Business Law

Chan v. Frazer (N.D. Cal.); Dean v. Reticulum Management, LLC (In re Dean) (Bankr. N.D. Tx)

The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:


Two recent decisions provide insight on how to litigate an action so that its outcome can be used to establish the nondischargeability of a debt in a subsequent bankruptcy. The cases are Chan v. Frazer, ___ B.R. ___, 2020 WL 5507545 (N.D. Cal., August 17, 2020) (“Chan”) and Dean v. Reticulum Management, LLC (In re Dean) ___ B.R. ___, 2020 WL 4519039 (Bankr. N.D. Tx., August 4, 2020) (“Dean”).

Chan can be found here.
Dean can be found here.

Chan – Facts:

The creditors/appellees sued the debtor/appellant prepetition in California Superior Court on a variety of claims, including fraud and breach fiduciary duty. After a bench trial, the Superior Court issued a Tentative Decision. At some point, the parties stipulated to sever the issue of punitive damages from the main proceeding for consideration later in the case. After extensive briefing on the Tentative, the Superior Court issued a Statement of Decision with detailed factual findings, ruling for the creditors on all claims except negligent misrepresentation and rejecting the debtor’s counterclaims. The Statement of Decision also awarded the creditors compensatory damages and set a status conference for punitive damage proceedings. However, the very next day, the debtor filed a Chapter 7 bankruptcy, thereby staying further proceedings in the Superior Court. About two months later, the Chapter 7 trustee and the creditors stipulated to modify the stay for the purpose of both the entry of judgment in the Superior Court action and to an amount of punitive damages. Less than a month later, the Superior Court entered a judgment that attached the Statement of Decision and awarded compensatory damages per the Statement of Decision and punitive damages per the stipulation. The debtor’s appeals failed. At that point, the judgment was final under California law (in some jurisdictions, not including California, a judgment is “final” notwithstanding an appeal unless a stay of judgment is granted).

The creditors then filed an adversary proceeding in the bankruptcy court objecting to the dischargeability of the judgment under section 523(a) (all statutory references are to the Bankruptcy Code). The parties made cross motions for summary judgment, with the creditors relying on collateral estoppel (issue preclusion) regarding the Superior Court proceedings to establish the facts needed to make the compensatory award nondischargeable and to support punitive damages. The Bankruptcy Court granted the creditors’ motion as to the compensatory damages, but denied it for punitive damages on the ground that it was the trustee, who was not in privity with the debtor, who stipulated to that award. The creditors then rejected the Bankruptcy Court’s offer to try the punitive damage issue in the adversary proceeding. The Bankruptcy Court therefore entered a judgment finding the compensatory damage award nondischargeable. The debtor appealed, arguing that the compensatory damage judgment was not entitled to collateral estoppel effect. Reviewing the collateral estoppel issue de novo, the District Court affirmed.


The District Court listed the following criteria for application of collateral estoppel: (1) the judgment relied on must be final under the law of the rendering jurisdiction; (2) the relevant factual issues to be established must be the same as those in the prior proceeding; (3) the issues must have been actually litigated in the former proceeding; (4) the issues must necessarily have been decided to support the earlier judgment; (5) the party to be charged in the present case must be the same party as in the earlier case (or in privity with the earlier party); and (6) assuming (1) through (5) are present, application of the collateral estoppel must be consistent with its underlying policies of protecting judicial integrity, avoiding harassing litigation, preventing collateral attack on earlier judgments and fostering judicial economy and efficiency.

The District Court rejected the debtor’s argument that the action was not litigated to a final judgment between the creditors and him (item (1) above) because the judgment was entered pursuant to the trustee/creditors stipulation rather than as a result of the debtor’s participation. In essence, the District Court reasoned that the trustee/creditors stipulation was not a substantive step, but a mere ministerial formality permitting entry of judgment based on the Statement of Decision. The debtor had fully participated in the substantive part of the litigation that resulted in the Statement of Decision. Later, the debtor had resumed his substantive participation by pursuing the post-judgment appeals. As the District Court wrote, “[t]he California Superior Court judgment as to liability and compensatory damages did not result from a stipulation, but instead, adopted and incorporated the . . . statement [sic] of Decision. . . .” The District Court also overruled the debtor’s alternative contention that there was no final judgment because the judgment was entered as a result of the trustee’s stipulation with the creditors, but the trustee was not a privy of the debtor. But looking to the same basic point it had just made, the District Court observed that up through the watershed Statement of Decision, the debtor actively participated in the litigation, with the trustee stipulation little more than a subsequent formality. In any case, with stay relief, a final judgment was entered, even though after the bankruptcy was filed.

