Using Issue Preclusion (Collateral Estoppel) to Establish the Nondischargeability of a State-Court Judgment

Using Issue Preclusion (Collateral Estoppel) to Establish the Nondischargeability of a State-Court Judgment-0

Using Issue Preclusion (Collateral Estoppel) to Establish the Nondischargeability of a State-Court Judgment

Written by Robert B., OLN Freelance Attorney.

One situation I frequently encounter in my practice – on both the creditor and debtor side – is whether a creditor can use a state-court judgment to obtain summary judgment in a bankruptcy court action (Adversary Proceeding) to determine that a particular debt cannot be discharged in bankruptcy. This blog post provides the general principles applicable to this situation.

As a preliminary matter, it is important to remember that only certain debts can be excepted from a debtor’s general discharge; ordinary contract and trade debts are almost always dischargeable. The most common nondischargeable debts arise from a debtor’s fraudulent conduct, breach of fiduciary duty, or intentional tort. 11 U.S.C. § 523(a)(2), (4), and (6), respectively.

The preclusive effect of a state-court judgment, i.e., whether the judgment can be used to establish your claims as a matter of law at the summary judgment stage, is determined by the law of the jurisdiction in which the judgment was rendered. Although the exact wording, interpretation, and application of the requirements for determining the preclusive effect of a judgment vary, most jurisdictions require that: (1) the issue sought to be precluded is the same as the one involved in the prior action; (2) it must have been determined by a valid and final judgment; and (3) the determination must have been essential to the prior judgment. Some jurisdictions also require that the issue be “actually litigated.” Default judgments are generally not entitled to preclusive effect in those jurisdictions.

Most challenges to the use of a prior judgment center around whether the elements of a previously adjudicated state-law claim are the same as the elements required to establish a claim under § 523(a) (Factor 1); whether an issue was essential to a prior judgment where there were multiple claims decided in the prior judgment (Factor 4); and whether a default judgment without findings can be used at all. In jurisdictions that give default judgments preclusive effect, most courts are willing to look to the underlying state-court pleadings to evaluate the substance of the judgment where the default judgment lacks specific findings.

Often the best way to quickly and cost effectively evaluate whether a state-court judgment will be entitled to preclusive effect in a bankruptcy court (other than hiring an OFN attorney) is to search bankruptcy cases from the jurisdiction in which the state-court judgment was rendered. Chances are the bankruptcy courts have already researched the applicable state law and opined on whether a judgment on particular state-law claim, e.g., fraud, breach of fiduciary duty, etc., is sufficient to establish the corresponding claim under the Bankruptcy Code.

Finally, on a practical note – if you are seeking to use a state court judgment to establish a § 523(a) claim, don’t base your complaint entirely on the state-court judgment. Be sure to make sufficient, additional allegations to support a stand-alone claim. This way, if the bankruptcy court declines to give preclusive effect to the prior judgment, you can proceed with your complaint without filing an amended complaint.



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