An Overview of Collateral Estoppel in Adversary Proceedings
Collateral estoppel applies to adversary proceedings.
The doctrine of collateral estoppel or issue preclusion provides that “when an issue of ultimate fact has once been determined by a valid and final judgment, that issue cannot again be litigated between the same parties in any future lawsuit.” Dowling v. United States, 493 U.S. 342, 347 (1990) (citing Ashe v. Swenson, 397 U.S. 436 (1970)). This doctrine, precluding the relitigation of issues, is designed to promote judicial efficiency, protect parties from multiple lawsuits, and prevent inconsistent judgments. See Lytle v. Household Mfg. Inc., 494 U.S. 545, 553 (1990); Allen v. McCurry, 449 U.S. 90, 94 (1980); Montana v. United States, 440 U.S. 147, 153–54 (1979).
The United States Supreme Court and the Fifth Circuit have repeatedly held that the the application of collateral estoppel is appropriate in bankruptcy dischargeability proceedings. E.g., Grogan v. Garner, 498 U.S. 279 (1991); Matter of Schwager, 121 F.3d 177 (5th Cir. 1997); Matter of Gober, 100 F.3d 1195, 1201 (5th Cir. 1996); In re Garner, 56 F.3d 677, 681 (5th Cir. 1995); In re Shuler, 722 F.2d 1253, 1255 (5th Cir. 1984), cert. denied, 469 U.S. 817 (1984)). The preclusive effect given to state-court judgments under the doctrine of collateral estoppel is a function of the full faith and credit statute. See Matter of Schwager, 121 F.3d at 181 (citing In re Garner, 56 F.3d at 679 (5th Cir. 1995) (citing 28 U.S.C. § 1738 (”[J]udicial proceedings of any court of any [State] … shall have the same full faith and credit in every court within the United States … as they have by law or usage in the courts of such State … from which they are taken.”)). And, when a bankruptcy court gives full faith and credit to a state-court judgment, it applies the rules of collateral estoppel from that state. Matter of Miller, 156 F.3d 598, 601 (5th Cir. 1998).
If the issue was litigated in a Texas court, look to Texas law on the issue of collateral estoppel.
In Texas, a party seeking to invoke the doctrine of collateral estoppel must prove: (1) that the facts sought to be litigated in the second action (i.e., the adversary proceeding) were fully and fairly litigated in the prior action (i.e., the state-court lawsuit); (2) that those facts were essential to the judgment in the first action; and (3) that the parties were cast as adversaries in the first action. See Matter of Gober, 100 F.3d at 1201; In re Plunk, 481 F.3d 302, 307 (5th Cir. 2007); Matter of Caton, 157 F.3d 1026, 1028 (5th Cir. 1998); Matter of Schwager, 121 F.3d at 181; see also John G. & Marie Stella Kennedy Mem’l Found. v. Dewhurst, 90 S.W.3d 268 (Tex. 2002); Sysco Food Servs. Inc. v. Trapnell, 890 S.W.2d 796 (Tex. 1994); and Barr v. Resolution Trust Corp., 837 S.W. 2d 627 (Tex. 1992); Van Dyke v. Boswell, O’Toole, Davis & Pickering, 697 S.W.2d 381, 384 (Tex. 1985); Bonniwell v. Beech Aircraft Corp., 663 S.W.2d 816 (Tex. 1984). Although not a requirement under Texas law, the federal test for collateral estoppel includes a requirement that the issues in the prior action be “identical” to the issues in the second action. See In re Doyal, 09-10114-CAG, 2010 WL 796941 (Bankr. W.D. Tex. Mar. 4, 2010).
An issue is “actually litigated” for collateral estoppel purposes if the issue is “raised, contested by the parties, submitted for determination by the court, and determined.” In re Keaty, 397 F.3d 264, 272 (5th Cir. 2005); see also Matter of Pancake, 106 F.3d 1242, 1244 (5th Cir. 1997) (citing prior holdings: when a Texas court enters judgment “after conducting a hearing or trial at which the plaintiff meets his evidentiary burden, the issues raised therein are considered fully and fairly litigated.”); James Talcott, Inc. v. Allahabad Bank, Ltd., 444 F.2d 451, 459–460 (5th Cir. 1971) (stating that “where a question of fact is put in issue by the pleadings, and is submitted to the jury or other trier of facts for its determination, and is determined, that question of fact has been ‘actually litigated.’ ”).
One of the more prominent cases dealing with the application of collateral estoppel in the context of a Texas judgment is Matter of Pancake. In Pancake, the Texas trial court struck the defendant’s pleadings and entered a default judgment. 106 F.3d at 1243–44. The defendant (judgment-debtor) later filed for bankruptcy and the plaintiff (judgment-creditor) sought a ruling from the bankruptcy court that the judgment-debtor’s debt was non-dischargeable because it was reduced to judgment in the state court fraud suit. Id. at 1244.
After restating the elements of collateral estoppel under Texas law, the court addressed whether the fraud issues raised in the judgment-creditor’s pleadings were fully and fairly litigated. Id. at 1244–45. And, in its analysis, the court cited earlier Texas-law opinions, which held: “[W]here a court enters a default judgment after conducting a hearing or trial at which the plaintiff meets his evidentiary burden, the issues raised therein are considered fully and fairly litigated for collateral estoppel purposes.” Id. at 1244 (citing In re Garner, 56 F.3d 677 (5th Cir. 1995); Bonniwell v. Beech Aircraft Corp., 663 S.W.2d 816 (Tex. 1984)). “The critical inquiry,” explained the court, is “whether an issue was fully and fairly litigated.” Id. at 1244. The court then explained that if the judgment-creditor “can produce record evidence demonstrating that the state court conducted a hearing in which [it] was put to its evidentiary burden, collateral estoppel may be found to be appropriate.” Id. at 1245.
Advise state-court counsel on the use of disjunctive broad-form questions in the jury charge.
There is tension—and, for a judgment-creditor, potential frustration—when an issue under Texas law is submitted to a state-court jury in a way that is not also worded with an eye toward later scrutiny under federal bankruptcy law. Although the Texas Rules of Civil Procedure require that, “whenever feasible,” a cause be submitted “upon broad-form questions,” state-court trial counsel should be wary. Tex. R. Civ. P. 277. For example, the Fifth Circuit has held that the elements of a § 523(a)(2)(A) claim are “virtually identical” to the elements of a Texas state-law fraud claim, In re Sims, 479 B.R. 415, 420 (Bankr. S.D. Tex. 2012) subsequently aff’d, 13-20095, 2013 WL 6442132 (5th Cir. Dec. 10, 2013) (citing In re Park, 271 Fed.Appx. 398, 400 (5th Cir. 2008); In re Johnson, 9 F.3d 1547, 1993 WL 503410, at 3 (5th Cir. 1993)). However, the U.S. Supreme Court has made clear that fraud under section 523(a)(2)(A) requires justifiable (though not reasonable) reliance by the plaintiff. In re Steves, 2013 WL 3230125 (W.D. Tex., June 26, 2013) (citing Field v. Mans, 516 U.S. 59, 74–75 (1995)).
Another challenge is where the parties submit to the state-court jury disjunctive mens rea elements. The following four (non-Texas) cases illustrate this challenge:
In In re Jenkins, the debtor asserted that the bankruptcy court incorrectly applied collateral estoppel in finding a state court judgment was non-dischargeable because the trial court jury instruction was disjunctive, requiring “willful, fraudulent, or malicious” conduct, which meaningfully differs from the conjunctive finding of “willful and malicious” conduct, as is required by 523(a)(6). Jenkins v. IBD, Inc., 489 B.R. 587, 601 (D. Kan. 2013). The court agreed and held that the trial court’s disjunctive jury instruction permitted the jury to award punitive damages upon a finding of fraudulent conduct alone, which was not sufficient to support “willful and malicious” conduct under § 523(a)(6). Id. at 602. The court further held that the disjunctive language was not trivial; it “[was] fatally problematic.” Id. at 602. Ultimately, the court found that the bankruptcy court erred in applying collateral estoppel and remanded the case to the bankruptcy court to determine whether the debtor’s alleged conduct was “willful and malicious” for the purpose of dischargeability. Id. at 602.
Likewise, In re DeVoll, the plaintiff sought to have a state-court judgment declared non-dischargeable. 266 B.R. 81, 84 (Bankr. N.D. Tex. 2001). In the state court, exemplary damages were awarded based upon the jury’s finding that the “conduct of the [Debtor] in converting plaintiff’s property, [was] done willfully, maliciously, or with reckless disregard to the rights of the plaintiff.” Id. at 96. The bankruptcy court held that if it could have determined from the record before it that the jury had found that debtor willfully and maliciously converted plaintiff’s property, the court could have concluded that the judgment was non-dischargeable pursuant to section 523(a)(6). Id. at 96-97. (“Question No. 3 to the jury was constructed using the disjunctive ‘or,’ and there is no evidence in the record before this Court that indicates which construction the jury gave to the disjunctive alternatives—e.g., that the jury found that the conversion was done: willfully, maliciously, and with reckless disregard; only willfully; only maliciously; only with reckless disregard; only willfully and maliciously; etc.”). However, because the court could not determine which of the possible alternatives the jury actually found, the court held that it could not find that the requirements of section 523(a)(6) had been met and held that the state court judgment was not excepted from discharge pursuant to section 523(a)(6). Id. at 97.
A similar issue arose in Matter of Martin. In that case, the plaintiff sought to have punitive damages obtained in a separate federal court action declared non-dischargeable, and the plaintiff asserted that collateral estoppel was applicable. 130 B.R. 930, 946 (Bankr. N.D. Ill. 1991). However, the jury instructions provided that punitive damages could be awarded if the jury found that the debtor had acted “either maliciously or in a wanton, willful, or reckless disregard of … Sylvester’s rights.” Id. Accordingly, the jury instructions allowed the jury to award punitive damages even in the absence of a finding of malice or willfulness on the part of the debtor. Id. The court held that the jury instructions were “insufficient evidence as to whether the $ 70,025.79 in punitive damages was awarded because Debtor acted ‘maliciously and willfully,’ which would cause them to be nondischargeable, or because Debtor acted with ‘reckless disregard,’ which would not cause them to be nondischargeable.” Id. at 946–47. The court further held that this precluded the plaintiff from asserting the doctrine of collateral estoppel with regard to nondischargeability of his punitive damages. Id. at 947.
