Karen Jacobus v. Michael J. Binns ( 2005 )

United States Bankruptcy Appellate Panel
FOR THE EIGHTH CIRCUIT
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No. 05-6008EM
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In re: *
*
Michael Binns and Mary Ann Binns, *
*
Debtors. *
*
*
Karen Jacobus, *
* Appeal from the United States
Plaintiff - Appellee, * Bankruptcy Court for the Eastern
* District of Missouri
*
v. *
*
Michael Binns and Mary Ann Binns, *
*
Defendant - Appellants. *
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Submitted: June 24, 2005
Filed: July 21, 2005
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Before DREHER, FEDERMAN, and VENTERS, Bankruptcy Judges.
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VENTERS, Bankruptcy Judge.
Debtor-Defendants Michael Binns and Mary Ann Binns (“Debtors”) appeal the
bankruptcy court’s order granting partial summary judgment in favor of Plaintiff
Karen Jacobus (“Plaintiff”) on her complaint to determine the dischargeability of a
debt under 11 U.S.C. § 523(a)(2)(A) and (B). The court granted summary judgment
under § 523(a)(2)(B) based on the application of collateral estoppel and the Rooker-
Feldman doctrine to a state court judgment against the Debtors, but denied summary
judgment under § 523(a)(2)(A). The Debtors timely appealed the court’s order as
well as the court’s subsequent denial of a motion to reconsider that order.
We have jurisdiction over this appeal from the final order of the bankruptcy
court. See 28 U.S.C. § 158(b). For the reasons set forth below, we reverse the court’s
order and remand the case for further proceedings consistent with this opinion.
I. STANDARD OF REVIEW
We review the court's entry of summary judgment de novo.1 A grant of
summary judgment must be reversed if there is a genuine issue of material fact
precluding judgment as a matter of law.2 The court’s application of collateral
estoppel and the Rooker-Feldman doctrine is also subject to de novo review. 3
II. BACKGROUND
On March 20, 2001, the Plaintiff initiated a lawsuit against the Debtors in the
Circuit Court for Randolph County, Illinois (“Circuit Court”). The lawsuit alleged,
inter alia, that the Debtors had defrauded the Plaintiff in connection with the sale of
1
Ahlborn v. Arkansas Department of Human Services, 397 F.3d 620, 622
(8th Cir. 2005).
2
Id. at 622-23.
3
Manion v. Nagin, 392 F.3d 294, 300 (8th Cir. 2004) (collateral estoppel);
Heartland Academy Community Church v. Waddle, 335 F.3d 684, 688-89 (8th Cir.
2003) (Rooker-Feldman doctrine).
2
their business to her by misrepresenting the value of the business, both orally and
through the production of written financial records. The Debtors were properly
served with process but chose not to appear or defend the lawsuit.4 On July 30, 2002,
the Circuit Court entered a judgment (“Default Judgment”) against the Debtors. The
Default Judgment awarded compensatory damages in the amount of $597,890, and
further stated, in pertinent part:
The Court Further Finds that with reference to the allegations in
the complaint, the Defendants’ failure to appear or otherwise answer the
pleadings, the Defendants’ admission that the gross sales amount of
Marilyn’s Hallmark in 1999 were [sic] intentionally overstated, that
Michael Binns provided false financial records to the Plaintiff to induce
the Plaintiff’s purchase of Marilyn’s Hallmark, the court assesses
$200,000 for punitive damages due to the intentional actions of fraud,
plus the costs of the suit in the amount of $1,116.75.5
The Debtors did not appeal or otherwise contest the Default Judgment.
The Debtors filed for protection under chapter 7 of the bankruptcy code on
December 11, 2003, and, on April 19, 2004, the Plaintiff initiated an adversary
proceeding against them to obtain a determination that the debt arising from the
Default Judgment is nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A) and (B).
The Plaintiff moved for summary judgment, and, on February 11, 2005, the court
ruled that the debt was not excepted from discharge as a matter of law under
§ 523(a)(2)(A), but that it was under § 523(a)(2)(B). The court determined that the
findings in the Default Judgment satisfied each of the elements of § 523(a)(2)(B), and
that those findings were binding on the court by the application of collateral estoppel
4
Admitted in paragraph 5 of the Debtors’ Answer to the Plaintiff’s
Complaint. Appellants’ Appendix, p. 9.
