowledge that injury is substantially certain to result from his acts can establish the requisite intent required in Geiger. See Su v. Carrillo (In re Su), 259 B.R. 909, 913 (B.A.P. 9th Cir. 2001); State of Tex. v. Walker, 142 F.3d 813, 823 (5th Cir. 1998), cert. denied, 525 U.S. 1102 (1999); Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 463-65 (6th Cir. 1999); Fidelity Fin. Servs. v. Cox (In re Cox), 243 B.R. 713, 719 (Bankr. N.D. Ill. 2000). Because a person will rarely admit to acting in a willful and malicious manner, those requirements must be inferred from the circumstances surrounding the injury. Lazzara, 287 B.R. at 723.

An act is “malicious” if it is taken “in conscious disregard of one’s duties or without just cause or excuse. . . .” Thirtyacre, 36 F.3d at 700. The test for maliciousness under § 523(a)(6) is (1) a wrongful act, (2) done intentionally, (3) which causes injury to the creditor, and (4) is done without just cause and excuse. Paul, 266 B.R. at 696. A debtor does not have to act with ill will or a specific intent to do harm to the creditor for the conduct to be malicious. Thirtyacre, 36 F.3d at 700. Whether an actor behaved willfully and maliciously is ultimately a question of fact reserved for the trier of fact. Id.

D. Collateral Estoppel

The doctrine of collateral estoppel precludes a relitigation of issues previously determined in another court. Brown v. Felsen, 442 U.S. 127, 139 (1979); Jensen v. Foley, 295 F.3d 745, 748 (7th Cir. 2002) (finding that collateral estoppel “prevents a party from relitigating an issue that it has previously litigated and lost”). The United States Supreme Court has held that collateral estoppel principles apply to proceedings involving the dischargeability of a debt under 11 U.S.C. § 523(a). Grogan, 498 U.S. at 285 n.11 (“[C]ollateral estoppel principles do indeed apply in discharge exception proceedings pursuant to § 523(a).”). Hence, “where a court of competent jurisdiction has previously ruled against a debtor upon specific issues of fact that independently comprise elements of a creditor’s nondischargeability claim, the debtor may not seek to relitigate those underlying facts in bankruptcy court, provided that the issues involved had been ‘actually litigated.’” Carlson, 224 B.R. at 663.

Federal courts must give full faith and credit to the collateral estoppel effects of state court judgments under state standards. 28 U.S.C. § 1738; Marrese v. Am. Acad. of Orthopaedic Surgeons, 470 U.S. 373, 380 (1985); Am. Nat’l Bank & Trust Co. v. Reg’l Transp. Auth., 125 F.3d 420, 430 (7th Cir. 1997). Bankruptcy courts are bound by this obligation. See Gouveia v. Tazbir, 37 F.3d 295, 300 (7th Cir. 1994). “The preclusive effect of a state court judgment in a federal case is a matter of state rather than of federal law.” A.D. Brokaw v. Weaver, 305 F.3d 660, 669 (7th Cir. 2002) (quoting CIGNA Healthcare of St. Louis, Inc. v. Kaiser, 294 F.3d 849, 856 (7th Cir. 2002)). Because this matter presents a question regarding the collateral estoppel effect of an Illinois state court order, the Court must apply the Illinois law of collateral estoppel.

In re Catt, 368 F.3d 789, 790-91 (7th Cir. 2004) (“The effect of a judgment in subsequent litigation is determined by the law of the jurisdiction that rendered the judgment. . . .”).

Under Illinois law, the essential elements for application of collateral estoppel are: (1) the issue decided in the prior adjudication must be identical to the issue in the current action; (2) the party against whom the estoppel is asserted must have been a party or in privity with a party to the prior case; and (3) there must have been a final judgment on the merits in the prior action. Kalush v. Deluxe Corp., 171 F.3d 489, 493 (7th Cir. 1999) (citing Herzog v. Lexington Township, 167 Ill.2d 288, 295, 657 N.E.2d 926, 929-30 (1995)). See also Nowak v. St. Rita High School, 197 Ill.2d 381, 389-90, 757 N.E.2d 471, 477 (2001); DuPage Forklift Serv., Inc. v. Material Handling Servs., Inc., 195 Ill.2d 71, 77, 744 N.E.2d 845, 849 (2001). In Illinois, collateral estoppel is “limited to the precise factual or legal issues actually litigated and decided when a prior order was entered.” People v. Williams, 138 Ill.2d 377, 393, 563 N.E.2d 385, 392 (1990).

V. DISCUSSION

Household argues that its claim against the Debtor that arose from the Mortgage Litigation was found by the state court to result from the Debtor’s fraud and willful and malicious injury to Household’s property interests, and is therefore nondischargeable under the Bankruptcy Code. “If a state court finds that a debtor intentionally injured a creditor, the bankruptcy court is required under the doctrine of collateral estoppel to hold the debt nondischargeable.” Prairie Eye Center v. Butler (In re Butler), 297 B.R. 741, 747-48 (Bankr.

C.D. Ill. 2003). “In the Seventh Circuit, collateral estoppel can apply to cases in which a court hearing a nonbankruptcy case has determined factual issues relevant to a subsequent nondischargeability claim, provided that the nonbankruptcy court used the same standards that a bankruptcy court would have used in determining the issues which are subsequently given collateral estoppel effect.” Katahn Assocs., Inc. v. Wien (In re Wien), 155 B.R. 479, 484 (Bankr. N.D. Ill. 1993). “Although Congress has vested jurisdiction to determine the dischargeability of debt in the bankruptcy court, it does not mean that every last fact issue bearing on dischargeability must be re-litigated, re-tried, and again decided when there has been a prior determination of the same facts by a court of competent jurisdiction.” Id.