The fourth case is In re Bachinski, a bankruptcy court in the Southern District of Ohio held that “[a] judgment does not have issue-preclusive effect if it makes several findings of fact or conclusions of law in the disjunctive and at least one of the alternative findings is insufficient to support a nondischargeability judgment.” In re Bachinski, 393 B.R. 522, 539 (Bankr. S.D. Ohio 2008). The court further reasoned that “the alternatives that might otherwise have supported nondischargeability are not ‘necessary to the final judgment’ and issue preclusion, therefore, cannot apply.” Id.
Fortunately, Texas law recognizes the challenges arising from broad form submission in the context of collateral estoppel—and Texas policy is what the judgement creditor will want to emphasize to the bankruptcy court when seeking to invoke the doctrine of collateral estoppel. One illustrative Texas case is Fort Worth Hotel Ltd. P’ship v. Enserch Corp., 977 S.W.2d 746 (Tex. App.—Fort Worth 1998, no pet.).
In Enserch Corp., the judgment-debtor argued that “collateral estoppel should not have been applied because the [jury] did not make any specific finding that a particular act or omission was negligent and a proximate cause of the explosion.” Id. at 753. The Court disagreed, however, noting that “the [jury] found that [judgment-debtor’s] negligence proximately caused the explosion. [And] [u]nder our system of broad form submission of issues, it was not necessary for the trial court … to submit individual questions on the various allegations of negligence in order to obtain the verdict.” Id.
The court then explained that “the policies behind collateral estoppel would [not] be served by narrowing the doctrine [as argued by the judgment-debtor]. Judicial efficiency would suffer if all negligence cases decided under broad form submission were denied collateral estoppel effect.” Id. at 754.
Although Texas courts have favorably addressed collateral estoppel when the judgment-creditor’s verdict is submitted in broad form, state-court trial counsel should seek advice from a bankruptcy practitioner regarding the definitions, instructions, and/or separate questions to efficiently protect a resulting judgment from discharge in a later bankruptcy case.
In applying collateral estoppel, a bankruptcy court should look to the state-court record.
When a state-court jury returns a verdict on issues different from issues
to be litigated in a later (or concurrent) federal-court proceeding, collateral
estoppel may still apply. For example, in
J.M. Muniz, Inc. v. Mercantile Texas Credit Corp., 833 F.2d 541, 542 (5th Cir. 1987), the facts litigated in the first action
(a state action involving usury claims) were the applicable to the second
action (a federal action addressing RICO and National Bank Act violations).
It the later federal-court action, it is important to call the court’s
attention to those portions of the state-court record demonstrating facts
that have already been litigated.
In applying collateral estoppel to a case, a bankruptcy court may consider the state-court pleadings, jury charge, jury verdict, judgment, and other “portions of the record from the prior state case … .” Matter of Davis, 3 F.3d 113, 115 (5th Cir. 1993) (emphasis added) (also citing Jeffrey T. Ferriell, “The Preclusive Effect of State Court Decisions in Bankruptcy,” 58 Am.Bankr.L.J. 349, 360–61 (1984): “[I]t is doubted whether a full transcript should be required, or even whether it would be helpful, in most cases.”). Indeed, to allow a prior defendant to re-litigate the prior case would “do violence to judicial finality, a fundamental tenet of our judicial system.” Matter of Shuler, 722 F.2d 1253, 1256 (5th Cir. 1984). Instead, those facts that were “actually litigated and necessary to the decision in the [state-court action], and that are discernible from the [state-court] record of the case, should not be reopened absent a compelling reason to avoid injustice. …” Id.
Two recent opinions provide a good summary of collateral estoppel in the discharge/dischargeability context; these opinions also provide an excellent model for findings of fact and conclusions of law: In re Kim, 12-40813, 2013 WL 5376526 (Bankr. E.D. Tex. Sept. 25, 2013); In re Lay, 11-43085, 2013 WL 868558 (Bankr. E.D. Tex. Mar. 1, 2013).
What effect does a pending state-court appeal have on the application of collateral estoppel in the adversary proceeding?
Generally, a state court judgment on appeal is sufficiently final under Texas law for the purposes of collateral estoppel. See Cardwell v. Gurley, 4-10-CV-706, 2011 WL 6338813, n.2 (E.D. Tex. Dec. 19, 2011) aff’d sub nom. In re Cardwell, 487 Fed. Appx. 183 (5th Cir. 2012); In re Hudson, 182 B.R. 741, 746, n.4 (Bankr. N.D. Tex. 1995) aff’d sub nom. Matter of Hudson, 107 F.3d 355 (5th Cir. 1997) (citing Scurlock Oil Co. v. Smithwick, 724 S.W.2d 1, 6 (Tex. 1986)); In re Davenport, 353 B.R. 150, 192-93 (Bankr. S.D. Tex. 2006).