5
Appellants’ Appendix, p. 26.
3
and under the Rooker-Feldman doctrine. In subsequently denying the Debtors’
Motion to Reconsider, the court reiterated its position that the Rooker-Feldman
doctrine precluded the re-litigation of the Circuit Court’s finding of fraud.
III. DISCUSSION
The Debtors raise four issues in this appeal: (1) whether the findings in the
Default Judgment are entitled to collateral estoppel effect; (2) the extent of that effect,
i.e., whether the findings contained in the Default Judgment satisfy the requirements
of § 523(a)(2)(B); (3) whether the application of the Rooker-Feldman doctrine to the
Default Judgment supports a determination of nondischargeability under §
523(a)(2)(B); and (4) whether the punitive damages awarded in the Default Judgment
are nondischargeable. The Debtors maintain that the court erred when it answered
all of these questions in the affirmative.
Because we find that the Default Judgment is not entitled to collateral estoppel
effect and that the Rooker-Feldman doctrine does not apply under these
circumstances, issues (2) and (4) are moot.
Collateral Estoppel
The court correctly held that the preclusive effect of a state court judgment in
a subsequent federal case is determined by reference to state law.6
It has long been established that [28 U.S.C.] § 1738 does not allow
federal courts to employ their own rules of res judicata in determining
the effects of state judgments. Rather, it goes beyond the common law
6
See Marrese v. American Academy of Orthopaedic Surgeons, 470 U.S.
373, 380, 105 S.Ct. 1327, 1331, 84 L.Ed.2d 274 (1985); See also, Migra v. Warren
City School Dist. Board of Ed., 465 U.S. 75, 104 S.Ct. 892, 79 L.Ed.2d 56 (1984);
Kremer v. Chemical Construction Corp., 456 U.S. 461, 102 S.Ct. 1883, 72
L.Ed.2d 262 (1982).
4
and commands a federal court to accept the rules chosen by the state
from which the judgment was taken.7
But we disagree with the court’s conclusion that default judgments have collateral
estoppel effect under Illinois law.
Admittedly, Illinois law is not crystal clear on this issue,8 and the case on which
the court relied to conclude that collateral estoppel applies to default judgments could
be interpreted to support its conclusion. However, we believe it would be more
consistent with the current status of Illinois law to decline to give collateral estoppel
effect to default judgments.
The court relied on Sawyer v. Nelson.9 In Nelson, the Illinois Supreme Court
considered whether judgment creditors who had obtained a judgment in an action
based on trover and malice could collaterally estop the judgment debtor from
asserting in a later proceeding that malice was not the “gist” of that action.10 The
judgment in the prior action did not indicate on which count or cause of action it was
based. Accordingly, the Illinois Supreme Court held that the judgment debtor would
not be prevented from denying malice in the later proceeding because “it did not
appear on the face of the record and was not shown by extrinsic evidence that the
precise question at issue was raised and determined” in the earlier proceeding.11
7
Marrese, 470 U.S. at 380 (citing Kremer, 456 U.S. at 481-82).
8
See In re Nikitas, 2005 WL 1331211 (Bankr. N.D. Ill. 2005) (discussing
and exploring the equivocal status of Illinois law on the collateral estoppel issue).
9
43 N.W. 728 (Ill. 1896)
10
Id. at 728.
11
Id.5
Although the judgment in the prior action had been obtained by default, the
Nelson court did not specifically discuss the default nature of the prior judgment nor
how this circumstance would have affected its analysis of the plaintiff’s estoppel
argument had the judgment been unambiguous on its face. Standing alone, this
distinction might not be enough to convince us that Nelson does not, in fact, reflect
the state of Illinois law on this subject. But the precedential value of Nelson is
limited by a more recent (and apparently the only) Illinois Supreme Court case
directly addressing (albeit in dicta) the applicability of collateral estoppel to default
judgments.