Frazer – Facts:

The plaintiff sued the debtor and a co-defendant prepetition alleging various theories of fraud and negligent misrepresentation. The court sent the matter to arbitration. After taking considerable evidence and briefing, in a written interim award the arbitrators sustained the negligent misrepresentation claim but found that the plaintiff had failed to meet its burden of proof on its other claims or to overcome the co-defendants’ defenses to those claims. The award was interim because determination of fees, costs and related items remained. The arbitrators did not make any factual findings, although any of the parties could have asked for them after the interim award. At that point, the debtor filed a bankruptcy. Severing the plaintiff/debtor dispute, the arbitrators completed the plaintiff/codefendant arbitration and issued a final award between against the co‑defendant. The state court confirmed that final award.

The plaintiff filed a proof of claim in the bankruptcy. It also filed an adversary proceeding objecting to both the dischargeability of the debtor’s debt to it under section 523(a), focusing on the debtor’s intentional conduct and to the debtor’s discharge altogether under section 727. The debtor first unsuccessfully moved to dismiss on the grounds that the interim award for negligent misrepresentation that rejected the fraud-based claims barred the plaintiff’s complaint under the Rooker-Feldman doctrine that prohibits federal collateral attack on a judgment in a state court. The debtor’s problem was that there was no final judgment giving rise to Rooker-Feldman. The parties then made cross motions for partial summary judgment. Both parties relied on res judicata (claim preclusion) and collateral estoppel arising from the interim award between them and the final award between the plaintiff and co-defendant, both of which had rejected all claims except negligent misrepresentation.

The bankruptcy court rejected the motions. In doing so, it focused principally on the debtor’s arguments, but its rationales applied equally to the plaintiff’s. It first ruled that res judicata was inapplicable because under Supreme Court authority the discharge issues at stake are committed uniquely to the bankruptcy court; in effect, it was saying that there are no nonbankruptcy causes of action encompassing discharge issues such that deciding the one essentially decided the other. See Brown v. Felsen, 442 U.S. 127, 133-39 (1970). It next found that collateral estoppel could not arise from the interim award because the arbitrators made no factual findings in that ruling, thereby preventing the bankruptcy court from determining if the facts necessary to the discharge issues had been decided by the arbitrators. With that lack, the interim award could not be effectively final (in contrast to the Statement of Decision in Chan). That there was a 900-page record of the proceedings was no substitute for factual findings by the arbitrators necessary to the judgment based on that record. It also held that the interim award was not a final judgment as to the debtor/plaintiff dispute. That the interim award as to the plaintiff/co-defendant dispute later became a final judgment did not invoke collateral estoppel because the debtor and co-defendant had pointed fingers at each other to explain the plaintiff’s injury meant that there was no privity between them; their interests were not identical. Thus, a result as to one would not bind the other. Finally, the bankruptcy court declined to exercise its discretion to rely on the arbitral proceedings for collateral estoppel effect against the plaintiff because of the lack of specific findings and because the plaintiff may have chosen to simplify its presentation to the arbitrators to focus on the easier-to-prove negligent misrepresentation; in other words, it may have lacked the incentive to establish the fraudulent conduct in that proceeding that the adversary proceeding required. Although the bankruptcy court’s memorandum opinion did not say so, its rulings meant that the matter had to be tried.

Author’s Comment:

The decision in Chan is correct. Procedurally, what happened in the bankruptcy leading to entry of the judgment is no different in essence than the common practice of granting stay relief to allow liquidation of a claim in another forum for purposes of establishing what claim, if any, the creditor has in the bankruptcy. Indeed, the outcome would be the same had the creditors successfully sought stay relief on their own to complete the arbitration to judgment. The trustee’s stipulation is a non-event for collateral estoppel purposes. Equally, Dean is right. Although there was a final judgment before the bankruptcy, unlike in Chan, it was not supported by the necessary factual findings by the trial court.

The two opinions illustrate a fundamental point about litigating nonbankruptcy actions with an eye to possible use in a subsequent bankruptcy case to determine a matter by collateral estoppel. Not only must there be a final judgment, but it must be supported with specific factual findings that alone would support the outcome a party later wants in the bankruptcy court under applicable bankruptcy law. Each party should base its prosecution or defense strategies on what facts the plaintiff would need to show were the action a nondischargeability case and then obtain a ruling by the trial court that specifies those facts in its favor. In a sense, parties should pre-try before the trial court what may become a nondischargeability action if bankruptcy may be looming. Both aims were satisfied for the plaintiff/creditors in Chan and neither for either party in Frazer. Another point is that parties in such litigation should keep an eye on the possibility of any privity issues; as it was in Dean, the doctrine can be very strictly interpreted to mean literal identity of interests, with no incompatibility at all between the parties to be characterized as privies. It is also worth noting that an arbitration can underwrite a final judgment, as in Chan if approved by a court of competent jurisdiction. Finally the presence of policy considerations, discretion whether to apply collateral estoppel and the somewhat opaque issue of privity can provide a court with wide latitude to reach what it thinks is a just result, so a party should be thinking about how it can manipulate proceedings to steer those considerations in its direction.

These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), 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.

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