The following is a case update written by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, analyzing a recent decision of interest:
A California bankruptcy court has held that a state court judgment previously entered against the Chapter 7 debtor, for secretly selling real property in which creditor had an unrecorded beneficial interest and diverting sales proceeds to her own use, is preclusive in creditor’s adversary proceeding to determine his debt nondischargeable. [In re Solario, 2020 WL 401792 (Bankr. E.D. Cal. Jan. 22, 2020)].
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While in a relationship with Kim Solario (Debtor) in 2008, Craig De Jong (Creditor) moved into Debtor’s residence in Escalon, California (Escalon Property), which was owned by Debtor’s mother. Creditor subsequently purchased an 80.02% interest in the Escalon Property but was not placed on record title.
In 2011, Creditor and Debtor ended their relationship and Creditor moved out of the Escalon Property. Thereafter, with the assistance of her mother among others, Debtor placed title to the Escalon Property in her name, sold it to a bona fide purchaser for value, and used the sales proceeds to purchase real property in Ripon, California (Ripon Property) for Debtor’s sole benefit. Debtor took these actions while falsely representing to Creditor that she would protect his interest in the Escalon Property and promptly pay him his share of any proceeds in the event of sale. Creditor subsequently sued Debtor, among others, in state court and in 2018 obtained a final judgment in the total amount of $460,465.47 against Debtor. Debtor filed for bankruptcy under Chapter 7 shortly thereafter.
Creditor filed an adversary proceeding to determine the entire judgment nondischargeable pursuant to 11 U.S.C. §§ 523(a)(2), 523(a)(4) and 523(a)(6), as arising from fraud, embezzlement or larceny, and willful and malicious conduct by Debtor. Creditor then filed a motion for summary judgment, requesting that the issues litigated in the state court action be afforded preclusive effect in the adversary proceeding based on the state court’s specific findings. Debtor opposed summary judgment, arguing that the state court made several legal and factual errors in entering the judgment. After a detailed analysis of the state court’s findings, the bankruptcy court granted summary judgment in Creditor’s favor.
The bankruptcy court began its analysis by rejecting outright Debtor’s efforts to set aside the state court’s findings in the judgment:
Because this court is ruling on this Motion for Summary Judgment applying the principles of Collateral Estoppel under the Doctrine of Res Judicata, there is no “evidentiary” or “factual” dispute. The State Court findings, conclusions, and judgment are what they state.
Defendant-Debtor’s argument is that the State Court was in error to grant Plaintiff the State Court Judgment and that this court should “correct” that error by allowing Defendant-Debtor to discharge those obligations as determined by the State Court . . . . This bankruptcy court does not sit as an appellate court to review and reverse a judgment of a California Superior Court.
Observing that “[t]he key inquiry in a motion for summary judgment is whether a genuine issue of material fact remains for trial” as set forth in FRCP 56(c), made applicable in adversary proceedings by Bankruptcy Rule 7056, the court noted that a state court judgment may be given preclusive effect in an action to except a debt from discharge. Applying the laws of the forum state (i.e., California) as stated in In re Harmon, 250 F.3d 1240, 1245 (9th Cir. 2001), the court opined that issue preclusion is only appropriate where five threshold factors are met:
(1) the judgment is final;
(2) the issue(s) are identical;
(3) the proceeding was actually litigated;
(4) the issue was necessarily decided in the former proceeding; and
(5) the parties are the same or were in privity.
Citing Harmon, the court also noted that its decision to apply issue preclusion is discretionary and subject to a determination of whether such preclusion would “further the public policies underlying the doctrine.” The court then reviewed the statutory grounds for nondischargeability pursuant to Bankruptcy Code Sections 523(a)(2), (a)(4) and (a)(6), respectively.
As noted by the court, a creditor must establish the following five elements to demonstrate “traditional fraud” under Section 523(a)(2)(A): (1) the debtor made representations; (2) that at the time he knew they were false; (3) that he made them with the intention and purpose of deceiving the creditor; (4) that the creditor justifiably relied on such representations; and (5) that the creditor sustained the alleged loss and damage as the proximate result of the misrepresentations having been made. The court also observed that section 523(a)(2) includes fraudulent conveyance schemes that would not include a “representation,” but are fraudulent under applicable non-bankruptcy law.
The court then concluded:
. . . . The State Court Judge determined that Defendant-Debtor engaged in a series of intentional fraudulent statements purporting to acknowledge Plaintiff’s 80.02% interest in the Escalon Property, . . . that Defendant-Debtor would protect Plaintiff’s interests, and that Defendant-Debtor would pay Plaintiff all of the proceeds relating to Plaintiff’s interests from a sale of the Escalon Property to Plaintiff. . . .
