California Court Discusses Issue Preclusion in Bankruptcy Cases

Typically, when people file for bankruptcy, the majority of the debts they owe will be discharged, subject to certain exceptions. In some instances, though, a party that is owed money from the debtor will file an adversary action arguing that a debt should not be discharged because it was incurred via fraudulent means. In a recent case, a California bankruptcy court analyzed whether a default judgment for fraud is sufficient to demonstrate that a debt should not be discharged as a matter of law. If you live in California and are overcome by debt, you may be able to seek relief under the bankruptcy code and should speak to a trusted California bankruptcy attorney as soon as possible.

Factual History

It is reported that the creditors made a set of loans to a company that was owned by the debtors. The company ultimately ran into financial trouble and was unable to make payments on the loans. The debtors then offered to transfer their inventory to the creditors as partial payment for the money owed and proposed a coordinated settlement. The creditors accepted the inventory but later determined it was worth over thirty thousand less than the debtors represented. Negotiations on the proposed settlement fell through, and the creditors filed a lawsuit against the debtors, alleging multiple claims, including fraud.

Allegedly, the debtors failed to file an answer, and a default judgment was entered against them. The debtors then filed a petition for bankruptcy, after which the creditors filed an adversary complaint, arguing that the default judgment should not be discharged. They filed a motion for summary judgment as well, arguing that the court was precluded from allowing the debtors to re-litigate the issue of whether they engaged in fraud. The court granted the motion, and the debtors appealed.

Issue Preclusion in Bankruptcy Cases

The issue preclusion of a state court judgment may provide a basis for summary judgment in a bankruptcy adversary proceeding. In other words, bankruptcy courts must grant the same preclusive effect to a state court judgment that would be granted in the state where the judgment was issued. Under California law, issue preclusion prohibits a party from re-litigating an issue that was previously decided, if the issues are the same in the first and second cases, the issue was actually litigated, the issue was decided in the first case,  and the party is the same in both cases.

When the cases involve a default judgment, issue preclusion will only apply if the defendant had actual knowledge of the suit or was personally served with the suit, or the record shows an express finding on the issue for which preclusion is sought. In the subject case, the appellate court found that the lower court erred in finding that the issues were identical in both cases and that the lower court necessarily decided the issue of whether the debtors engaged in fraud. As such, the court overturned the prior ruling.

Speak to a Seasoned California Bankruptcy Attorney

While most debts are dischargeable via bankruptcy, some are not, and it is critical for anyone seeking debt relief to understand their obligations. If you are interested in filing for bankruptcy, it is prudent to speak to an attorney to discuss your options. California bankruptcy attorney Matthew D. Roy can advise you of what debts you may be able to discharge by filing for bankruptcy, and he can assist you in seeking a favorable result. He can be contacted at (916) 361-6028 or through the form online to set up a meeting.