Taking a Default Judgment to the Bankruptcy Court

• Publication year: 1998
• Pages: 67
• Citation: Vol. 27 No. 10 Pg. 67

27 Colo.Law. 67 Colorado Lawyer 1998.

1998, October, Pg. 67. Taking a Default Judgment to the Bankruptcy Court

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67

Vol. 27, No. 10, Pg. 67

The Colorado Lawyer
October 1998
Vol. 27, No. 10 [Page 67]

Specialty Law Columns
Business Law Newsletter
Taking a Default Judgment to the Bankruptcy Court
by Avi Rocklin, Kelly Lambert

Collateral estoppel, or issue preclusion, generally applies in bankruptcy cases. However, the application of the doctrine to prepetition state court default judgments in nondischarge cases raises several legal issues that courts have struggled to resolve. These issues include the difference between the elements of the doctrine of collateral estoppel as applied by state and federal courts, and the interplay of the doctrine with the full faith and credit statute

Proponents of the offensive use of collateral estoppel argue that full faith and credit requires that a bankruptcy court give a prepetition state court judgment preclusive effect in nondischargeability cases. Opponents of the use of the doctrine reply by asserting that such application of collateral estoppel contravenes congressional intent to repeal the full faith and credit statute by enacting the Bankruptcy Code

"Full Faith and Credit" Statute

Under 28 U.S.C. 1738 ("full faith and credit statute"), federal courts must accord full faith and credit to state court proceedings

It has long been established that 1738 does not allow federal courts to employ their own rules . . . in determining the effect of state judgments. Rather, it goes beyond the common law and commands a federal court to accept the rules chosen by the State from which the judgment is taken.1

The difficulty in applying the full faith and credit statute arises from the different state and federal standards for collateral estoppel. The application of collateral estoppel in federal courts requires that issues be "actually litigated."2 In contrast, many state courts require only that a party have a "full and fair opportunity" to litigate an issue.3 These differing standards create confusion in dischargeability proceedings.

U.S. Supreme Court Consideration

In Brown v. Felsen, the U.S. Supreme Court reviewed the preclusive effect of a state court consent judgment. It held that res judicata, or claim preclusion, does not apply in bankruptcy discharge proceedings.4 Twelve years later, in Grogan v. Garner, the Supreme Court ruled that collateral estoppel, or issue preclusion, does apply in dischargeability proceedings.5 However, the Grogan Court did not decide the narrower issue of whether collateral estoppel applies to default judgments. Moreover, the Court did not specifically address the issue of whether a state court default judgment should be subject to the state's rules for collateral estoppel or excepted from the application of full faith and credit in bankruptcy dischargeability proceedings.

In a non-bankruptcy case, Marrese v. American Academy of Orthopedic Surgeons, the Supreme Court refused to create an exception to full faith and credit when a party sought to apply preclusive effect to a state court judgment to a subsequent federal antitrust claim.6 The Court stated that "[t]he fact that the petitioners' antitrust claim is within the exclusive jurisdiction of the federal courts does not necessarily make section 1738 inapplicable to this case."7

In deciding whether to accord full faith and credit to a state court judgment, the Supreme Court instructed lower federal courts to consider the law of the state in which the judgment was entered.8 If the state court would not give preclusive effect to the judgment, the federal court should also decline to do so. If, however, the state court would give preclusive effect to the judgment (as Colorado state courts would do), the federal court also must give preclusive effect to the judgment unless Congress has expressly or implicitly created an exception to 1738.9 For the Colorado litigant holding a default judgment and attempting to achieve collateral estoppel in the bankruptcy court, the question therefore becomes whether the Bankruptcy Code implicitly repeals the requirements of 1738.

Interpretations of Congressional Intent

In 1970, the Bankruptcy Act was amended to vest exclusive jurisdiction for fraud exceptions to discharge in federal bankruptcy courts.10 The amendment was intended to curb the tactics of harassing creditors who pursued debtors in state court actions after a discharge was granted.

Prior to the 1970 amendments, many debtors had relied on the discharge without realizing the consequences of ignoring a state court proceeding. Congress' primary purpose in enacting the 1970 amendments was to prevent creditors from taking advantage of debtors who were unable to retain counsel because bankruptcy had stripped them of their assets. . . . A second primary purpose, however, was to take 17 claims [now 523(a) claims] away from state courts that seldom dealt with the federal bankruptcy laws and to give them to the bankruptcy court so that it could develop expertise in handling them.11

Since 1970, the federal courts have retained exclusive jurisdiction over the fraud exceptions to discharge in the 1978 adoption of the Bankruptcy Code,12 as well as in subsequent amendments.

Whether the exclusive jurisdiction policy behind 11 U.S.C 523(a) implicitly repeals 1738 is unclear. The...