In Housing Authority for LaSalle County v. Young Men’s Christian Association
of Ottawa,12 the Illinois Supreme Court noted without further comment that several
courts had determined that “default judgments have limited preclusive effects under
the doctrine of collateral estoppel.”13 (Despite the use of the word “limited,” all of the
cases cited by the YMCA court hold that collateral estoppel does not apply at all to
default judgments.) The YMCA court appears to have made that comment only to
emphasize a distinction between collateral estoppel and res judicata – a doctrine that
the YMCA court observed “always” follows from default judgments – but we find the
statement to be persuasive evidence of the Illinois Supreme Court’s position on the
collateral estoppel/default judgment issue, especially considering that it would be
highly unlikely that the court would recite these cases and a law review article
12
461 N.E.2d 959 (Ill. 1984) (“YMCA”).
13
Id. at 963. (citing Grip-Pak, Inc., v. Illinois Tool Works, Inc., 694 F.2d
466, 469 (7th Cir. 1982), In re McMillan, 579 F.2d 289, 292-93 (3rd Cir. 1978).
6
arguing for the abolition of collateral estoppel for default judgments14 if there was
Illinois Supreme Court precedent to the contrary.15
Therefore, we find that collateral estoppel does not apply to default judgments
under Illinois law. Consequently, the court’s grant of summary judgment, which was
based on the application of collateral estoppel to the Default Judgment, must be
reversed and the case remanded for a trial on the merits of the Plaintiff’s complaint.
We note that reversal would still be necessary here even if collateral estoppel
did apply to default judgments under Illinois law because the Circuit Court’s findings
in the Default Judgment are insufficient to establish a claim under § 523(a)(2)(B).
To prevail under § 523(a)(2)(B), the Plaintiff has to establish by a
preponderance of the evidence that the Debtors obtained money from her (1) by the
use of a statement in writing that was materially false; (2) that pertained to their
business’s financial condition; (3) on which she reasonably relied; and (4) that the
Debtors made with the intent to deceive the Plaintiff. 11 U.S.C. § 523(a)(2)(B).
14
Collateral Estoppel in Default Judgments: The Case for Abolition, 70
Columb. L. Rev. 522 (1970).
15
Cf., In re Paternity of Rogers III, 697 N.E.2d 1193, 1197 (Ill. App. Ct.
1998). The Plaintiff relies heavily on Rogers in support of her argument that
Illinois law gives collateral effect to default judgments, and the Plaintiff’s
argument is consistent with the decision of the Fifth Circuit Court of Appeals in In
re Caton, 157 F.3d 1026, 1028-29 (5th Cir. 1998), which also relied on Rogers to
reach the same conclusion. In re Caton, 157 F.3d 1026, 1028-29 (5th Cir. 1998).
We respectfully disagree with the Caton court, however, and find Rogers’s
statement that “the defensive use of collateral estoppel may be applied to bar
relitigation of [an] issue even where a default judgment has been entered provided
no injustice results from the application of the doctrine,” to be unpersuasive here
because it (1) comes from a lower Illinois court, (2) is dicta, and (3) is inapplicable
because this case involves an offensive use of collateral estoppel.
7
The Plaintiff relied on the Default Judgment to establish all of these elements
as a matter of law, but the Default Judgment only stated that the Debtors committed
“fraud,” without any findings or discussion of the reasonableness of the Plaintiff’s
reliance. The Plaintiff’s state law complaint was also silent on that issue.
Those omissions are critical because a finding of reasonable reliance cannot be
inferred from a bald finding of fraud under Illinois law. We have not found, nor have
the parties identified – in the pleadings or at oral argument – any clear statement of
Illinois law on the degree of reliance necessary to establish fraud. Some cases
indicate that reasonable reliance is required,16 while others only require a “right to
rely” or justifiable reliance.17 And at least one Illinois Supreme Court case has recited
the elements of fraud without any mention of the degree of reliance required.18
16
See, e.g., LaCola v. U.S. Sprint Communications, 946 F.2d 559, 567-68
(7th Cir. 2001) (finding that Illinois law requires reasonable reliance to establish
fraud); Roda v. Berko, 81 N.W.2d 912, 914 (Ill. 1948) (reliance must be
“reasonable”). See also, Rirapelli v. Advanced Equities, Inc., 813 N.E.2d 1138,
1142 (Ill. App. Ct. 2004) (stating that reasonable reliance is an element of Illinois
common law fraud and noting that the terms “justifiable” and “reasonable” with
regard to reliance in a fraud claim are used interchangeably).