The State Court findings and conclusions establish a complex fraudulent scheme conducted by the Defendant-Debtor . . . to defraud Plaintiff of his proceeds from the sale of his interest in the Escalon Property. There was not merely an isolated misrepresentation, but a web of false promises and misrepresentations that Plaintiff justifiably relied upon to lull Plaintiff into a position where his [sale] proceeds … could then be diverted by Defendant-Debtor to her personal financial advantage.
Next, citing to the Supreme Court’s decision in Moore v. United States, 160 U.S. 268, 269 (1885), the court pointed out that embezzlement in the context of nondischargeability under 11 U.S.C. § 523(a)(4) has often been defined as “the fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come.” The court also acknowledged that for the purposes of 523(a)(4), a bankruptcy court is not bound by the state law definition of larceny, and instead may follow federal common law which defines larceny as “a felonious taking of another’s personal property with intent to convert it or deprive the owner of the same” (citing 4 Collier on Bankuptcy, ¶ 523.10 (15th ed. rev. 2008)).
Examining the state court’s findings, the court ruled that the judgment was nondischargeable pursuant to Bankruptcy Code section 523(a)(4):
Defendant-Debtor, by her fraud and misrepresentation obtained possession of Plaintiff’s 80.02% portion of the proceeds from the sale of the Escalon Property without his consent or authorization, and then, with the intention of stealing the Plaintiff’s portion of the proceeds for her own benefit, carried away [those] proceeds and used them to purchase the Ripon Property which Defendant-Debtor claimed to own and in which asserted Plaintiff had no interest. . . .
The Judgment . . . obligations . . . are nondischargeable pursuant to 11 U.S.C. § 523(a)(4) as having arisen from and ancillary to Defendant-Debtor committing larceny [and embezzlement] of Plaintiff’s [sic] proceeds from the sale of the Escalon Property.
Finally, the court pointed out that in order for a claim to be nondischargeable pursuant to section 523(a)(6), both willful and malicious injury must be established. The court discussed the injury standards in the Ninth Circuit:
The willful injury standard in this Circuit is met “only when the debtor has a subjective motive to inflict injury or when the debtor believes that the injury is substantially certain to result from his own conduct.” . . . . Whereas the malicious injury standard is satisfied by demonstrating that the injury “involves (1) a wrongful act, (2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or excuse.” [Internal citations omitted.]
Observing that an injury to intangible property rights is covered by section 523(a)(6)’s discharge exception, the court reasoned that conversion of another’s property without the owner’s knowledge or consent, done intentionally and without justification or excuse, is a willful and malicious injury within the meaning of the section. Analyzing California law, the court identified the elements of conversion as: “(a) plaintiff’s ownership or right to possession of personal property, (b) defendant’s disposition of property in a manner inconsistent with plaintiff’s property rights, and (c) resulting damages.” After carefully reviewing the state court’s findings, the court came to the following conclusion:
The Findings and Conclusions made in the State Court Action establish that Defendant-Debtor’s conduct was: (1) a wrongful act, (2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or excuse. . . . Defendant-Debtor had actual knowledge of Plaintiff’s 80.02% interest in the Escalon Property, acknowledged such interest to Plaintiff, and . . . without just cause or excuse, secretly sold the Escalon Property and then took Plaintiff’s proceeds . . . . She did this . . . contrary to the express representations by Defendant-Debtor that the proceeds from the sale of the Escalon Property for Plaintiff’s interests . . . would be paid to Plaintiff. . . .
. . . Defendant-Debtor conspired to and did convert Plaintiff’s property . . .  and her obligation under the State Court Judgment for such conversion is nondischargeable pursuant to 11 U.S.C. § 523(a)(6).
Although this decision is not a surprise, it offers substantial guidance to litigants. Where possible and practicable, parties should seek to include the trial court’s express, specific factual findings and conclusions of law in the judgment or statement of decision. As demonstrated by the bankruptcy court’s detailed analysis of the trial court’s findings here, when determining whether to give preclusive effect to a prior judgment, bankruptcy courts will likely carefully examine whether the prior court’s findings establish the elements of nondischageability pursuant to Section 523.
For discussions of cases involving similar issues, see:
- 2014-18 Comm. Fin. News. NL 36, When Co-Obligors are Jointly and Severally Liable, Creditor’s Judgment Against One Obligor Exonerates Non-Party Obligors Due to the Doctrine of Claim Preclusion.
- 2010 Comm. Fin. News 79, Borrower Claiming Invalidity of Nonjudicial Foreclosure is Collaterally Estopped by Stipulation for Judgment in Prior Unlawful Detainer Case Brought by Foreclosure Purchaser.
These materials were authored by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, a member of the ad hoc group and 2018-19 Chair of the CLA Business Law Section. Editorial contributions were made by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.