Tuesday, February 16, 2010

Non-Dischargeable Default Judgments - An Opportunity and a Trap

An issue is presently pending before Judge Opperman in the United States Bankruptcy Court regarding the collateral estoppel effect of a “true default judgment” (ie- one entered after a defendant fails to appear or defend). Judge Opperman is expected to issue an opinion that will provide substantial guidance to area state court litigators in thinking ahead as to the potential that a default judgment may be entitled to collateral estoppel effect in a subsequent non-dischargability adversary proceeding.

The pending case before Judge Opperman is First American Title Company v Chambers, Adversary Proceeding # 09-02044-dob. There, the defendant was sued in Midland County Circuit Court on a three count complaint which included a fraud count along with counts for breach of warranty and contract. The defendant did not answer and a default judgment was entered via the standard SCAO form. The question is whether this form judgment can be deemed a determination that fraud was both “actually litigated” and “necessarily determined” by the state court and thus be afforded collateral estoppel effect.

The best advice for creditor attorneys seeking non-dischargability (at least until an opinion is issued by Judge Opperman) is to take an extra step when seeking a state court default judgment and obtain a judgment that specifies that fraud is the basis for both the liability and the damages. I believe it is very likely that a creditor will meet the collateral estoppel test by filing a motion for entry of a default judgment specifying that the default judgment is requested on the fraud count. Taking this action is likely to satisfy both the “actually litigated” and “necessarily determined” aspects of collateral estoppel.

For debtors, there is a large potential for being unwarily trapped in a non-dischargeable judgment. A debtor may not contest a case as they know they owe money. However, it is one thing to owe money and quite another to have engaged in fraudulent conduct that would justify the denial of a bankruptcy discharge.