In this matter, the factual findings articulated by the state court derived from the same standards this Court uses for purposes of § 523(a)(2)(A) and § 523(a)(6) nondischargeability actions, and this Court gives full faith and credit to the state court’s Contempt Order. In this matter, the requirements for the Court to apply the doctrine of collateral estoppel have been met.

Applying Illinois law, the Court will discuss each requisite element for the application of collateral estoppel. First, the issues decided in the prior adjudication must be identical to the issues in the current action. Detailed findings of fact from the earlier proceeding are necessary to enable the bankruptcy court in the subsequent adversary proceeding to determine which facts were actually proven, which issues were decided, and what was essential to the other court’s judgment. It is both fair and logical that a party be required to prove all essential elements of its case at least once before the doctrine of collateral estoppel may be appropriately applied in the second proceeding.

“A bankruptcy court usually reviews the entire record of an earlier proceeding when deciding whether a matter has been actually litigated for purposes of collateral estoppel.” Id. at 486. In this matter, the Court has been provided with a sufficient portion of the record from the earlier proceeding including the Contempt Order and the corresponding hearing transcript. A review of that record indicates that with respect to the elements under § 523(a)(2)(A), the state court articulated its findings of fraud, and the Court thus finds that the elements of actual fraud were actually litigated in the state court.3

As stated in the Contempt Order, the state court found that the conduct of the Debtor in connection with [the Mortgage Litigation] revealed a pattern of wilful [sic] deceit, deception and disregard of [his] legal obligations and the process of this Court. Not only [has he] taken every advantage of the wrongful release of [his] legal obligation reflected by the Household Mortgage and Note, but [he has] failed to comply with the Agreed Final Judgment Order, and [has] failed to appear as directed to explain said failure despite having been afforded notice via proper service and a full opportunity to be heard. Pl. Ex. 18 at p. 3 ¶ 12.

The Contempt Order also stated that the Debtor represented that he had the financial means to comply with the state court’s direction and that he intended to comply with that direction, however “[s]aid representations were false, and were made with full knowledge of their falsity and an intent to deceive Household and the Court. Both Household and the Court relied on these representations in, respectively, agreeing to and entering the [Final Order]. Said representations were thus fraudulent.” Id. at ¶ 13. In addition, the state court found that both

3

In the Final Order, the state court reserved ruling on the fraud and conversion issues and stated that it “makes no finding regarding . . . any claim that the conduct of [the Debtor], including but not limited to the conduct in obtaining the release of the [Note], was wilfully [sic] fraudulent, or that the obligations of [the Debtor] are otherwise nondischargeable in bankruptcy.” Pl. Ex. 10 at p. 4 ¶ 11. In the Contempt Order, however, the state court made its express findings on both the fraud and conversion issues and stated that the Contempt Order “supercedes paragraph 11 of the [Final Order]. . . .” Pl. Ex. 18 at

p. 4 ¶ 8.
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the release of the Note and the Final Order “are adjudged to have been procured through willful fraud. . . .” Id. at p. 4 ¶ 3. As demonstrated by the state court record and Contempt Order, this Court finds that the issue of actual fraud was actually litigated and decided for purposes of collateral estoppel, and that the state court made a finding of actual fraud for purposes of § 523(a)(2)(A).

Turning to § 523(a)(6), the state court found that the Debtor’s conduct with respect to the Mortgage Litigation constituted willful and malicious injury to the property and interests of Household. As set forth in the Contempt Order, in addition to finding actual fraud, the state court found that the Debtor’s conduct reflected “willful and malicious injury to the property and interests of Household.” Pl. Ex. 18 at p. 3 ¶ 16. The state court also found that the release of the Note and the Final Order were “adjudged to reflect the willful and malicious injury to the property interests of Household.” Id. at p. 4 ¶ 3. As required by § 523(a)(6), the state court adjudged the Debtor’s behavior to have caused willful and malicious injury to Household. Therefore, this Court finds that the issue of willful and malicious injury to Household under § 523(a)(6) was actually litigated and decided in the state court for purposes of collateral estoppel. Accordingly, the first element for the application of collateral estoppel has been met.

Second, the Court finds that both the Debtor and Household were parties to the prior proceedings. Thus, the second requirement for the application of the doctrine of collateral estoppel under Illinois law has been satisfied. In addition, at all times in the state court proceedings, the Debtor was represented by counsel who argued unsuccessfully at the Contempt Order hearing.

The third element of collateral estoppel involves final judgment on the merits in the prior action. The merits of the § 523(a)(2)(A) and § 523(a)(6) nondischargeability action must have been adjudicated to final judgment in order for collateral estoppel to be applicable. The Court finds that the Contempt Order constitutes a final adjudication on the merits, and according to that order, all essential elements under § 523(a)(2)(A) and § 523(a)(6) were adjudicated to final judgment. Therefore, the third and final element for collateral estoppel to apply has been met. The Court holds that there are no material issues of fact in dispute and that Household is entitled to judgment as a matter of law. Thus, the Court hereby grants Household’s motion for summary judgment.

V. CONCLUSION

For the foregoing reasons, the Court grants the motion of Household for summary judgment. The Court finds the debt owed by the Debtor to Household is nondischargeable pursuant to § 523(a)(2)(A) and § 523(a)(6). The trial in this matter set to commence on August 29, 2005 is hereby stricken.

This Opinion constitutes the Court’s findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate order shall be entered pursuant to Federal Rule of Bankruptcy Procedure 9021.

ENTERED: