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Ruling in Prior Litigation Precludes Relitigation of Factual Issues in Bankruptcy Nondischargeable Adversary Proceeding

When a debtor files for bankruptcy, it is principally to obtain a fresh start and discharge of debts from creditors. But not all debts are dischargeable. The Bankruptcy Code lists 19 categories of nondischargeable debts, which Congress has determined are not dischargeable for public policy reasons.

Some debts are always nondischargeable, including certain taxes, child support, and court fines and penalties, to name a few. Others are not deemed automatically excepted from discharge, but can be when challenged by creditors. When a case is filed, bankruptcy courts set a deadline for creditors to raise nondischargeability issues, and creditors who wish to except a debt from discharge must initiate an adversary proceeding (by filing a complaint) setting forth the basis for the discharge objection. These types of debts include those obtained by fraud or false pretenses and those resulting from a tort, among others.

Issues related to the nondischargeability of a debt in a Chapter 7 bankruptcy were recently examined by the United States Bankruptcy Court for the Western District of Michigan. In the case, Trost v. Trost, Sherry Trost, the plaintiff, sought to except from discharge debt owed by the debtors (her stepson Zachary and his wife Kimberly) to her. The debt related to an ownership dispute involving videotapes and other memorabilia from a television show, Michigan Outdoors, that was created and operated by Fred Trost, Sherry's late husband and Zachary's father. Sherry alleged that she became the owner of these assets after Fred died, and that the debtors/defendants converted the property to their own use.

Before the bankruptcy was filed, Sherry sued Zachary and Kimberly in U.S. District Court, and obtained a judgment for common law conversion under Michigan law. Following two appeals which upheld the judgment, the debtors filed their Chapter 7 case, and Sherry initiated the adversary proceeding objecting to discharge of the debt. Both parties filed motions for summary judgment. Sherry argued that the prior federal court judgment finding debtors/defendants liable for conversion was entitled to preclusive effect under section 523(a)(6) of the Bankruptcy Code, which provides that debts incurred as a result of willful and malicious injury to another or to the property of another are nondischargeable. As explained by the court, "willfulness" under section 523(a)(6) requires "a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury." Sherry argued that the facts necessary to establish "willful and malicious injury" were actually litigated and necessarily determined in the district court litigation, and thus, based on the doctrine of "collateral estoppel," the debt should be excepted from discharge.

Collateral estoppel - an issue that often arises in nondischargeability actions - is a doctrine by which an earlier decision reached by a court in a lawsuit between the parties is conclusive as to the issues, therefore precluding them from being relitigated in subsequent proceedings involving the same parties. As explained by the court in Trost, the Sixth Circuit Court of Appeals has stated that precluding an issue in subsequent litigation "requires that the precise issue in the later proceedings have been raised in the prior proceeding, that the issue was actually litigated, and that the determination was necessary to the outcome."

The debtors/defendants argued that collateral estoppel should not apply because the "willful and malicious injury" standard required for the debt to be nondischargeable in bankruptcy differed from the standard for conversion under Michigan law (which the prior district court judgment was based on), and thus the precise factual issues required for nondischargeability were neither raised, nor necessary to the outcome, in the district court. In short, while section 523(a)(6) requires an intentional act, the debtors/defendants argued that common law conversion in Michigan can be committed "unwittingly."

While noting this technical distinction, the court ruled in favor of Sherry Trost, finding the debt nondischargeable. The court noted that there was no question the conversion claim had been "thoroughly – perhaps more than exhaustively – litigated."  The court stated that nothing in the record suggested that the debtors/defendants' conversion of property was "unwitting." Rather, the court found that the prior record proved that the debtors/defendants' actions were willful and malicious as required by section 523(a)(6).

Because collateral estoppel precludes relitigating "factual issues" that were actually determined in a prior action, and because the findings of fact in the previous actions clearly evidence the debtors/defendants willful and malicious actions that were without just cause or excuse, the debt was declared nondischargeable.
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Trost v. Trost, Adv. Proc. No. 13-80266 (Bankr. W.D. Mich., May 12, 2014).

Categories: Chapter 7

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 concentrates her practice in the areas of Bankruptcy, Finance, Collections, Real Estate, and Commercial Litigation. In the bankruptcy area she represents creditors and Chapter 7 Trustees in all aspects of bankruptcy. Patricia also represents small and mid-sized businesses to large corporations in multi-faceted litigation matters in state and federal court. Her work with financial institutions includes collections, loan workouts, foreclosures, receiverships and various complex banking and finance issues. 

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