17
See, e.g, AMPAT/Midwest, Inc. v. Illinois Tool Works, Inc., 896 F.2d
1035, 1041-42 (7th Cir. 1990) (concluding, after an extensive examination of
Illinois law, that a plaintiff’s reliance on a representation only need be justifiable
to support a cause of action for fraud); Soules v. General Motors Corp., 402
N.E.2d 599, 601 (Ill. 1980) (stating that reliance by the plaintiff must be “justified,
i.e., he must have had a right to rely”).
18
See, e.g., Bd. of Educ. of City of Chicago v. A, C and S, Inc., 546 N.E.2d
428, 452 (Ill. 1989).
8
Thus, in the absence of a definitive statement in Illinois law on the degree of
reliance required for fraud, the Circuit Court’s bald finding of fraud would be
insufficient to establish all of the elements of § 523(a)(2)(B).19
Rooker-Feldman Doctrine
The court’s order cannot be affirmed on the alternate basis cited for the court’s
decision – the Rooker-Feldman doctrine – because that doctrine is inapplicable here.
Noting that many courts have erroneously used the doctrine to augment preclusion
doctrines (such as the use proposed here), the Supreme Court recently clarified the
limited scope of the doctrine:20
The Rooker-Feldman doctrine, we hold today, is confined to cases
of the kind from which the doctrine acquired its name: cases brought by
state-court losers complaining of injuries caused by state-court
judgments rendered before the district court proceedings commenced
19
One possible source for the court’s error on this point is the court’s
reliance on O’Melveny & Myers v Federal Deposit Insurance Corporation, 512
U.S. 79, 114 S.Ct. 2048, 129 L.Ed.2d 67 (1994), for the proposition that the
definition of fraud under § 523(a)(2)(B) is determined by reference to state law.
O’Melveny & Myers does not stand for that proposition; rather, it holds that state
law controls state law causes of action, even though a governmental entity (the
FDIC) is the plaintiff. Moreover, unlike § 523(a)(2)(A), § 523(a)(2)(B) does not
rely on an extrinsic definition of fraud, or even use the term fraud. Instead,
§ 523(a)(2)(B) lists the elements necessary to establish the particular brand of
fraud for a determination of nondischargeability under that provision.
We note tangentially that the definition of fraud under § 523(a)(2)(A) is
determined by reference to general common law principles and is set forth in the
Supreme Court decision of Field v. Mans, 516 U.S. 59, 79 n. 9, 116 S.Ct. 437,
444, 133 L.Ed.2d 351 (1995).
20
Exxon Mobil Corp. v. Saudi Basic Indus. Corp., 125 S.Ct. 1517, 161
L.Ed.2d 454 (2005)
9
and inviting district court review and rejection of those judgments.
Rooker-Feldman does not otherwise override or supplant preclusion
doctrine or augment the circumscribed doctrines that allow federal
courts to stay or dismiss proceedings in deference to state-court actions.
Thus, this case simply does not present a situation covered by the Rooker-
Feldman doctrine – the state court losers (the Debtors) are not trying to obtain a
review and a rejection of the Default Judgment; to the contrary, the state court winner
(the Plaintiff) is trying to offensively use the Default Judgment to establish the basis
for a derivative claim, i.e., a determination of nondischargeability. And that use of
a state court judgment falls clearly within the ambit of the collateral estoppel doctrine.
Punitive Damages
As discussed above, the dischargeability of the punitive damage portion of the
Default Judgment is a moot issue in light of our rulings herein.21
IV. CONCLUSION
For the reasons stated above, we reverse the bankruptcy court’s order granting
summary judgment in favor of the Plaintiff on the complaint to determine the
dischargeability of a debt under 11 U.S.C. § 523(a)(2)(B). The case is remanded for
a trial on the merits of the Plaintiff’s complaint.
21
Additionally, it does not appear that the Debtors properly preserved this
argument for appeal.
10